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When the Party’s OverThe Politics of Fiscal Squeeze in Perspective$

Christopher Hood, David Heald, and Rozana Himaz

Print publication date: 2014

Print ISBN-13: 9780197265734

Published to University Press Scholarship Online: May 2015

DOI: 10.5871/bacad/9780197265734.001.0001

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date: 03 June 2020

Fiscal Squeeze in Germany:

Fiscal Squeeze in Germany:

Drifting Away from the Politics of the Switching Yard?

(p.161) 8 Fiscal Squeeze in Germany
When the Party’s Over

Martin Lodge

Kai Wegrich

British Academy

Abstract and Keywords

Decisive fiscal squeeze might surprise observers of the German political system, insofar as party political dynamics, welfare state complexity, and intergovernmental financial arrangements are commonly said to inhibit decisive reforms. This chapter traces the fiscal squeeze carried out in post-unification Germany in the 1990s and 2000s and highlights how the politics of fiscal squeeze had damaging political consequences for the Social Democratic Party. Squeeze at the federal government level was largely about ‘natural wastage’ in staff numbers and targeted cutbacks. The welfare state witnessed considerable reform as a result of cumulating pressures resulting from unification, triggering significant political consequences. Finally, squeezing at the level of the intergovernmental fiscal transfers reflected attempts to contain fiscal pressures on local governments, and wider pressures within the system of German federalism, leading to the creation of a constitutional ‘debt brake’ on public budgets.

Keywords:   Germany, post-unification, fiscal squeeze, welfare reform, federalism, drift, debt brake, Social Democratic Party

IN THE LATE 1990s GERMANY WAS DESCRIBED AS THE ‘sick man of the Euro’ (The Economist, 3 June 1999). Germany was represented as a fossilised corporatist system that was saddled with high labour costs, a political system that was unable to reform, and a welfare state that was increasingly creaking at its seams. The political need to transfer resources to eastern Germany, especially during the first half of the 1990s, meant that the inflation-shy Bundesbank imposed high interest rates that were said to stifle economic development in the West. The transfers (approximately €1,600bn until 20091) added tax burdens to the West and were blamed for destabilising the overall German economy.2 During the early 2000s, Germany cheated on the provisions of the euro’s Stability and Growth Pact. Academic observers shared the view of a stagnating system: ‘Given Germany’s painfully slow, incremental process of political and economic change, for some time there is likely to be a growing gap between rapid problem accumulation and slow problem-solving in existing political and economic institutions’ (Kitschelt & Streeck 2003: 2).

As the Noughties turned into the Teens, the headlines changed: Germany was praised for its reforms that had kept its public finances in order, reduced real wages and seen a fall in unemployment rates. Germany witnessed export-led economic growth at time when most other European economies were, at best, stagnating (The Economist, 15 June 2013). Academic observers, (p.162) typical of stereotype, were less impressed, but did note considerable fiscal consolidation-driven change beneath the surface of existing welfare state institutions (see Howarth & Rommerskirchen 2013; Palier & Thelen 2010; Streeck & Mertens 2010).

Apparently successful fiscal squeezing should come as a surprise to observers of the German political system for at least three reasons. First, the German system of executive and cooperative federalism has long been seen as incapable of reform. Due to decision rules that require extra-large majorities to initiate or change concurrent intergovernmental policies, a ‘joint decision trap’ is said to exist: the pivotal voting power of actors likely to lose from cutting back programmes prohibits policy adaptation to changing circumstances (Scharpf 1988). Thus, the growth of federal spending programmes is difficult to reverse as veto-players in the political system are able to block any reform. Outright reform blockage was particularly noticeable during the final term of the CDU–FDP administration (1994–98; the coalition had been initially established in 1982) under Helmut Kohl, where the second chamber, the Bundesrat, opposed major reform attempts as it was dominated by Social Democrat-led governments.3 This contrasted with earlier periods when individual Land governments could be ‘bought off’ in intergovernmental negotiations. In those areas where the centre-right government managed to introduce cost-containing elements (such as the introduction of a ‘demographic factor’ in pensions policy), the subsequent SPD–Green government (1998–2005) initially reversed or suspended these measures. More generally, despite attempts at reforming the system of fiscal federalism, the economic diversity of the Länder continued to increase, with economically declining areas faring considerably worse than more prosperous (southern) Lander. In addition, redistribution towards eastern Germany added a further dimension. Similarly, economic disparity explained why some local governments were facing considerable financial constraints given decreasing autonomous tax income and increasing demands for social benefit payments, whereas others were hardly affected.

Second, the German system of public finances has been characterised as a Verschiebebahnhof (a switching yard). The idea of the ‘switching yard’ suggests that German policymakers have used budgetary and organisational fragmentation as well as the federal system to shift around expenditures and revenues in order to fix short-term problems in non-transparent ways. (p.163) Especially when it came to social matters, changes in taxes at the federal level shifted problems to areas where local governments had to pick up the pieces in administrative cost terms. In other words, one aspect of the politics of the federal switching yard involved the federal level (often in agreement with Land governments) burdening local governments with increasing financial obligations. Local governments responded by privatising and closing public services, by reducing investment into capital assets, and by engaging in derivatives markets. The latter came unstuck during the financial crisis of 2008, causing local governments to lose further discretion in their expenditures. Thus, local governments argued that their financial room for manoeuvre was increasingly constrained. Indeed, some local governments were under ‘special supervision’ from their Land government as they declared themselves unable to run a balanced budget as required constitutionally.

Third, the most prominent switching yard has traditionally been the German welfare state (Trampusch 2009). The complex nature of an insurance-based system coupled with a variety of schemes and budgets allowed policymakers to shuffle money around in order to fill short-term needs in non-transparent and blame-avoiding ways without having to address long-term developments.

However, from the viewpoint of 2014, all three of these blockages appear in a different light.

First, despite much scepticism and criticism, the reforms of the federal system included a Schuldenbremse (literally ‘debt brake’, but in the following translated as ‘debt ceiling’). This rule-based constitutional provision required the federal and the Land governments to operate on the principle of balanced budgets. It was agreed in 2009 and replaced an earlier constitutional provision that had allowed for broader discretion.

Second, the intergovernmental switching yard paid increasing attention to local governments’ claim that their financial position had been destabilised. Tasks that previously had been jointly or concurrently ‘owned’ by both federal and Land governments were returned to Land sovereignty. Furthermore, budgetary reforms paid increasing attention to relieving the financial plight of local governments.

Third, the financial pressures arising from the welfare state led to considerable labour market reforms in the mid-2000s (the so-called Hartz IV Reforms, discussed below). Partly these pressures arose from the continued need to subsidise the activities of the Employment Agency (then called Bundesanstalt fur Arbeit). Partly, and more importantly, changes occurred because of the dire financial situations of many local governments.

The German case is an example of a domestic crisis that led to internal reforms; furthermore, it is a case that evolved over three decades and affected different aspects of the switching yard at different points. For connoisseurs of (p.164) the German political system, the politics of fiscal squeeze represent either a story that emphasises the ‘gridlock’ of the political system as a mechanism that will lead to inevitable decline, or one that highlights the inherent flexibilities in the system that allows for incremental reform (Behnke & Benz 2009: 224). Such a pattern of build-up of cost pressures, incremental reforms to achieve cost containment, and subsequent pressures arising from these measures in other areas of this interlocking political system makes it difficult to suggest that squeezing went through distinct periods (for such an approach, see Breuer et al. 2011). In terms of consequences for political actors, fiscal squeezing was significant. The splits within the SPD over welfare state reforms and the need for the Red–Green coalition to rule in a continuous informal grand coalition with the CDU via the latter’s majority in the Bundesrat from 2002 onwards (after a series of disastrous SPD election results at the Land levels), motivated then Chancellor Schröder to engineer an early election in 2005 under constitutionally questionable circumstances (Reutter 2012). The divisions within the SPD led to the rise of a socialist party (WASG: Arbeit und Soziale Gerechtigkeit—Die Wahlalternative) in 2004. This party, containing some former prominent Social Democrats (including Oskar Lafontaine, formerly SPD Land prime minister, federal finance minister and chairperson, and chancellor candidate in 1990), eventually merged with the remnants of the former East German governing Communist Party to form Die Linke. That party gained considerable success at the ballot box in western parts of Germany (it had maintained its electoral significance in the eastern parts).

The inconclusive 2005 election led to the formation of a grand coalition under Chancellor Merkel. This grand coalition further contributed to the rise of Die Linke and, subsequently, to the SPD’s worst election result in post-1945 Germany in the 2009 general election.4 In addition, the grand coalition also facilitated the liberal party, the FDP, which campaigned on an ‘anti-state’ platform (until it eventually entered government with the CDU after the 2009 elections). The FDP represented a ‘protest vote’ of disenchanted Christian Democrat voters who wanted not just to signal their dislike of the (median-voter-seeking) ‘social democratisation’ of their party, but also to pave the way for a CDU–FDP coalition. The Fáilure of the FDP to enter the Bundestag after the 2013 election was largely due to its vote migrating mostly to the CDU or the anti-euro protest party, the AfD (Alternative fur Deutschland). The opposition parties (SPD, Green and Linke) either lost or only gained (p.165) moderately, thereby suggesting an electorate that was keen on austerity in the domestic setting, and, most of all, austerity in the Eurozone. In other words, the politics of financial consolidation in post-unification Germany had considerable political implications, both in the way in which financial pressures at different points in the system triggered reforms, and in the way in which these reforms informed electoral politics.

The following looks first at the aggregate developments in terms of the size of the German state. It then illustrates developments in expenditure across federal ministries over the period 1991–2013 to investigate ‘who lost where and how’. Finally, this paper turns to political reforms that were driven by concerns about fiscal consolidation.

The Overall Picture

Figure 8.1 notes a degree of consolidation after a temporary peak in 1995.5 That peak can be explained by the one-off incorporation into the general budget of the Treuhandanstalt, the agency responsible for privatising the eastern Germany economy. However, even without this peak, there is an approximately 4 percentage points decline, mostly falling on public expenditure rather than the social insurance-related expenditures of the welfare state. The late 1990s also benefited from a mild economic upturn. Figure 8.1 represents annual developments from 1990 onwards, and five-year datapoints beforehand. This figure also points to one essential aspect, namely the relative shares of public expenditures as separated between the share of governmental spending and the share of spending by social insurance schemes. The fluctuation in the late 2000s reflects the federal government’s response to the financial crisis.

In terms of share in overall debt, the patterns have been broadly stable over time. The federal government was responsible for about 60 per cent of the overall debt (62.5 per cent in 2007), the Länder accounted for about a third (32.1 per cent in 2007), and local governments for around 5 per cent (5.4 per cent in 2007). For local governments and Land governments revenue raising was not a major consideration when faced with calls for financial consolidation. This was because of their limited revenue-raising autonomy. Land governments could only raise approximately 8 per cent of tax on their own, local governments even less. Land governments were staff-heavy in terms of their expenditure and therefore had to rely on privatisation, outsourcing and related wheezes to reduce public expenditures. To increase revenue in any significant way, Land governments had to rely on negotiations (p.166)

Fiscal Squeeze in Germany:Drifting Away from the Politics of the Switching Yard?

Figure 8.1. Share of public expenditure as % GDP, Germany 1960–2010.

Source: Official budgetary documentation, Federal Ministry of Finance.

Fiscal Squeeze in Germany:Drifting Away from the Politics of the Switching Yard?

Figure 8.2. Revenue as % GDP, Germany 1960–2012.

Source: Official budgetary documentation, Federal Ministry of Finance.

with the federal government to increase their share of revenue drawn from federal taxation.

Figure 8.2 points to the contribution of tax and social insurance revenue as percentage of GDP. It highlights a politically engineered flatlining around 40 per cent since the 2000s, after a rise in the 1970s and 1980s. The rise in revenues is largely a result of increases in social insurance contributions (as noted below, largely because of rising unemployment). These contributions declined from 2000, whereas the tax income has remained broadly stable. Within the tax system, the period since 1990 has been characterised by a decline in direct and corporate tax and a rise in indirect taxation (such as value added tax (from 14 to 19 per cent), and taxes on tobacco and mineral (p.167)

Fiscal Squeeze in Germany:Drifting Away from the Politics of the Switching Yard?

Figure 8.3. Share of particular expenditures in federal budget as %, Germany 1975–2010.

Source: Official budgetary documentation, Federal Ministry of Finance.

oil-related products) (BMF 2012). Again, the pre-1990 data are in five-yearly steps, while the data from 1990 reflect annual changes.

When major spending cutbacks are proposed, one of the key expectations is that squeezing will focus on large-expenditure items rather than ongoing running costs. Figure 8.3 looks at the three key federal expenditure items in terms of their share in the overall federal budget. It shows a decline in the share of personnel cost over the years, especially since unification. The period 1975–2005 is illustrated in five-year steps, and on an annual basis after 2005. Significantly, the patterns point to some variation in the share of investment-related expenditures, especially the reduction in the share of investment expenditure in the second half of the 2000s. The decline in share of interest payments has, partly, to do with the low-interest climate post-financial crisis and the overall reduction in state debt. Partly it reflects the growth in investment expenditure in response to the financial crisis in the late 2000s.

The overall picture points to a degree of containment in certain parts of the budget, broad stability in the overall ‘state quota’, but also some degree of incremental decline after a peak in the early 1990s which was caused by unification. This mixed picture is also illustrated when focusing solely on federal departments. The biggest loser among federal departments is defence, whereas ministries involved in social security-related expenditures gain. The growth in social expenditure reflected the shift of expenditures away from insurance schemes to direct federal subsidies. The agriculture portfolio witnessed a considerable reduction in transfer payments. In contrast, other ministries, such as environment, gain. The latter gains largely because of a growing emphasis on renewable energy as well as a growth in the budget for research and education. More broadly, there is also a broad growth in the share of mandatory over discretionary expenditures. As noted by Streeck & Mertens (2010: 16), the percentage of discretionary expenditures declined from 39.6 per cent in 1970 (p.168) to 21.5 per cent in 2008. This could be largely explained by debt payments and the rise in social security payments.

Fiscal Squeeze at the Centre?

Among these developments which affected overall public spending, certain trends within executive government are noticeable. Post-unification, staff numbers were slimmed down. As redundancies were unlawful, this largely operated through a process of ‘natural wastage’: at most every second position was replaced. Departments relied on short-term positions staffed from civil service ‘pools’. Squeezing also raised issues about how programmes could be administered. Politicians did agree on spending programmes for particular initiatives, but often ‘forgot’ to add administrative costs to their spending commitments. This partly encouraged the recruitment of external consultants for the running of programmes. Similar trends occurred at the Land level, while privatisation, corporatisation, and outsourcing of public services were particularly widespread in local government. Table 8.1 illustrates aggregate staff numbers according to different ranks. It also distinguishes between (a) staff numbers in federal departments (and the small number of staff working for parliament and the federal president), and (b) subordinate federal units. Despite increases in the years 2008–14, the overall trend since unification is one of ongoing decrease.

Across the federal bureaucracy running costs were to be capped, if not reduced. Again, this raised problems among those agencies that were exposed to fluctuations in, for example, electricity prices. One of the primary ways to cut staff costs, apart from not replacing retiring staff (leading to a rapid ageing

Table 8.1. Staff numbers in the German Federal Administration.


Higher posts

























































Note: B-posts represent senior civil service positions; higher posts are A16–A13; a denotes staff in federal departments; b denotes staff in subordinate federal units.

Source: BT11/700 (1988), BT12/1000 (1992), BT13/2000 (1996), BT14/1400 (2000), BT15/1500 (2004), http://www.bundesfinanzministerium.de/bundeshaushalt2008/html/index.html (2008), BT17/14300 (2014).

(p.169) of the civil servant population), was to cut additional payments. In 2002, civil service rewards were changed, in that two extra payments (holiday and Christmas pay) were combined and their amount was reduced from one month’s salary to 84 per cent (63 per cent in eastern Germany). This was reduced further between 2005 and 2010 (to 60 per cent). In terms of actual staff expenditure reductions, the ministry of defence witnessed the largest fall. The other two ‘losers’ were the ministry of finance and the ministry of the interior. All other ministries witnessed a pattern of stable decline due to the policy of ‘natural wastage’.

Within the federal government, some different trends in altering spending priorities can be distinguished. One is the trend to reduce subsidy payments to particular industries, starting in 2004. Targets included, for example, subsidy payments for coal production once the traditional system that relied on price support (the ‘Kohlepfennig’) had been turned into a tax-funded subsidy programme. Other subsidy schemes that relied on co-funding with Land governments also suffered, especially as the Länder proved less willing to continue (and capable of continuing) co-financing arrangements.

The second theme was a system of targeted squeezing. Once the federal cabinet had agreed on an overall spending reduction target, this target was translated into targets for individual departments. The specific reduction target depended on a number of factors, one being the extent to which spending commitments were mandatory (due to legislative commitments) or not. A second factor influencing the intensity of the cutback requirements was whether the spending commitment reflected overall government priorities (namely, renewable energy, education and research). The result was that those ministries, such as the federal economics ministry, suffered more cutbacks because of their spending profile. A third theme was the reduction in investment in the mid-2000s. Whilst not directly noticeable in the investment-related expenditures of the federal departments themselves, the reduction in investment spending was more prominent in the wider departmental budgets.

Similar trends were noticeable at the Land level. The immediate period following unification was characterised by over-optimistic projections as to future economic and demographic growth profiles. By the mid-1990s, a concern with fiscal consolidation was noticeable. There was little scope to raise revenues, and staff costs represented a far higher share of public expenditure at the Land than the federal level. This meant that there was little leverage to reduce expenditure levels quickly. As at the federal level, staff costs were reduced through staff non-replacement. This meant that some Land administrations were slimmed down: for example, Hamburg (a city state) reduced its staff numbers by 30 per cent throughout the 1990s. Berlin cut its staff by 50 per cent over the period of 1991 to 2011 (through a hiring freeze) and cut wages by 10 per cent. Brandenburg reduced its administrative staff by 8,000 (p.170) over a period of five years (1999–2004). As at the federal level, budgeting was conducted through the development of targets. More coercive means were applied where departments proved unwilling to squeeze. One such means was the ‘lawnmower’ approach, which required all budget lines to be cut by the same amount. At the same time, civil servants engaged in budget negotiations at the federal and Land level noted how spending departments increasingly showed a united front when seeking to challenge the finance ministry.

In general, therefore, the politics of public spending among federal and Land executive governments did not change fundamentally; however, it took place in a context in which staffing levels were slimmed down, and where there was an increasing willingness to tackle long-established subsidy payments. This occurred not just by capping spending, but also in the way in which spending was financed, with certain items moving from ‘special budgets’ to direct tax-funded budget lines.

Welfare State

Whereas expenditure consolidation by federal or Land ministries attracted little public attention, attempts to contain costs in different areas of the welfare state had considerable political consequences. Wage-based contributions to statutory insurance schemes have been a hallmark of the German welfare system. These schemes involved the areas of unemployment, health and pensions. In the 1990s, a further component, an insurance-based mechanism to finance old age care, was added to the system. As an insurance-based system, welfare benefits were financed from contributions by employers and employees. So-called contribution rates (i.e. the overall amount paid by employers and employees) were therefore critical in determining the overall cost of, and demand for, labour. They therefore were seen as directly related to the costs of unemployment (for extensive discussion, see Trampusch 2009).

The ability to use the various insurance-based schemes as a ‘switching yard’ meant that policymakers could utilise the welfare state to avoid difficult choices. From the 1980s, the politics of economic reform started to focus on the aggregate employer and employee contribution rate as a cause for rising unemployment. Starting from a rate of 25 per cent of gross income throughout the 1960s, contribution rates steadily increased from the mid-1970s onwards and, even more prominently, throughout the 1980s. This was largely attributable to rising unemployment. However, it was not just rising levels of unemployment that accounted for the growth in indirect labour costs, it was the actual policy response. That is, a subsidised ‘early retirement’ policy was (p.171) established in order to reduce official unemployment rates. This early retirement policy pleased (nearly) all relevant constituencies: companies could cut down their workforces, trade unions protected their members from less generous redundancy packages, and the federal government could claim to be keeping unemployment rates down. However, as this scheme was financed through the unemployment and pension system, the social security contribution rates needed to be increased by 3.7 per cent over the 1980s (from 32.2 per cent in 1980 to 35.9 per cent in 1989). Some squeezing did take place, partly through cutbacks in eligibility (such as means-testing) and through rises in contributions. For example, in the area of pensions, there was a switch in adjusting pension levels by moving from a system that traced increases in the gross to increases in the net wage in 1989, thereby leading to reduced increases in pension payments. Furthermore, age of retirement provisions was equalised between women and men. There was, however, also some selective welfare state expansion, especially regarding family-related measures (Leibfried & Obinger 2003).

The economic and social impact of unification added considerable pressure on the German welfare state—and undermined the earlier, small-scale cost-containment measures. By the mid-1990s, the contribution rate had increased to 40 per cent of gross wages. Much of the social adjustment cost was shouldered by the insurance system rather than through tax-financed public expenditures. This conveniently reduced the potential tax burden and therefore also ensured that the CDU’s election promise not to raise taxes was not directly broken. The early retirement device was widely applied to address the collapse of the eastern German economy.6 This policy, however, proved increasingly unsustainable and was identified as a ‘vicious cycle’ (Streeck 2009: 60): contribution rates added to the non-wage labour costs, increasing rates were seen to trigger further growth in unemployment, and rising unemployment rates required even higher contribution rates.

In response, the then CDU–FDP government committed itself to keeping the contribution rate below 40 per cent. This meant that federal budgetary subsidies were used to beef up the affected insurance schemes. As a result, the federal budget became increasingly preoccupied by the concerns of the welfare state: by the early 2000s, social security was consuming approximately 35 per cent of the federal budget. The alternative, benefit cuts, was seen as politically unpalatable. Table 8.2 provides an overview of developments from (p.172)

Table 8.2. Monthly pay-as-you-go rates contributing to German social insurance system (%).

Health insurance

Pension fund

Old age care

Unemployment insurance




























































































Source: Official budgetary documentation, Federal Ministry of Finance.

1990. Figure 8.4 shows the increasing involvement of the federal government in the financing of the pension system alone.

Cost-containing efforts from the 1990s onwards led to a different type of switching-yard politics. It was the switching itself that started to cause additional ‘pain’, whereas in the past the switching around was largely used to alleviate temporary inconvenience. For example, the incremental reforms of pension and unemployment benefit schemes throughout the 1990s sought to contain, if not reduce, benefits. Tougher eligibility criteria and reduced generosity in benefit were intended to reduce the financial burden of the agency

Fiscal Squeeze in Germany:Drifting Away from the Politics of the Switching Yard?

Figure 8.4. Federal government contribution rates to pension system (€m).

Source: Official budgetary documentation, Federal Ministry of Finance.

(p.173) responsible for unemployment benefits, the Bundesanstalt fur Arbeit. However, this created a growing number of social benefit claimants, as individuals were no longer eligible for unemployment benefits. As local governments were responsible for social benefit payments and the actual delivery of social programmes (such as social benefit payments, social housing, child and youth care), this policy development placed a considerable burden on local governments. In response, local governments created secondary labour markets by establishing their own enterprises, so-called ‘Beschaftigungsgesellschaften’. These locally owned companies offered time-limited employment opportunities to recipients of social welfare payments. Unsurprisingly, the time-limited contracts were designed in a way that would make individuals eligible for unemployment benefits once their contract had ended (and thereby return them to the financial responsibility of the unemployment benefits system). The federal government responded by tightening eligibility criteria further. In addition, welfare state expansion added further strain on local government finances. For example, federal legislation granted every child the right to attend kindergarten. However, the financial cost to provide for additional kindergarten places fell on local governments.

Elsewhere, cost-containment measures taken in the 1990s, such as the introduction of a ‘demographic factor’ in the pension system, faced outright opposition from the then Social Democrat opposition and trade unions (Streeck 2009: 61; Leibfried & Obinger 2003). The demographic factor was to reduce pension levels from 70 per cent to eventually 64 per cent of the former net wage. Politically, it was the first time in post-1945 history that pension reforms were pushed through without the support of the opposition party (as well as business and trade union support). It also reflected public opinion (Haverland & Stiller 2010: 433): public opinion polls suggested that a later retirement age was less popular than increased contributions or reduced benefit levels. The 1998 SPD election manifesto promised a reversal of these cost-containment measures. The ‘demographic factor’ was ‘suspended’ for two years once the SPD–Green government had taken office in late 1998.

Dynamics of welfare state reform, and in particular the way in which cost containment affected the ability to use the politics of the switching yard, changed considerably by the mid-2000s. In 2002, public uproar over gamed job placement data by job centres (a consequence of target-driven performance management systems) provided the immediate context for a further exercise in labour market reform.7 However, the wider context was constituted by the federal budgetary deficit that violated the criteria of the Stability and Growth Pact (despite the receipts of the 3G licence). A further condition was (p.174) the lack of reform initiatives that emerged from the corporatist Bundnis fur Arbeit, which had been established to allow peak business and trade union organisations to negotiate a reform package to enhance employment (Streeck 2003). The collapse of this tried-and-tested device to deal with German welfare state problems can be partly explained by the changing labour market conditions that weakened the traditional power bases of business and trade unions alike. It was also due to the lack of party political consensus and party discipline (especially in the SPD) to motivate the ‘social partners’ to seek a consensual set of reform proposals. These three conditions motivated then Chancellor Schröder to abandon the corporatist tradition of welfare state negotiations and to establish an executive-driven inquiry to develop proposals for far-reaching reform of employment policy. This inquiry was chaired by former Volkswagen executive and confidant of Chancellor Schröder, Peter Hartz.

The so-called Hartz reforms (various packages were introduced between 2003 and 2005) included tightened eligibility criteria for the receipt of welfare and unemployment payments (such as reducing the duration of particular benefit payments8) and created so-called ‘mini jobs’ that did not require social insurance contributions. They also merged two tax-based funds, the (income-related) unemployment and the (flat-fee) social security schemes, into a general social assistance scheme (Weishaupt 2010). The merged scheme was no longer income-related. Instead, flat-rate benefits were paid at the level of social welfare payments, on a means-tested basis. In the area of pensions, the demographic factor (called ‘sustainability factor’) was reintroduced in 2003. The ‘early retirement’ policy itself was retired. These reforms marked a change away from a ‘pay as you go’ insurance system and from a payroll to a general tax-based system. The Hartz reforms were also predicted to release local governments from some of their financial constraints (BT15/1516).

Reforms of the 2000s also included growing incentivisation to encourage private provision by placing an emphasis on choice and individual ‘responsibility’. For example, reforms in 2001 introduced old age protection that encouraged voluntary private arrangements. Similarly, the 2003 Health Care Modernisation Law emphasised the importance of individual responsibility in containing costs by reducing the burden on employers and the insurance scheme. This was done by changing certain insurance provisions (e.g. dentures had to be insured personally), increasing contributions in general and for particular medical services (e.g. visits to dentists), and removing certain services (e.g. spectacles for non-disabled adults). At the same time, the federal welfare state also expanded to reflect the governmental aim to make working (p.175) life more child-friendly. This involved the expansion of kindergarten places as well as encouraging the development of all-day schools. In both cases the federal government was required to subsidise a considerable part of the administrative cost (which fell to the local and Land levels); in both cases this involved €4bn from the federal budget.

These reforms proved a significant change in the nature of the German welfare state. Furthermore, they proved politically very costly for the SPD–Green coalition government. They facilitated the split in the SPD and the triggering of a constitutional crisis by Chancellor Schröder to allow for early elections. In terms of squeezing, by increasing a direct link between federal budget and social welfare payment, they also reduced the scope for switching-yard politics between different welfare schemes in the future. The age of retirement was increased from 65 to 67, although this measure was to be phased in over a period of two decades.9 They also proved cost-containing, at least in the medium term (because unemployment rates fell). More generally, contribution rates and government subsidies remained at a constant (albeit relatively high) level, as economic growth (and reduced unemployment) contained cost pressures on the welfare state.

In sum, the changing nature of the welfare state, especially in the context of unification, meant that the politics of the switching yard entered a new era. Given the political commitment to keep the overall contribution rate below 40 per cent, the federal budget became ever more involved in supporting the activities of the insurance funds. The federal budget therefore became ever more exposed to the vagaries of the labour market, encouraging further cost-containment-related reforms and more political interest in the traditional autonomously organised corporate interests that were at the heart of the German welfare state. Within the welfare state ‘switching yard’, the traditional corporatist negotiation patterns were abandoned. In terms of actual measures, the politics of welfare state austerity created a clear boundary line and labour market ‘dualism’ between (western German) insiders who continued to benefit from the (less generous) existing regime, and outsiders (mostly in eastern Germany) (Palier & Thelen 2010; Eichhorst & Marx 2011).

Fiscal Federalism

As noted, the developments affecting the financing of the welfare state had a direct impact on the second traditional switching yard, namely the fiscal transfers affecting the relationship between federal, Land and local governments. (p.176) The German system of federalism has been defined as ‘executive federalism’, as it privileged the involvement of Land governments in federal law-making via the Bundesrat. Furthermore, the Land governments gave up policy autonomy in exchange for federal resources and joint voting-power at the federal level, thereby reducing the power of Land parliaments. The growing involvement of the Länder in negotiating and voting on federal legislation since the late 1960s was originally justified on the basis that the problems of contemporary society could only be solved with the resources of the federal government.

In addition, German federalism was also an ‘administrative federalism’, as Land and local governments were engaged in the implementation of federal legislation. The federal level was rarely involved in implementation. In addition, local governments, despite being constitutional creatures of the Lander, had the constitutional guarantee of ‘local self-administration’. All levels of government, therefore, were supposed to be financially autonomous, but, in the case of the Land and local governments, depended on the federal government for their (administrative) wellbeing.

Local governments were particularly hit by federal switching-yard politics (see Hassel & Schiller 2010). One particular cause was retrenchment in terms of unemployment benefits: long-term unemployed were moved into the category of social benefit recipients. This meant that local governments had to find the resources to support social assistance in a variety of ways, such as in terms of subsidised housing and child support. The economic downturn after 1990 further added to the pool of the long-term unemployed, who were either ‘retired’ early or became social benefit recipients. Further reforms in the mid-1990s sought to relieve the financial difficulties faced by some local governments (especially those in economically deprived areas). This relief of the local government burden involved, for example, reforms of the financing of asylum seekers and the introduction of an insurance-based scheme to deal with old age care.

Apart from intentional switching-yard-type politics, local government finances were further stretched by unintended consequences. For example, the reform of the tax code introduced by the Schröder government in 2000 was mainly about reducing the burden on business. However, it also resulted in the collapse of one essential revenue source for local governments, the Gewerbesteuer (local corporate tax). Local governments’ revenues fell from €19.35bn in 2000 to €15.29bn in 2003. Combined with rising costs for social benefits and services—not least triggered by the ‘switching yard’ policy of the federal government—local governments in the late 1990s and early 2000s witnessed increasing debt rates, cuts in investment and financing of administrative tasks from loans (Kassenkredite). According to Hassel & Schiller (2010: (p.177) 109, quoting Jungfer 2005), the overall debt of the 127 largest German cities increased from €1.3bn in 1993 to €8.7bn in 2003.

Hassel & Schiller (2010) suggest that the proverbial window of reform that facilitated the Hartz IV reforms of 2005 was constituted by two problem streams, namely the depletion of local government finances and the realisation that the federal budget could no longer accommodate rising subsidy payments to insurance funds. Accordingly, the merger of two social benefits systems (unemployment and social assistance) and the move towards a means-tested flat-rate social assistance scheme were only feasible as financial resources were depleted. The concern with financial sustainability was further raised by Germany’s violation of the 3 per cent deficit criterion set out in the Maastricht Treaty. Although the welfare state reforms did not solve the financial problems of local government, the ‘nationalisation’ of social assistance via Hartz IV had a number of cost-containing effects. First, it removed unemployment benefits from the politics of the switching yard as they became increasingly tied to the federal budget. Second, the decrease in the number of unemployed (from 11.7 per cent in 2005 to 6.8 per cent in 2012) also allowed for a reduction of federal subsidies to the labour agency (the Bundesagentur Arbeit10). However, cost containment had, as yet, not involved the pension system.

Besides the intergovernmental politics of the welfare state switching yard, there were also far-reaching initiatives in the area of intergovernmental relations (Renzsch 2010). The constitution required equivalent living conditions across all Lander. One of the key motivations to reconsider financial flows was that existing agreements to deal with the generous treatment of eastern Länder were set to end in 2019 (as set out in legislation). The initial ‘Solidarity Pact’ of 1995 (that was supposed to deal with the money flows across the different Lander) placed the major burden for supporting the eastern Länder on the federal government. It also changed the constitutional settlement regarding concurrent legislation (Art 72.2/3): the federal government was only to legislate in areas where federal legislation was seen as ‘necessary’ to achieve equivalence in living conditions (Wolf 2010).

The constitutional court played a significant role in changing the nature of intergovernmental financing. The initial Solidarity Pact was ruled out as unconstitutional by the Federal Constitutional Court in 1999 after a case had been taken against the Pact by the governments of Bavaria, Baden (p.178) Württemberg and Hesse (all, at the time, governed by Christian Democrats).11 The second Solidarity Pact of 2005 moved towards a more competitive understanding of federalism that no longer aimed at ‘equal living conditions’ across the Länder (by ensuring that all Länder would have at least 95 per cent of the economic ‘strength’ of the average of all Lander). Instead, the constitutional aim (Art 107.2 of the Basic Law) was to ensure that different economic performances across the Länder were to be ‘appropriately compensated’. A joint commission of Bundestag and Bundesrat was established to reallocate responsibilities between federal and Länder level. The joint commission initially failed as the run-up to the 2005 election made an agreement between Christian Democrats and Social Democrats problematic. Some of the reform proposals were taken up after the 2005 election, although the overall reforms were considered a Fáilure (Scharpf 2009). In particular, fiscal federalism remained outside the deliberations. However, the commission’s work led to the prohibition of the direct imposition of federal tasks onto local governments. There were continued concerns (voiced by local governments) as to whether Land governments were using federal funds to support local governments, or used them for alternative spending priorities.

Earlier, in 1992, the Federal Constitutional Court had ruled that the dire financial position of Bremen and Saarland required a federal bailout.12 In 2006, it also found that Berlin required help.13 However, the Court also argued that the federal government and the Länder should develop a system that would put the finances of the Länder on a more sustainable basis. This ruling occurred in a favourable political climate. The federal government was keen to reduce its financial transfers to various Lander. The rich Länder demanded a system that reduced their transfer payments (in the complex system of horizontal fiscal equalisation, horizontaler Landerfinanzausgleich). The poor Länder were open to reform, but asked for more burden-sharing, especially in the area of social services. These background conditions influenced the deliberations of the so-called second ‘federalism reform commission’ that concentrated solely on fiscal relations and came to an agreement in 2009 (Heinz 2012).

Debates ensued as to whether a new system of fiscal relations should rely on tightened up constitutional provisions. According to (the old) Article 115, the federal government was not allowed to debt-finance expenditures beyond the level spent on investment over the course of a business cycle. This provision had (p.179) been shown to be hardly effective; the criteria as to what constituted ‘investment’ were soft and there had been considerable creativity in defining the relevant business cycle in the past. The experience of Land and local government finances did not suggest that a tightening up was a viable policy option.

The alternative was to introduce a ‘debt brake’ (or ceiling) which would introduce provisions resembling the Maastricht criteria into the German constitution. These proposals were initially backed by the then SPD finance minister. The main opposition to these proposals emerged from the left-wing factions of the Social Democrats, economically weak Land governments and the Bavarian Christian Democrats. However, the opposition was overcome, again, placing most pressure on the SPD in terms of managing an overall agreement with a ceiling on public expenditure while accommodating concentrated opposition to such fiscal straightjackets.

According to the new Art 109 (and 115) of the Basic Law, German public finances, at the federal and Land level, were to respect a ‘structural balanced budget’ rule.14 Land budgets were to be balanced from 2010. The federal government was to run a balanced budget as of 2016. However, the federal government was granted some leeway: governments could run a deficit of 0.35 per cent of GDP over a business cycle. Nevertheless, the provisions were said to be open to manipulation via devices such as private-public partnerships. Moreover, they could be suspended should some vaguely defined economic or natural emergency situations occur.

Monitoring was conducted by a ‘Stability Council’, consisting of the federal ministers of finance and economics as well as finance ministers of the Lander. In case of a diagnosed budgetary imbalance, the affected Land government had to agree on sets of corrective measures and to report on progress. In addition, five Länder were given additional payments to facilitate their transition to the changing constitutional landscape. These payments, amounting to €7.2bn in total, were provided on a co-financing basis between the federal government and ‘rich’ Lander. In terms of fiscal consolidation, the overall effect was uncertain. It was uncertain whether some Land governments would comply with the new fiscal rule (including Saarland and Bremen, but potentially also the largest Land, North Rhine Westphalia) (RWI 2013). However, the early monitoring system made the system more predictable for the federal government, and most Länder committed themselves to a policy of consolidation by, for example, including a ‘debt ceiling’ into their own constitution.

(p.180) The rise of the debt ceiling as a viable policy option has to be seen in the context of the federal government’s response to the financial crisis. As the US financial market’s credit crunch caught up with Europe, it was the German IKB bank that required the first bailout in Europe, in August 2007. This was soon followed by Sachsen LB. A further bailout was required to rescue the mortgage lender Hypo Real Estate in September 2008 (shortly after the Lehmann collapse) (see Zohlnhofer 2012: 231–3). Widespread financial problems involving the (public) Landesbanken led to the resignation of a number of Land ministers who were accused of having neglected their oversight obligations. The federal government’s response involved a punitive bank stabilisation package that led to some partial bank nationalisations, a facility to create a ‘bad bank’ for toxic assets and a loan facility for businesses to ensure their access to credit. In addition, the federal government issued an economic stimulus package that amounted to €54.3bn (2.1 per cent of GDP) and did not immediately respond to the constitutional court that ruled two tax increases unconstitutional (Zohlnhofer 2012: 233). The perceived need to address financial market concerns about the extent of these stimulus packages facilitated calls for budgetary consolidation in general, and supported the move to a rule-based debt ceiling in particular.


The politics of fiscal squeezing in Germany hardly suggests an axing of expenditures. Significant changes to the settings of public expenditure did happen—within ministerial departments (through cost containment in administrative costs, especially staffing), within the welfare state (by changing policy settings and funding streams), and within the system of fiscal federalism (by introducing a debt ceiling). These changes emerged as a result of accumulated effects rather than as the consequence of one-off cutbacks. One major exception is the reform package involving the welfare state (Hartz IV). Overall, however, the politics of fiscal squeezing was a result of incremental change in a number of ways. First, squeezing throughout the past thirty years was a result of a gradual build-up of financial pressures that eventually could no longer be addressed through the conventional methods of the politics of the switching yard, as resources were depleted, or as governments had committed themselves to rules or targets that made it difficult to grant discretionary expenditures. For example, the perceived plight of some local governments could no longer be met by discretionary transfers or tax re-negotiations.

Second, squeezing was conducted in an incremental way. Partly this was a result of a highly interdependent system that required negotiated settlements that balanced winners and losers. Partly it was because of the legal restrictions (p.181) that constrained the scope for scaling back administrative personnel and put an emphasis on ‘natural wastage’ in staffing. Partly, incremental change was a result of intended and unintended changes, such as the ones noted above on the changes to the welfare state and the tax system. Demands for financial consolidation led to partial changes in the type of welfare state that would influence spending over time rather than immediately.

Third, squeezing measures in the areas of fiscal federalism and the welfare state were of an incremental nature. Measures were taken that shifted revenue sources around (for example, by moving from pay-as-you-go contributions to indirect taxation) and by reducing the generosity of welfare schemes. However, the decision to change the policy settings of the welfare state on this basis could also be seen as a non-incremental decision.

The politics of financial consolidation also had significant effects on the political system itself. As noted, financial consolidation led to splits within the SPD and between the SPD and some trade unions, and thereby directly affected its decline in electoral fortune throughout the 2000s. However, the politics of financial consolidation also shifted the parameters of political debate (Streeck & Mertens 2010; Howarth & Rommerskirchen 2013). The initial attempts at budgetary consolidation in the 1980s were largely framed in the context of ‘Standort Deutschland’ (a debate about the viability of Germany as an economically viable location), namely in the way in which the costs of the welfare state were potentially impeding the wellbeing of the economy. This debate shifted to a different kind of argument in the 2000s because of the financial crisis, the bailout of other European governments, and a degree of disillusionment over the high costs of unification. The ‘health’ of the budget became a political football in itself, as did the lack of scope for elected governments to service little else but mandatory expenditures.

While there were the predictable outcries by concentrated interests in the case of proposed cutbacks, politicians (with the exception of Die Linke) were endorsing the importance of the Schuldenbremse (see Zohlnhofer 2011). The electorate was similarly not opposed to reform per se. In short, while the consolidation of the German public finances was largely incremental, especially when seen in cost terms, the effects of these reforms in political terms were significant in hastening the decline of the Social Democrats while in federal government in particular. Whether these political consequences were to represent a continued pattern remains to be seen, as core support for the SPD and the Christian Democrats has continued to decline, while the electoral appeal of Die Linke has waned and support for the FDP has collapsed.15

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Proceedings of the British Academy, 197, 161–183. © The British Academy 2014.

(2) Initially, the financing of unification involved a ‘solidarity surcharge’ on income tax, and an additional increase in mineral oil tax. In 1998, a tax surcharge of 5.5 per cent was imposed on income, capital gains and corporate tax liabilities. The additional revenues were counted as federal revenue. In addition, the federal equalisation pact between the German Länder was enhanced. After 2004, the latter targeted structurally disadvantaged regions across the whole of Germany. Further measures included increases in VAT and other taxes, such as those on tobacco, mineral gas and insurance.

(3) The German bicameral system includes the Bundestag, composed of directly elected representatives which forms the federal government, and the second chamber, the Bundesrat. The latter represents the governments of the Lander. A clear dominance of one party (or block of parties) in the Bundesrat can lead to a reform blockage under specific conditions, namely when the party political adversarial logic outweighs the compromise-seeking logic of intergovernmental negotiations (Lehmbruch 2000).

(4) The SPD lost 11.2 per cent of its vote and ended up on 23.0 per cent. Die Linke gained 11.2 per cent (up 3.2 per cent), the CDU received 33.6 per cent (a loss of 1.4 per cent), the FDP 11.6 per cent (a gain of 4.7 per cent) and the Greens achieved 10.7 per cent (a gain of 2.6 per cent). For analysis of the electoral punishment suffered by the SPD in 2009, see Bytzek (2011).

(5) All figures are taken from the official budgetary documentation published by the Federal Ministry of Finance.

(6) Between 1993 and 2002, 675,944 employees in eastern Germany were retired early; the annual number of early retirements in the east peaked at 160,000 in 1995 (in the west, the total number for that year was 111,000) (Trampusch 2009: 110).

(7) The gaming scandal involved the revelation that only 30 per cent of supposedly ‘successful’ placements had been correctly recorded (see ‘Der Beton lebt’, Der Spiegel, 18 February 2002).

(8) From 32 to 12 months for the under 50-year-olds, to 15 months for those up to the age of 55, and to 24 months for those up to 58 years old.

(9) It was noticeable that the ‘coalition agreement’ between CDU–CSU and SPD in 2013 agreed on a partial moderation of these proposals due to SPD demands.

(10) One aspect of the reform package was also a change in the organisational status of the employment agency, symbolised by the change from Bundesanstalt to Bundesagentur. This was to signal a more incentive-driven approach.

(11) Bundesverfassungsgericht, 11 November 1999, Az. 2 BvF 2, 3/98 and 1, 2/99; BVerfGE 101, 158 (http://www.bverfg.de/entscheidungen/fs19991111_2bvf000298.html, last accessed 2 September 2013).

(12) Bundesverfassungsgericht, 27 May 1992, Az. 2 BvF 1, 2/88 and 1/90, BVerfGE 86, 148 (http://www.servat.unibe.ch/dfr/bv086148.html, last accessed 2 September 2013).

(13) Bundesverfassungsgericht, 19 October 2006, Az. 2 BvF 3/03, http://www.bverfg.de/entscheidungen/fs20061019_2bvf000303.html, last accessed 2 September 2013).

(14) BMF (n.d.), ‘Compendium on the Federation’s Budget Rule as set out in Article 115 of the Basic Law’, http://www.bundesfinanzministerium.de/Content/DE/Standardartikel/Themen/Oeffentliche_Finanzen/Schuldenbremse/2012-06-14-kompendium-en.pdf?blob=publicationFile&v=3 (last accessed 2 September 2013).

(15) The CDU–CSU vote in the 2013 federal election saw a return to 41.5 per cent. However, whether this election represented a reversal of a long-term decline of the CDU–CSU remained to be seen.