Amidst an exceptional turnout of 84% of the electorate, Germany has voted in a crucial election that will see Friedrich Merz become Chancellor. Compared to last October, when it became apparent that an election would be called, the vote for the CDU/CSU is down slightly vis a vis the polls, the AfD have not rallied as much as their admirers would have believe, the Sahra Wagenkneckt Party and FDP failed to win enough votes to participate in parliament.
The surprise has been the rise of the left wing party, Die Linke (to whom voters likely shifted from the BSW party). At the regional level, there was a stark preference for the AfD in the ‘old East’ of Germany.
Merz struck a forceful tone in the aftermath of the election, and we believe that this is a major plus for the EU. Merz is not as charismatic as Macron but has broadly the same beliefs and pro-EU conviction. For the first time in over a decade, the French and German leaders share a vision and sense of urgency. The Franco-German locomotive is moving again, in the context of major damage has been done to trans-Atlantic relations in the past week by the Trump administration (a sign of this are comments from the Spanish foreign minister for a new approach to relations with China).
Merz wants to form a coalition as soon as possible (this means the second week of April, the current parliament in in place till March 24) and needs to achieve several policy milestones.
On coalition formation, the easiest option is a partnership with the SPD which would give a slight majority (52%). In this context Olaf Scholz would be unlikely to serve in such a government and would likely be replaced by Boris Pistorius – the current defence minister and someone who is on the same wavelength as Merz and has been flagged as interior minister (Lars Klingbeil the SDP’s parliament head could be foreign minister).
Forging a coalition with the Greens might be desirable in the long-term but it could drag out negotiations (Robert Habeck who has a poor relationship with Merz is leaving frontline politics, which helps). It may be that a voting arrangement is found with the Greens to have their support to change the Basic Law (and thus the debt brake). Yet together the CDU/CSU. SDP and Greens would excruciatingly fall short of the 66% needed to change the Basic Law.
Merz’ policy agenda will be a busy one – lowering personal and corporate taxes, cutting back regulation (i.e., planning), and a tougher immigration policy framework. There is an obvious and well documented need to spend more on defence and arguably an even greater need to renew infrastructure in transport and energy. Some of this could be achieved by recapitalising transport providers and national and state investment banks (i.e. KfW).
With an EU summit on defence spending to be held next week (March 6 – Merz will surely attend) there are a few options open to Germany to boost spending. One is to vote in a change to the debt brake (difficult given parliamentary arithmetic – there is talk of doing it in this parliament), declare an emergency ‘event’ that merits high spending as was the case with COVID and it will be argued that President Trump has created a crisis. The other is for Germany to play an outsized role in underwriting European defence bonds.
Economically, my our sense is that the end of the troubled Scholz led coalition could trigger an ‘animal spirits’ rebound in the economy. German bond yields may rise, and there is scope for the euro to halt its descent (relative to the dollar). The strong positives here are the return of the Franco-German alliance, and a sense of urgency on the economy and defence. If there is a way for Germany to quickly ease its debt constraints that would be a positive.
Read the full article here
