The overlooked opportunities of competitive federalism

Manfred Weber
Chief Executive Officer of the Association of German Banks

Germany’s firmly rooted federal system evolved historically, and its history also contains more than a few oddities. In the 1920s, for example, Prussia alone covered more than two-thirds of the entire territory of the Reich, whilst a host of dwarf states were scarcely visible on the map. On top of this, some of the Länder still maintained diplomatic relations with each other though they were little more than administrative units at the time.

Many aspects of our federal system today also appear strange. For instance, whereas the influence of the Länder on federal legislation is stronger than in virtually any other federal state in the world, the Länder have only very limited legislative powers of their own and no fiscal sovereignty. They usually only compete keenly with each other when the distribution of federal funds is involved. In contrast, the Länder often shun competition – one of the guiding principles of any federal system – and in some cases actually expressly reject the idea of assuming more individual responsibility.

Citizens, too, are still not sure what to make of such a federal system – at least this is what the results of a demoscopic survey commissioned by the Association of German Banks suggest. Given the complex and interwoven decision-making system that federalism in Germany has evolved into in the meantime, this may not be surprising. At the same time, the survey showed that a large majority of interviewees were unhappy with the role played by the Bundesrat (parliament’s upper chamber, in which the Länder are represented) in the past: More than 70% thought that Bundesrat decisions were determined too much by party politics, thereby blocking important government reform bills. However, interviewees were split on the question of whether the competences of the Länder and the federal government should be separated more strictly so that the federal government can pass more laws in future also without the consent of the Länder: Only just under half were in favour of a stricter separation of competences.

The new federal government has rightly made federalism reform a priority issue. While the changes to the constitution that have now been initiated are to be welcomed, they reveal at the same time that Berlin lacks the courage to radically revamp the current federal system. Thus, despite the efforts to cut the number of laws that the Länder can veto, it must be assumed that the Bundesrat will still be able in future to block major bills and thus frustrate any government’s key political projects. On the other hand, although framework legislation (laid down by the federal government, with the details being filled in by the Länder) will be dropped and “joint tasks” (i.e. participation of the federal government in the discharge of Länder responsibilities) reduced in future, there is no sign of any significant strengthening of the Länder, e.g. by allowing them to levy important taxes of their own. As the close financial ties between the federal government and the Länder will be left virtually untouched, Germany continues to deprive itself of the opportunity to couple transparent fiscal federalism to stronger competition. The enormous potential for social innovation that lies in any federal system therefore remains untapped.

Yet politicians, business leaders and academics in Germany agree on both the general benefits of federalism and the basic need to correct the system. The fact that, despite this, little progress has been made to date on untangling federal government and Länder competences is due not least to the existing system of financial claims and equalisation payments, which would then be up for discussion. The tenacity with which the current fiscal equalisation mechanism is defended regardless of its many shortcomings is proof of this. But, above all, the scepticism expressed by many politicians about more competition between the Länder is proving to be a major obstacle.

This lack of courage when it comes to introducing more diversity, competition and individual responsibility has left its mark on citizens. When asked whether as much as possible should be decided uniformly at federal level in Germany or whether the Länder should not take a lot of decisions themselves, almost two-thirds of interviewees were in favour of decision-making taking place largely at federal government level. Evidently the fear that some Länder would not be able to stand up to competition from other others is causing many citizens to question the benefits of federalism. The frequently voiced complaints that the transfer of decision-making powers and responsibilities to Länder level – a current example is pay arrangements for civil servants – would widen the gap between richer and poorer Länder help to reinforce the prevailing mood of scepticism.

Politicians have a dual responsibility: Firstly, to make sure that the current changes to the constitution and various federal laws do not mark the end of the federalism reform. And, secondly, to call for lively competition between the Länder and underline the advantages of the federal system much more strongly than they have done so far. Like in many other policy areas, the rule here is that more competition opens up opportunities for more innovation and thus for more prosperity. We cannot afford to pass up these opportunities.