Implications of the German election

As expected from the opinion polls, the three parties of the outgoing coalition - the SPD, Greens and Free Democrats – were hammered in Germany’s federal elections.

The Free Democrats lost all their seats – and the SPD slumped to a new low vote of only 16%. It ended up in third place. The CDU came top of the poll, but with a very modest 30% of the vote. Its new leader, Friedrich Merz, had toughened its position somewhat on migration, but not enough to see off the challenge of the AfD.

The AfD saw its vote almost double to nearly 20%, based on its messages of closing the borders, reviving the economy and adopting a different energy policy to enjoy cheaper fuel. The election campaign was dominated by the issues of no growth, squeezed living standards and the continued large numbers of migrants. In its later stages, the politicians were also talking about President Trump and the difficulties of European defence and Ukraine. The AfD is against making a major commitment to Ukraine. They wish to concentrate on domestic problems.

The Merkel legacy

Mr Merz takes over from Angela Merkel who, over 16 years as leader of the CDU and Chancellor of Germany, made fundamental changes to its policies and some of its beliefs. She bowed to the Greens in shutting down all Germany’s nuclear power. This decision cost Germany badly in the Ukraine energy crisis. She imposed a strict debt brake limiting the German state deficit to 0.35% of GDP. As a result, Germany has a much lower state-debt-to-GDP ratio than the other larger European countries. She was an enthusiast for net zero.

These policies are now leading to considerable damage to the German motor industry, as it has found it difficult to adapt to new electric vehicles. The car industry was a key source of Germany’s industrial strength and balance of trade surplus.

Mrs Merkel made the economy dependent on cheap Russian gas, only to see Germany forced to close pipeline gas transit from Russia following the invasion of Ukraine. She was the ‘go-to’ person to create compromises within the European Union (EU). She was largely successful in limiting excess EU spending and borrowing. This was blown away by the post-Covid EU recovery plans.

What kind of government will emerge?

The main parties in Germany all agree that the AFD must be kept out of any government that is formed, despite their good result. This leaves two possible coalitions. The most likely is the revival of the old grand coalition between the CDU and the SPD. The other is the CDU bending further to share power with the Greens and the left, Die Linke.

Either of these coalitions will require Mr Merz to dial back some of his words on migration. There will be pressure on him to relax the controls on German deficits and debts, which he may be willing to accept as he seeks some economic revival.

It is expected that the CDU will approve more borrowing for specified proposes such as investment and rearmament. It will mean some limited fiscal stimulus from more borrowing.

Mr Merz argues for European unity

In his first important remarks after the election result, Mr Merz spoke critically of US President Donald Trump and said his new aim is to unite Europe, and to get the continent to take responsibility for its own defence. His idea of Europe goes wider than the EU, as he sees the UK and Norway playing important roles in the defence of the continent.

He will find he does need first to win over the European Commission and leading EU states to his positions, as much of what needs to be done requires active EU support or EU consent. Mrs Merkel grew into the unofficial job of political leader of the EU because she sought compromises and worked with other states to achieve agreements.

Today, Europe is very divided on the defence issues. France and the UK propose a peace keeping force for Ukraine, should a peace soon be arranged. Germany and Poland, with two of the larger armies, oppose. The states nearest the Russian borders spend considerably more than the 2% NATO minimum on defence. Germany only pledges the minimum and some other Western states are still below the threshold. Europe is still very dependent on US technology, weapons systems and military support in its defensive actions. Germany is very conscious it relies on the US nuclear umbrella, whilst France and the UK have their own nuclear weapons.

There are also considerable disagreements on how far the EU should go in becoming a full transfer union, sending more money from the richer to the poorer areas as unitary states do. There are disagreements on how much the EU should borrow on behalf of member states, with Germany traditionally against this. The EU is a customs union which imposes tariffs on 73% of all the Word Trade Organisation (WTO) product lines on goods into the EU. There will be different views on whether the EU should start to bring those tariff barriers down in response to President Trump’s demands for reciprocity.

It will not be easy agreeing a new coalition, assuming Mr Merz sticks to his categorical and often repeated statements that he will not do a deal with the AfD. The half of the voters who voted for change in a conservative direction will not want the promises on the economy and migration diluted and will be hostile to too much influence for the SPD or the Greens. The likely outcome is a government that borrows a bit more, spends a bit more, starts to rearm but does not have Cabinet agreement to do anything very radical.

It is unlikely the CDU can unite Europe. President Macron has gone to Washington this week rather than arranging an early meeting with the CDU Leader. He is promoting a scheme Germany does not want. We should expect some modest recovery later this year when Germany will get some benefit from lower EU interest rates and from some incremental spending. It will be a struggle for Mr Merz to sustain his modest poll ratings, when he admits a less popular party or two to form a government.