How is Germany’s Subsidy war Tearing Apart the European Union and Helping Russia?


German Chancellor Olaf Scholz refers to it as a “defensive shield”: 200 billion euros worth of measures to protect German households and businesses from a winter energy shortage. Both the size of the package and Scholz’s language reflects the magnitude and origins of the threat Germany faces. As Russian President Vladimir Putin bombarded Ukraine with heavy weapons, he simultaneously cut off vital energy supplies to Europe. Germany has been more exposed than any other country. Over more than a decade, Berlin, enticed by the promise of a cheap and reliable supply of Russian natural gas, became increasingly reliant on the Kremlin to heat and light German homes and factories. Before Putin invaded Ukraine, more than fifty percent of Germany’s natural gas supplies were Russian. In just the previous year, Germany paid Russia approximately $25 billion for energy imports. This year, despite its efforts to reduce its reliance, Berlin was compelled to continue purchasing Russian fossil fuels, which have become more expensive due to the war: In the first six months of the war, Germany reportedly spent approximately $19 billion on Russian energy imports.

In other words, Germany has learned its lesson the hard way: Russian gas was not particularly affordable, nor was it dependable.

Businesses and households in Europe’s largest economy faced the possibility of severe energy shortages, or at the very least, sudden price spikes for electricity and heating, as a result of Russia’s decision to restrict the supply at the end of the warm summer months. Robert Habeck, Scholz’s energy and climate minister, stated at the announcement of the “shield”: “The energy crisis is undermining social peace, and we are addressing this.”

The primary features of the shield are intended to maintain artificially low energy prices by capping gas and electricity prices, reducing gas taxes, and encouraging investment in renewables.

According to Scholz, it is “good news for all who are concerned” about rising costs. On the sidelines of an informal summit of European leaders in Prague earlier this month, he stated, “It’s hard to find a country that isn’t taking similar steps.”

However, Berlin’s detractors argue that “similar” is not quite accurate, and many are concerned that Germany’s response could threaten Europe’s unity and resolve in the face of Russian aggression. Putin’s invasion has had the effect of uniting Europe thus far, with leaders speaking with a unified voice against the Kremlin and in support of Ukraine. Germany’s shield, which provides Germans with far more generous benefits than other Europeans are likely to receive, has already angered other European nations. Additionally, there is concern that the German package could increase energy prices for everyone else.

Noah Gordon, a fellow in the Europe program at the Carnegie Endowment for International Peace, told Grid, “It stirs up old divisions within Europe.”

He continued, “Germany was the taskmaster in Europe, warning nations to watch their policies and how they affected the rest of Europe.” “Then there’s this uncoordinated, barely announced policy to the French and Europeans.” In addition, because Germany is such a sizable nation and economy, its movements have real effects on the rest of Europe.

The sheer magnitude of Berlin’s relief plan is the primary point of contention between Germany and its European detractors. The economics are unmistakable: the headline cost of nearly $200 billion reflects the financial demands of assisting both German households, the majority of which rely on gas for heating, and industry in what remains one of the world’s manufacturing superpowers.

Nick Andrews, a Europe analyst at the investment research firm Gavekal Research, told Grid that capping energy prices for the entire population, including all households and businesses, would be extremely expensive.

The total cost of the package, which will be financed by new government borrowing, is approximately 5 to 6 percent of Germany’s gross domestic product, or the total size of its economy. Analysts estimate that the figure rises to around 8 percent when earlier measures are included. Berlin estimates that the actual cost of the package is approximately 2 percent of GDP, given that its components are spread out over two and a half years.

According to calculations by the Financial Times, this indicates that Germany’s overall support for its economy in the face of the energy crisis is at least three times larger than that of the majority of other eurozone nations. In other words, Scholz exaggerates when he asserts that these other nations all employ “similar measures.”

Due to the size and strength of its economy, Germany can afford to do so; the government can borrow money more cheaply than its weaker European counterparts. Other, weaker European nations are unable to match the generosity of the German shield.

In addition to the disparity between the wealthy and the poor, the shield is likely to affect energy prices. By capping energy costs to prevent skyrocketing energy bills for its citizens, Germany may be disincentivizing conservation; if German consumers anticipate a generous support mechanism, why should they sacrifice their consumption? This increases the likelihood that 84 million Germans will purchase more energy, boosting European demand and driving up gas prices for other nations.

On the one hand, it is logical that German officials make policy decisions for the benefit of German citizens. On the continent, however, which is home to the European Union, NATO, and the European Commission, all institutions to which Germany belongs and dominates the shield appear to other member nations as a finger in the eye.

“The richest country, the most powerful E.U. the country is attempting to use this crisis to gain a competitive advantage for its businesses on the single market,” Poland’s Prime Minister Mateusz Morawiecki said in response to the package, encapsulating the sentiment of many critics of Berlin’s plans. That is not right.

“Faced with the common threats of our time, we cannot divide ourselves according to the space in our national budgets,” said Mario Draghi, the outgoing prime minister of Italy and former head of the European Central Bank, who is widely regarded in policy circles across the continent.

Controversy over the German measures even shook the Brussels-based European Commission, the bloc’s pan-continental executive arm, as two top officials, one from Italy and the other from France penned a joint opinion piece condemning Berlin’s approach.

As Putin resumes attacks on civilian targets in Ukraine, it is “more important than ever” to avoid fragmenting the internal market, creating a race for subsidies, and calling into question the principles of solidarity and unity that underpin the European project, they stated.

Analysts warn that this “race for subsidies”, a competition among European nations to keep energy costs low for their citizens could have catastrophic effects on the economies of Europe’s weaker nations.

Particularly at risk are southern European nations.

Italy, for example, “is much more under pressure in terms of budgetary spending” than Germany, Gavekal’s Andrews told Grid.

Italy already relies heavily on European Union assistance to sustain its economy. And when it borrows money on the market, it must pay higher interest rates due to its weak economic position.

Germany’s generous subsidies may compel Italy to increase aid to its citizens, which could upset Rome’s fragile economic equilibrium.

Andrews explained, “This year, the Italian government’s energy relief packages have been so carefully planned that they are essentially… neutral [in terms of the country’s budget].” Therefore, any measures taken to subsidize consumers and some businesses have been more or less offset by [other budget-balancing measures].

As a result of the German shield, other nations are considering whether they will need to spend more than they can afford on such aid packages. This could trigger a crisis in Europe’s weaker economies. Andrews singled out Greece among the other vulnerable nations: “They still have very high levels of debt.”

For Germany’s detractors, these risks highlight the need for European cooperation in the face of a shared threat.

Europe as a whole may be subject to a price ceiling for gas supplies. Proponents of this view argue that Europe is a massive consumer with the purchasing power to negotiate lower prices with international suppliers other than Russia. By purchasing gas collectively, the bloc could shield its citizens from price increases. 

Opponents argue that large gas suppliers like Qatar could respond by diverting supplies to non-European buyers, similar to what Russia has done. Why sell below market price to Europe when Asia and the rest of the world are willing to pay more?

Until very recently, Germany was one of the most prominent voices in the latter camp, arguing that “if the price is capped, people will simply sell their [supplies] to Japan, for example,” as explained by Gordon of the Carnegie Endowment.

Scholz stated that his government was now discussing “the possibility to limit price spikes” across the continent by implementing a mechanism to cap costs. This opposition has softened in recent days. However, it is unclear how precisely this would function.

Criticism of Germany’s shield has also caused Berlin’s opposition to the use of joint, Europe-wide borrowing to fund energy subsidies for weaker nations to soften. There is precedent for such cooperation from the covid pandemic when the bloc enacted a $700 billion-plus recovery fund supported by joint borrowing; the idea was to use the economic strength of the larger European players, such as Germany, to help fund support for smaller and weaker economies.

Again, the specifics of a potential European-wide relief plan are hazy; much remains to be determined. Analysts assert, however, that something must give for Europe as a whole to be able to withstand the energy and inflation crises. And to ensure that Putin’s desire to sow discontent and division among Ukraine’s European allies is thwarted.

As French Finance Minister Bruno Le Maire warned when Germany announced its shield package, “we risk the fragmentation of the eurozone if there is no consultation, no solidarity, no targeted business support, and no respect for level playing fields.”

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