July 18: 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 behaviour 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.
Even if this pessimism proves wrong more often than not, it is like buying earthquake or fire insurance: sometimes it comes in handy. You can’t judge the policy by asking whether your house catches fire every single year.
Keynesians have criticised fiscal caution at this point in the economic cycle, arguing that fiscal stimulus will give economies more, not less, protection against adverse events. But is that argument valid?
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 sceptical 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-term planning, and have also managed to liberalise their labour markets, have flexibility and recently passed a constitutional amendment for a nearly balanced budget by 2016, meaning the structural deficit should not exceed 0.35 per cent of GDP.
The German government is also making credible long-term commitments to reduce its debt. Germany’s ratio of debt to GDP has been hovering at 70 per cent.
Yet many investors consider German bonds a haven, in part because the government has a reputation for addressing fiscal issues promptly and responsibly. It is working to cut government spending, although not in crucial long-term areas of research and education.