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11/04/2008 02:42 PM

Sinking into a Recession

Economic Crisis Mounts in Germany

By SPIEGEL Staff

German Chancellor Angela Merkel is putting up a lot of money to try to quiet hysterical markets. At the same time, though, Germany and Europe appear to be sinking quickly into a recession. Experts believe a massive economic stimulus package is needed to stop the slide.

German Finance Minister Peer Steinbrück is a frugal man by trade. Keeping track of the country's money is part of his job description, while reducing its debt is his most important goal. He expects Germans to do their part by going along with drastic tax increases, and he wants his fellow cabinet members in Chancellor Angela Merkel's government to carefully control their spending.

Last week, Steinbrück felt the need, once again, to cast his protective net over his treasury. At issue was whether the Germany needs a comprehensive economic stimulus program to jumpstart the economy. The left-leaning Social Democratic Party (SPD) called for a spending package worth €25 billion ($37.3 billion), while Economics Minister Michael Glos, a member of the conservative Christian Democratic Union (CDU), argued in favor of tax cuts across the board.

Workers at Kiel's Lindenau dockyard: Ironically, the economic downturn is affecting those who were responsible for the recovery of the last few years.
DPA

Workers at Kiel's Lindenau dockyard: Ironically, the economic downturn is affecting those who were responsible for the recovery of the last few years.

With his characteristic directness the finance minister, who was against both proposals, set his opponents straight. Economic stimulus programs, he said heatedly, would "only increase the national debt and impose a higher financial burden on future generations." Steinbrück went on to speculate that the programs could end up consuming vast amounts of money without having any significant effects on the economy.

Steinbrück has prevailed -- at least for now. But his alleged argument in favor of frugality and economic rationality could prove to be a mistake when it comes to economic policy.

The financial crisis is still anything but overcome, and there is good reason to fear that yet another major bank or two could falter. And the world's stock markets are still in a state of upheaval. Since the beginning of the year, the 30 stocks that make up Germany's DAX index of blue chip companies have lost the unthinkable sum of €346 billion ($517 billion). The banking debacle has fueled fears of recession worldwide, while weaker nations like Iceland and Pakistan are already teetering on the brink of bankruptcy.

Even levelheaded economists are drawing parallels to the Great Depression of the 1930s. Central banks are flooding the markets with low-interest capital, and yet banks remain extremely reluctant to issue new loans, even for creditworthy projects. This, in turn, has led to companies putting their investment plans on hold and a growing feeling of uncertainty among consumers.

A movement has been put into motion that resembles the scenarios British economist John Maynard Keynes described more than 70 years ago in his "General Theory." Because trust has been essentially destroyed in the financial and credit markets, banks, companies and consumers are hording their money instead of lending or spending it. This behavior leads to what Keynes described ask a "liquidity trap" in the economy. In the end, massive government expenditures, paid for with public debt, are needed to resolve the crisis.

Economists and politicians in many countries have now recognized -- and reacted to -- the fact that what the Financial Times calls the "mother of all financial crises" comes awfully close to the scenario Keynes outlined. Governments from Washington to Tokyo, hoping to slow down the economic decline, want to lower taxes, issue more government contracts and increase public assistance for businesses and the unemployed. The cloak of emergency aid has already been used to conceal a number of new subsidies, including assistance for the US banking industry and the ailing American automotive industry.

Graphic: A new ice age?
DER SPIEGEL

Graphic: A new ice age?

In Germany, on the other hand, the political elite has behaved as if it were dealing with a run-of-the-mill dent in growth. Members of parliament across the political spectrum have cautiously proposed a wide range of measures to jump-start the economy, while at the same time stressing that what they have in mind is not an economic stimulus program. Their proposals had hardly been unveiled before senior strategists at party headquarters began trimming away, arguing that government welfare for citizens should be saved for the election campaign.

As a result, the stimulus package Berlin's Grand Coalition government of Christian Democrats and Social Democrats plans to unveil this week will be greatly reduced in scope. It is expected to include a few tax incentives for car buyers, private households and businesses, as well as low-interest government loans for municipalities and homeowners. While the German government is providing close to €500 billion ($747 billion) to bail out the banks, it expects to spend no more than €5 billion ($7.5 billion) a year to boost the real economy. This is less than a quarter of the amount officials in Steinbrück's ministry have consistently named as the minimum necessary for an effective growth package.

After having hesitated for so long with its bank rescue package that countries like the United States and Great Britain ended up leading the way, the Grand Coalition is now about to propose a plan that would fall far short of expectations.

According to former Economics Minister Wolfgang Clement, a Social Democrat, what Germany needs now is "heavy investment in schools and universities and a compact infrastructure investment program." Clement believes that the only solution to the global economic crisis is a "global investment boom," and that this is not the time to get bogged down in details, but rather to take a more forceful approach.

But officials at government headquarters in Berlin have a different take on the economic situation. "A broad stimulus program," Chancellor Angela Merkel said last week, would only set off a "short-term blaze."

It is certainly true that economic stimulus programs can be harmful if they are poorly planned and put in place at the wrong time. But when applied in a sensible way, such programs have often proved to be beneficial.

"Right now, increased government spending is just what the doctor ordered," says this year's winner of the Nobel Prize in Economics, Paul Krugman. Dominique Strauss-Kahn, the director of the International Monetary Fund, seems to agree when he proposes "quick and forceful" multinational spending programs.

This advice is partly intended for Germany. As recently as late summer, the German economy was considered extremely crisis-proof, with its relatively manageable banking sector and many fundamentally solid exporting companies. The experts, hoping to preserve calm, said that this combination of factors would help Germany navigate the financial crisis more effectively than most other industrialized nations.

But now it is precisely this strength in world markets that has become so disastrous to the German economy. A Wall Street banker who has lost his job is unlikely to be buying a Porsche these days. And Russia's cash-strapped oligarchs now lack the capital to buy German building machines. With key buying countries like the United States and Great Britain rushing into recession, business is also suffering in Germany, the world's leading exporting nation.

'Any Plan I Make Is Obselete the next Day'

Only a month ago, German government experts predicted that the domestic economy would grow by at least one percent next year, but now they have reversed their forecast to a one-percent decline in growth. Such a sharp decline has not occurred in many years.

The situation in the euro zone, the 15-nation currency bloc, is even worse. The European Commission announced on Monday it expected negative growth for the third quarter. The euro zone economy contracted by 0.2 percent in the second quarter, and this would place the bloc within the definition of a recession used by many economists. In addition, the euro zone is only expected to grow by 0.1 percent in 2009, down from an already low April estimate of 1.5 percent.

The crisis feeds the crisis, at least judging by the current experiences of Kronoply GmbH in Brandenburg, one of the world's largest producers of laminate flooring and a supplier of derived timber products. The company gets the raw materials for its wood flooring from the forests of the eastern German state of Brandenburg, and it exports its products to specialized dealers and DIY stores the world over. Until some time ago, the company earned about one-fifth of its revenues in the United States.

But now that millions of Americans have lost their homes to foreclosure, the company has "almost completely lost" its US business," says Kronoply Managing Director Roland Kovacic. And the crisis is spreading, as Kronoply's American competitors, facing plunging sales in the United States, are shifting to the Japanese market. Thanks to a more favorable exchange rate, they can undercut Kronoply's prices in Japan.

As laminate flooring begins to stack up in Kovacic's distribution center, his factory buildings are emptying out. Kronoply has already sent some of its temporary workers home, and now Kovacic plans to cut 70 of the company's 700 full-time positions.

German Finance Minister Peer Steinbrück (left) and Chancellor Angela Merkel: The programs could end up consuming vast amounts of money without having any significant effects on the economy.
DPA

German Finance Minister Peer Steinbrück (left) and Chancellor Angela Merkel: The programs could end up consuming vast amounts of money without having any significant effects on the economy.

The situation at Kronoply resembles conditions in many German industrial firms today. In the machine-building industry, some companies are reporting a decline in orders in the double-digit percentage range. MAN, a manufacturer of utility vehicles and machinery, has seen a decline in order volume by almost 40 percent in the third-quarter of this year. At Lufthansa, profits declined by more than half in the same period. The Association of German Collection Companies predicts 35,000 corporate bankruptcies next year, compared to about 30,000 this year and close to 29,000 in 2007.

The downturn has been accelerated by the fact that Germany's key industry, the automobile industry, is the hardest-hit. Only a few months ago, Daimler, Audi and Volkswagen were boasting about their glowing sales figures in the United States and Eastern Europe, and domestic sales were also beginning to pick up.

But now auto industry executives are forced to look on in consternation as the crisis infects their sector. "Any plan I make on a given day is bound to be obsolete the next day," says Klaus Maier, the head of sales and marketing at Mercedes-Benz.

To address the crisis, Germany's leading corporations have interrupted production and are planning an extended Christmas vacation period. At BMW, management and labor representatives are currently in negotiations over whether the assembly lines in some of the company's plants, such as the one in the Bavarian city of Regensburg, should be shut down for an even longer period of time. Porsche will shut down production at its plant in Stuttgart's Zuffenhausen neighborhood from Dec. 22 until Jan. 9, 2009. If sales remain sluggish, Porsche may shift some of the production of its Boxster and Cayman models away from its Finnish contract manufacturer Valmet to Zuffenhausen, so that the plant there will be utilized to capacity.

Graphic: Billions for the Economy
DER SPIEGEL

Graphic: Billions for the Economy

If the auto plants are shut down, suppliers of tires, seats, car radios and other parts will also be forced to interrupt their production, and eventually the slowdown will spread to sub-suppliers. Problems in the auto industry will also snowball quickly into downstream sectors, such as advertising, engineering and various trade professions.

With sales down across the board, manufacturers are asking themselves how they will be able to keep their employees occupied in the coming months. Many companies are reducing working-time accounts, some have announced abbreviated working weeks and others are already preparing for layoffs. Almost all companies have already sent home their temporary workers. Tiremaker Continental will lay off 5,000 temporary workers worldwide by year's end, while Ford plans to let go 200 temporary workers at its plant in the western German city of Saarlouis.

Can Efforts Stop Downward Spiral into Recession?

Ironically, the economic downturn is affecting those who were responsible for the recovery of the last few years. The number of temporary workers has increased by more than 500,000 within the last decade, and now they are the first to be let go. One of them is Kevin Eberhardt, a 23-year-old metalworker from the eastern German city of Erfurt.

Only a few weeks ago, Eberhardt's temporary agency sent him to work for an automotive firm in the eastern city of Leipzig. It was a sure-fire job, he was told, and the work paid €8 an hour. Eberhardt accepted the job, and he and his girlfriend spent the last of their savings on the move. But after he had worked in Leipzig for three weeks as a vacation replacement, his new employer no longer had any work for him.

Now, after Eberhardt has moved into a three-room apartment in Leipzig and lost the job that prompted the move in the first place, his temporary agency has offered him another job, this time in Munich. But his girlfriend has just found a job in Leipzig, and who will guarantee Eberhardt that the job in Munich will last? He decides to turn down the offer. "And now they say everything is about to get worse," he says. "I'm beginning to ask myself whether I have any prospects at all anymore."

At times like this, when the economy threatens to descend into a downward spiral of pessimism and people biding their time, the question is: Can the public sector make up for the decline in demand in the private sector?

Yes, say economists, provided a few conditions are met:

The state has essentially three options at its disposal for stimulating the economy. The first seeks to influence the conditions of production in companies with such measures as low-interest loans, improved depreciation options and lower company contributions to employee healthcare and retirement premiums. The second option is directed at consumers. Governments stimulate private consumption by allowing citizens to hold onto more of their money. Finally, in the third option the government itself acts as a buyer of goods and services, such as by commissioning the construction of public buildings.

Experts are divided over which instrument produces the strongest stimulus. Should the German government send every taxpayer a check for €100, as the administration of US President George W. Bush did this past spring? Should it abolish the solidarity surcharge in Germany -- a special tax paid by all Germans to cover the costs of the reunification of East and West Germany or, as suggested in a proposal by the economics institute RWI Essen (RWI), would it be better to reduce social security contributions?

The results of a study by the Institute for Empirical Economic Research at the University of Leipzig suggest that a debt-financed government investment program would provide the greatest relative benefit. The authors of the study calculated that additional spending on infrastructure and home building is twice as effective as reducing taxes or social security contributions. This is partly explained by the fact that many Germans would simply deposit their tax rebate checks into their bank accounts, instead of spending the money. For this reason, a program based in large part on giving tax breaks to those in higher income brackets makes no sense.

The experts also agree that a government program to stimulate demand must be vigorous to have a positive effect on the economy. Smaller spending programs, they say, are ineffective. The economists at the University of Leipzig based their calculations on the assumption of €45 billion ($67 billion) in additional government investment within the next three years. According to Thomas Mayer, an economist with Deutsche Bank, an "aggressive impulse" is needed to stimulate demand.

The economic stimulus program with which Sweden pulled itself out of its banking crisis in the early 1990s is seen as a blueprint for Germany. Under that program, it took the government three years and one-tenth of the gross domestic product to jump-start the economy.

In light of Sweden's success, economists are all the more disappointed with the package of measures the government is now developing. The two main parties, the CDU and the SPD, have agreed to the classic minimum compromise, as a document from the Economics Ministry indicates. Under the program, companies will pay fewer taxes when they purchase a new machine or production facility. The state-owned KfW Bank will make an additional €15 billion in loans available to small and mid-sized businesses. Additional government funding will also be provided for programs to promote energy conservation investments in communities (€3 billion) and companies (€1 billion), as well as for new investment in public infrastructure and transportation (€3 billion). Anyone buying a new car will be exempt from paying automobile tax in the first year of ownership. The tax exemption even applies to the first two years of ownership in the case of especially environmentally friendly vehicles. At the same time, the annual automobile tax will revised so that, beginning in 2011, it will be based on a vehicle's CO2 emissions.

According to government sources, the planned automobile programs will stimulate spending of roughly €30 billion ($44.8 billion). In truth, however, the government will spend only an additional €10 billion ($14.9 billion) in the next two years to stimulate the economy.

Still, experts don't believe that the measures will be sufficient to stop the downward spiral into recession. Part of the reason, they argue, is that a portion of the government funds will flow into projects that would be undertaken anyway. Besides, the package is simply too small to be capable of halting the downward trend.

For a time, it seemed as though the SPD and the conservatives were on their way to introducing a real stimulus program. The Social Democrats envisioned a government spending package worth at least €25 billion ($37.3 billion). The plans of Economics Minister Glos to quickly reduce the tax burden on citizens by billions of euros were well received within the CDU and its Bavarian sister party, the Christian Social Union (CSU).

Meanwhile, Finance Minister Steinbrück, concerned about his budget, saw to it that the SPD abandoned its concept. Chancellor Merkel, a Christian Democrat, quickly lost her resolve to significantly reduce taxes when her advisors told her to save her handouts to the people for next year's election.

The about-face happened quickly, too quickly for some leading politicians in the CDU and CSU. Just as CDU General Secretary Ronald Pofalla was announcing additional tax cuts for citizens, Volker Kauder, the party's parliamentary leader, was spreading the opposite message to the people: "There is currently no money for tax cuts."

What next? At this point, only one thing is clear: Once 2009, an election year, rolls around, the Grand Coalition will be more consumed with itself than anything else.

NINA BOVENSIEPEN, INA BRZOSKA, DIETMAR HAWRANEK, ALEXANDER NEUBACHER, MICHAEL SAUGA, JANKO TIETZ

Translated from the German by Christopher Sultan

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