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Germany's Economic Insurance Policy

Warming to the 'Steadying Hand' of Government

By Christian Reiermann

If there is a recession in Germany, economists want to see leaders implement an economic stimulus program based on the American model. The strategy is part of a German resurgence in the ideas and proposals of legendary economist John Maynard Keynes.

The contents of a drawer are likely to play a decisive role in Germany's economic policy in the coming weeks. Oddly enough, the desk this drawer should fit into isn't an actual one. It's that of Michael Glos, the German Minister of Economics.

When Glos asked his staff to prepare an emergency plan "to keep in my drawer," he meant for them to prepare a plan containing measures designed to safeguard Germany against a recession, should the economy suddenly go south. Although that prospect isn't yet in sight, Glos wants to be prepared.

According the proposal to be delivered, the government would use investment programs and tax cuts to stimulate consumer spending and corporate investment. It's something new for Germany.

Getting over Economic Taboos

Because Americans are further along in the decline of their economy, they're also further along with their bailout measures. With a $150 billion (€102 billion) economic stimulus package, President George W. Bush and the US Congress hope to counteract the looming recession. The Federal Reserve Bank has rushed to the aid of politicians by significantly lowering the key interest rate -- most recently to 3 percent.

The deliberations in Berlin and actions in Washington mark a shift away from a policy of government nonintervention in economic decline. Under this most recent approach, the government takes an active role, stepping in to put a stop to economic slowdown through a series of measures.

Even the International Monetary Fund (IMF), which has always favored a policy of telling crisis countries to clean up their government finances first, is changing direction under its new chairman, Dominique Strauss-Kahn. "A new financial policy is probably the best way to respond to crises," says the IMF chief.

Given the magnitude of the crisis, politicians would prefer not to rely solely on the economy's ability to fix itself. During Germany's last economic downturn, then Chancellor Gerhard Schröder put great store in what he called his "steady-hand policy."

But now those in power are suddenly waving their hands energetically. They want state intervention to stabilize the economy when growing uncertainty throws off balance the unregulated interplay between supply and demand. This new approach represents a revival of the ideas of British economist John Maynard Keynes, ideas many believed had been relegated to the history books.

Early Attempts at Intervention

Until the 1970s, the governments of industrialized nations attempted to control their economies, responding to signs of weakness by introducing economic stimulus programs worth billions. In those days, central banks were all too willing to increase the money supply.

The outcome was mixed at best, at least in Germany. The country's first postwar economic stimulus program, introduced in 1967 by a grand coalition government led by the conservative Christian Democrats and center-left Social Democrats and spearheaded by then Economics Minister Karl Schiller, was relatively successful.

But later programs in the 1970s quickly fell flat. Unemployment went up, growth remained weak and inflation rose because the government had borrowed to increase the money supply. A policy that had been launched to stabilize the economy eventually led to a number of crises.

"The attempts to control the economy back then have been discredited, and rightfully so," says Bert Rürup, chairman of the German Council of Economic Experts, which advises the government. According to Rürup, the government implemented the economic stimulus tools in the 1970s in a completely incorrect way. It increased demand, even though the crises were not caused by weak consumption.

The real cause of the weak economy was the rapidly rising price of oil. Economists refer to this effect as a "supply shock." Today, they know that boosting demand is in fact harmful in this type of situation. "It was bound to fail," says Rürup.

Where Theory Found Success

After that, Keynes's works stood untouched and gathered dust on the back shelves of libraries -- except for those in Anglo-Saxon countries. American politicians are still fond of dipping into treasury funds to help the economy regain its footing. And these measures have worked there.

In the United States, the success of such programs can be attributed to the relative lack of a social welfare state. In Germany, on the other hand, unemployment insurance prevents demand from plummeting during a crisis. A similar mechanism is almost completely absent in the United States. "The need to react in an anti-cyclical way is greater there than it is here in Germany," says Rürup. This explains why the state is able to create demand so much more effectively in the United States.

The Americans have jump-started their economy a number of times in recent years, and their success has now prompted German economists to rethink their strategy. "A pragmatic view of measures designed to stimulate demand has emerged in recent years," says Rürup, adding that the majority view today is that, although the government should not intervene at every sign of weakness, it should not remain idle either. "It should only act when there is a threat of recession."

But Would It Work Here?

Hans-Werner Sinn, the president of the Munich-based Ifo Institute for Economic Research, is also convinced that American-style intervention is worth emulating. "It will be very effective," Sinn believes.

Tax cuts, combined with low interest rates, could protect the United States against a deep recession. Sinn recommends that the German government take a similar approach if the outlook for growth worsens. "It should do everything in its power to counteract decline, and it should lower taxes," says Sinn, adding that the advantage of lowering taxes is that it would be "effective on a wider front." It would put more money in consumer's hands, thereby boosting consumption.

Sinn also recommends a broadening of depreciation allowances for companies. Such measures, he says, would be more effective than the government investment programs that were common in the past. "Tax relief should be financed through loans," says Sinn. He believes that things are going well for the German government, which presented a balanced budgetin 2007, and that it has sufficient leeway to take on new debt.

Rürup, on the other hand, believes it would be more sensible to reduce payroll-related cost instead of taxes. Tax cuts would have no impact on the more than a third of all employees who pay no taxes at all. "That's why it would be preferable to further reduce employer contributions to social insurance," Rürup says. "This would relieve the tax burden, especially on low and mid-range incomes."

This encouragement from industry only helps the cause of officials at the Economics Ministry. They would like to reduce the burden on taxpayers by about €4 billion ($5.85 billion), a move they say would be especially beneficial to low- and moderate-income workers. The justification for this preferential treatment sounds, well, Keynesian. People in these income groups -- or so the theory holds -- are more likely to spend the additional money right away, which would be the most effective way to boost domestic demand. But officials at the Economics Ministry are also considering increases in government investment in infrastructure and a subsidy program for homeowners.