Merz’s Massive Spending Isn’t Germany’s Saving Grace

Editors’ Note: MarketMinder is politically agnostic. We assess developments for their potential economic and market implications only.

Is austere Germany about to unleash a fiscal stimulus of epic proportions? Headlines say so, pointing to Chancellor-in-waiting Friedrich Merz’s plans for a constitutional amendment allowing increased defense and security spending—and a €500 billion spending package to match. But this thinking is off-base, in our view—the outlook for German stocks and its economy doesn’t hinge on massive public investment, which would likely trickle out too slowly to matter for markets anyway.

First, some background: Earlier this month, Merz announced he would push to exempt German defense and security spending over 1% of GDP from the country’s debt brake—a constitutional rule that limits government borrowing—allowing him to move forward with a proposed €500 billion infrastructure fund without running afoul of borrowing limits.^[i] With the exemption, the plan could boost German spending by €1 trillion over the next 10 years. Many see this as an avenue for Germany to self-support its defense and infrastructure efforts rather than rely on the United States. The timing here isn’t too shocking, considering the proposal comes amid transatlantic trade tensions and the Trump administration’s seeming back-and-forth stance on Ukraine—and on the heels of February’s German election.

In Germany, constitutional amendments require supermajority approval, or agreement from two-thirds of the Bundestag.^[ii] The new parliament takes office on March 25, at which time Merz’s Christian Democratic Union (CDU), its Bavarian sister-party the Christian Social Union (CSU) and the Social Democratic Party (SPD) are expected to launch potentially long coalition talks, so Merz and current Chancellor Olaf Scholz are trying to push this plan through now. But neither the current government nor the incoming one have a supermajority. They will have to court support elsewhere, with the Green Party the principal target, since only its support is needed under the outgoing administration (the other two possibilities, the far-right Alternative for Germany and The Left, aren’t likely to support the proposal). With plenty of uncertainty around voting allegiances in the upcoming regime, Merz had incentive to move quickly.

Initially, the Green party threw a wrench into the plan, vetoing it tied largely to a lack of climate-related initiatives. But the Greens’ rejection was less about declining the shift outright and more about getting some of its goodies folded in. Hence, negotiations kicked off last Thursday. Despite a fiery debate, Merz initially offered a €50 billion allowance for climate projects.^[iii] He later upped that to €100 billion, and the Greens accepted just one day later.^[iv] The package must pass before the new Bundestag convenes, with a vote expected Tuesday. But with his supermajority in tow, this deal looks close to done.

Pundits couched this as a major positive, suggesting Germany needed the spending as a sort of fiscal stimulus (even though that isn’t what the motivation is). Since the move will allow Germany to meet its defense spending obligations and pursue more public investment, economists have routinely argued the move is necessary to jolt the economy out of its two-year slump. Their thinking is rooted in the idea that Germany’s economic model is outdated—far too export-reliant and thus exposed to largely uncontrollable foreign demand trends. They suggest the country needs big public investment to modernize and find its footing, and building up its own defense and infrastructure offers a way to do so.

To an extent, they have a point. Germany has long been living with the fruit of its quasi-mercantilist model, in which past governments supported national champions. That kept Germany’s manufacturing sector a relatively larger share of GDP than other developed nations and meant exports were a big economic factor as governments targeted trade surpluses. But it also meant weak consumer demand in China—Germany’s second-largest export market—contributed to flagging German manufacturing output in recent years.^[v] So in theory, investing in areas that improve domestic demand and modernize industry could help the country move away from the old model.

But this is a big if. We are neither for nor against Merz’s plans inherently, but Germany’s economic future doesn’t rely on them. For one, throwing more public investment at these problems just repeats past errors. No matter the scale, government funding tends to funnel into only a handful of industries and companies, thus creating winners and losers. In this case, it seems Industrials firms and defense contractors will be the biggest beneficiaries, plus whatever the green spending targets. Many sectors likely won’t see any investment. Plus, defense spending isn’t always known to be massively efficient—look at cost overruns on US fighter jets and ships. Of course, the money could be spent more broadly and smartly downstream from this initial spend, once it is in the private sector’s hands. But that isn’t assured and takes time anyway.

Which raises another point: From a market perspective, too, it is being doled out sloooooowly. In nominal terms, Germany’s GDP finished 2024 at €4.3 trillion.^[vi] If doled out in even increments, that means this would be about 1% – 2% of GDP. Perhaps that is a fair boost, but it doesn’t seem massively game changing. And markets look only 3 – 30 months in the future. In our view, the funding likely fades into the background as other economic, political and sentiment factors come to center stage. Merz’s plan is also now widely known. Whatever oomph it has, markets likely already reflect. Picking new winners within the Industrials sector just doubles down on the old economic model, giving it a modern tinge rather than effecting wholesale change. This isn’t some shock therapy that will suddenly unleash market forces to create and grow businesses in other sectors.

Either way, Germany isn’t in terrible economic shape, so it doesn’t really need a lifeline. Yes, real GDP inched down the last two years running. But it wasn’t a steady plunge—just a quarterly flip between growth and contraction as weak heavy industry and relatively healthy consumer spending and services played tug of war. Household consumption, German GDP’s biggest component, is faring better-than-appreciated. Global trends favor Germany’s sector makeup, too. Global manufacturing is improving, and resilient consumer demand outside of Germany should support the country’s many export-driven businesses.

And sentiment is really, really low toward Germany—a fact the global celebration of a stimulus plan actually illustrates, in a perverse sense. Pundits seem pleasantly surprised by this because they think the alleged “Sick Man of Europe” needs a Keynesian cure. That backdrop suggests almost any growth that didn’t hinge on public largesse would positively surprise and boost stocks.

Thus, we would recommend tuning out the inevitable hype if Tuesday’s vote passes. We view Germany’s economic and market prospects favorably overall, but not because of public investment. Rather, its economy was already recovering nicely amid dour sentiment and political gridlock is highly likely in its upcoming government—another potential tailwind. We will keep a close eye on where things go from here, but we doubt Merz’s spending package is the economic swing factor many think.