Germany’s New ‘Traffic Light’ Coalition Delivers Gridlock

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While Germany waits to learn whether the lockdown Grinch will steal Christmas, there is now one present under the tree: a new government, meeting incoming Chancellor Olaf Scholz’s goal of having an administration in place before St. Nick’s arrival. His Social Democratic Party (SPD) has completed coalition talks with the Greens and Free Democrats (FDP), and all three parties have blessed this so-called traffic light coalition (named for the parties’ colors of red, green and yellow, respectively). They will be sworn in Wednesday, sending retiring Chancellor Angela Merkel riding off into the sunset. Yet while the faces and parties in charge are changing, the new coalition’s economic agenda mostly extends the status quo. Gridlock is also getting an extension, as the ruling parties have next to no ideological overlap. This has already watered down major initiatives, as the coalition’s official plans are a shadow of the parties’ campaign pledges. They could very well diminish further as lawmakers grind away at them in debate. In our view, it all adds up to a fat lot of nothing for stocks, keeping uncertainty low—a bullish political backdrop that spans much of Continental Europe as 2021 closes.

The coalition’s leadership and policies shaped up as most expected. Christian Lindner, leader of the pro-business FDP, will take the post of finance minister. Green co-leader Annalena Baerbock will be foreign minister, while her counterpart, Robert Habeck, will be climate and economy minister. As for policy, COVID containment will probably dominate everything in the near term, with rising cases and a contentious potential vaccine mandate monopolizing attention. Beyond that, at the Free Democrats’ insistence, the coalition has pledged to leave the country’s constitutional debt brake alone, which limits the bandwidth to jack up spending—potentially jeopardizing plans to increase infrastructure and defense spending. The FDP secured a pledge to avoid tax hikes, further reducing spending wiggle room. It wouldn’t surprise us if arguments over spending deepened divisions within the coalition and gridlock. The FDP did cease opposing the SPD and Greens’ insistence on hiking the minimum wage to €12 per hour, but negotiations over how to implement that remain.

Energy plans could also cause friction, despite the apparent enthusiasm for them now. The coalition agreement includes a pledge to accelerate the phase-out of coal-fired power plants to 2030 instead of 2038, a big win for the Greens—although perhaps a weird pledge to hype amid an energy crisis. The plan includes a pledge to get 80% of power from renewables when coal is phased out, but it isn’t clear how that will work when the country also remains opposed to nuclear. France, the UK and others are counting on mini-modular nuclear reactors in their push to reduce carbon emissions, but Germany is sticking with its decision to abolish nuclear power after 2022. Considering a shortage of wind power contributed heavily to the present energy crisis, relying on wind and solar for 80% of the electrical grid seems like just a bit of an odd choice to us, making this area seem ripe for gridlock to throw sand in the gears.

For the most part, we don’t see the new government as radically different from the old one. Under Merkel, Germany had a divided coalition that had little ideological overlap and moved gradually, avoiding radical change. Under Scholz, Germany will have … a divided coalition with little ideological overlap and a policy agenda that doesn’t tee up radical change. In our view, it makes no difference to stocks that the leadership happens to now be center-left instead of center-right. Policies, not personalities, are what matter most to stocks, and two governments that can’t advance much differ little on actual policy grounds.

An internally divided do-little government should be just fine for German stocks—as it has been under Merkel in recent years. Gridlock reduces the likelihood of redistribution and big changes to property rights. Whatever your personal opinion of such changes, when legislation creates winners and losers, prospect theory tells us the losers hate it far more than the winners enjoy it, creating a net negativity that can weigh on stocks. Not only does gridlock reduce this risk, but it means that whatever legislation does pass ends up being much milder than initial proposals, creating relief for investors—much as we have seen throughout US President Joe Biden’s first year in office. In our view, this is a positive not just in Germany, but throughout Europe and the developed world, where coalition and minority governments are the norm these days. Politics is just one driver, but there don’t appear to be major speedbumps on this front for now.