The Difference betweeen Germany and the United States Isn't Debt, It's an Industrial Policy

The libertarian economist Tyler Cowen has an op-ed entitled What Germany Knows About Debt in the New York Times today extolling the virtues of German fiscal prudence.

In many countries, including the United States, there are calls for the government to spend more to jump-start the economy, and to avoid the temptation to cut back as debts mount.

Germany, however, has decided to cast its lot with fiscal prudence. It has managed rising growth and falling unemployment, while putting together a plan for a nearly balanced budget within six years. On fiscal policy and economic recovery, Americans could learn something from the German example.

Twentieth-century history may help explain German behavior today. After all, the Germans lost two World Wars, experienced the Weimar hyperinflation and saw their country divided and partly ruined by Communism. What an American considers as bad economic times, a German might see as relative prosperity. That perspective helps support a greater concern with long-run fiscal caution, because it is not assumed that a brighter future will pay all the bills.

Cowen, who teaches economics at George Mason University and runs the libertarian Marginal Revolution blog, goes on to question the validity of Keynesian calls for another round of fiscal stimulus by pointing to the German experience after unification, the rather unequal absorption of the East by the much larger West.

Certainly, in Germany, the recent history of fiscal stimulus wasn’t entirely positive. After reunification in 1990, the German government borrowed and spent huge amounts of money to finance reconstruction and to bring East German living standards up to West German levels. Millions of new consumers were added to the economy.

These policies did unify the country politically but were not overwhelmingly successful economically. An initial surge was followed by years of disappointing results for output and employment. Germany’s taxes remain high, and overall West German living standards failed to rise at the same rate as those of most other wealthy countries.

Persuading former East Germans to spend more as consumers turned out to be less important than making sure that they had the skills to mesh with the economic expansion of the country. It is no surprise that many Germans are now skeptical about debt-financed government spending or excessive reliance on domestic consumers.

In recent times, Germany has shown signs of regaining a pre-eminent economic position. Policy makers have returned to long-run planning, and during the last decade have liberalized their labor markets, introduced greater wage flexibility and recently passed a constitutional amendment for a nearly balanced budget by 2016, meaning that the structural deficit should not exceed 0.35 percent of gross domestic product.

Amid the sluggish economies of much of Europe, Germany has booming exports and is nearing full capacity utilization. And many of its workers are postponing vacations to produce, and earn, more. The unemployment rate in Germany is 7.5 percent — below that of the United States — and falling.

The above was enough to send an already exasperated Paul Krugman into the throes of outright despair.

I’ll be frank: the discussion of fiscal stimulus this past year and a half has filled me with despair over the state of the economics profession. If you believe stimulus is a bad idea, fine; but surely the least one could have expected is that opponents would listen, even a bit, to what proponents were saying. In particular, the case for stimulus has always been highly conditional. Fiscal stimulus is what you do only if two conditions are satisfied: high unemployment, so that the proximate risk is deflation, not inflation; and monetary policy constrained by the zero lower bound.

That doesn’t sound like a hard point to grasp. Yet again and again, critics point to examples of increased government spending under conditions nothing like that, and claim that these examples somehow prove something.

Paul Krugman then goes on to point out why the German experience of the 1990s is not analogous to the situation we currently face here in the United States today.

1. This was not an effort at fiscal stimulus; it was a supply policy, not a demand policy. The German government wasn’t trying to pump up demand — it was trying to rebuild East German infrastructure to raise the region’s productivity.

2. The West German economy was not suffering from high unemployment — on the contrary, it was running hot, and the Bundesbank feared inflation.

3. The zero lower bound was not a concern. In fact, the Bundesbank was in the process of raising rates to head off inflation risks — the discount rate went from 4 percent in early 1989 to 8.75 percent in the summer of 1992. In part, this rate rise was a deliberate effort to choke off the additional demand created by spending on East Germany, to such an extent that the German mix of deficit spending and tight money is widely blamed for the European exchange rate crises of 1992-1993.

All true and Paul Krugman is right to debunk the comparison between the German situation of the 1990s and the American reality as of now. But there is also the present to account for. The German economy is far different than the American economy. Whereas in the United States exports account for about 13 percent of GDP, exports account for over 40 percent of the German economy. A fiscal stimulus that is aimed at raising internal demand isn't going to have the same impact in Germany as in the US. Even so, the Merkel government passed two discretionary economic stimulus programmes amounting to €84 billion, or $108.5 billion USD.

The German economy has rebounded, again largely on the strength of exports to emerging markets. Indeed, Chancellor Merkel just completed a week long state visit to Russia, China and Kazakhstan. In tow were 25 German industrialists signing trade deals. For example, Siemens signed a €2.2-billion ($2.8-billion USD) order to supply Russian Railways with more than 200 trains for its regional network at the meeting in the Urals city of Yekaterinburg. Siemens also inked an agreement to help Russia develop the Skolkovo high-tech hub outside Moscow -- Russia's answer to Silicon Valley -- and another deal with state conglomerate Russian Technologies and RusHydro utility company. Germany is now Russia's main economic partner and the two countries did some €47 billion worth of trade in 2008. As an aside, I'll note that internal German demand is still down about 1.1 percent from pre-recession levels, so it's not like the German economy is back to where it was before the downturn.

But if there is a lesson for the US to learn from the Germans, or indeed from just about any other major economy, it is on the merits of having an industrial policy.

One key part of this effort is state support for a public and quasi-public technology infrastructure at the applied end of the R&D chain. The Fraunhofer Society, which is an umbrella group for about 40 research institutes, is intended to fill the gap between basic and company-based industrial research. While most of the research is driven by industry contracts, the infrastructure of the Fraunhofer Society is publicly funded.

Germany is also one of the biggest promoters of basic research; with 20 percent of total world expenditures on basic science, it takes second place behind France (with 21 percent) and ahead of the US (with 16 percent) and Japan (with 12 percent). Given that the US is a much larger economy, $14.256 trillion versus $2.182 trillion, US underinvestment in basic scientific research should be painfully obvious. In addition to the basic research performed in the university system, the state also supports basic research through the Max-Planck Society, which is an umbrella organization for about 60 specialized research institutes focusing mainly on different areas of physics, biology, chemistry and medical research. About four-fifths of its budget comes from the federal and regional governments.

Germany also boast a publicly financed vocational training programme that works with the private sector. Vocational education and training is a joint government-industry program, one of these public-private enterprises that are common outside the United States. The federal government and the Länder(German states) share in the financing of vocational education in public vocational schools, with the federal government bearing a slightly higher share. Known as the Dual System and created in 1969, many economists point to Germany's vocational training programme as one of its competive advantages. Indeed, about 65 percent of the country's workforce is trained through the vocational education system.

In the United States, industrial policy has been traditionally largely set by venture capital and investment banks but over the past two decades our financial sector has morphed into glorified casinos instead of performing their traditional role of picking winners. Bring up the idea of an industrial policy, you are likely to be met with epithets of being a Marxist. And the idea of education as a public good, thanks to Ronald Reagan and the Friedmanites, is an anathema. Let me remind you that there are those who not only want to disband the Department of Education but to destroy the public school system itself. And in case it's not obvious, Germany's fiscal prudence is not burdened by an Empire. Germany spends but 1.28 percent of GDP on its military whereas we spend 4.16 percent. If you want to talk about restoring sanity to our insane spending, let's start there.


Tags: Fiscal Stimulus, Germany, Keynesian economics, libertarianism, US Economic Policy, industrial policy (all tags)


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