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To Bail or Not to Bail

German Government 'Has to Step into the Breach'

By Nina Bovensiepen, Dietmar Hawranek and Christian Reiermann

Ever since the world economy began to slump, Berlin has been besieged by demands to intervene. For years there has been deep resistance to stimulus programs in the Federal Republic -- but now even German thinking has started to change.

In matters of principle, German Finance Minister Peer Steinbrück of the left-leaning Social Democrats (SPD) is a man of almost Lutheran conviction. He sees economic stimulus programs as the work of the devil. “No matter how large a package the government launches, it cannot subsidize the economic crisis away,” he told a group of industry leaders in Berlin last Friday, “and I also have no intention of doing so.” Steinbrück is unwilling to budge on these principles.

For decades this point of view has been entrenched in the religious canon of German political debate. The state should not get involved in the ups and downs of the economy because it cannot smooth the turbulent waters of the business world, no matter how many billions of dollars it pumps into the system.

Wasn't this proved by the countless programs of the 1960s and 1970s? All that money vanished and achieved nothing. “Government debt rose, and the downturn came anyway,” says Steinbrück.

German Chancellor Angela Merkel of the center-right Christian Democrats (CDU) harbors the same reservations about state intervention in times of crisis. So do most politicians in Germany. The economic stimulus package approved by the German government three weeks ago -- not surprisingly -- was a half-hearted effort. It provides for only about €5 billion ($6.25 billion) a year.

This explains why Merkel and Steinbrück remain skeptical about proposals by the EU Commission to introduce a comprehensive €130 billion growth plan. They reject the idea -- at least for now -- of mobilizing fresh capital for such a scheme. As they point out, Germany’s share of the plan, some €25 billion, has already been earmarked, along with other funds, for domestic use, such as raising child benefit allowances next year.

In view of the increasingly gloomy economic outlook, it remains unlikely that the German government will get off so cheap. Almost every day, more bad news hits the wires about another hard-hit economic sector, and the Federal Ministry of Economics has sounded the alarm in an internal report: “We are on the brink of a recession in the world economy the likes of which we have not seen for decades.”

This report describes the downturn as global and warns that it could “snowball out of control.” What’s more: “Especially in Germany, which ranks among the most open industrial nations, it is likely that the drop in demand from abroad will spread to create a long-term downward spiral on the domestic market.”

German Economics Minister Michael Glos of the Christian Social Union (CSU), the sister party to the CDU, has been pushing for decisive measures to shore up the economy, but his calls have largely fallen on deaf ears. That could soon change, though, as the front against state intervention begins to crumble -- not least among leading economists.

There is a growing willingness to help struggling companies. The German government is considering offering carmaker Opel loan guarantees if the company should run into difficulties. And politicians in German state governments are calling for even more sweeping measures.

Hesse Governor Roland Koch (CDU) is pushing for a “protective screen for the automotive industry” modeled after the bailout for the financial sector. And Jürgen Rüttgers (CDU), the Governor of North-Rhine Westphalia, has made no secret of the fact that he wants to help not just carmakers and their suppliers, but also the chemical industry.

Although the chancellor and finance minister continue to hesitate, around the world a new understanding has emerged of what the state can and should do to help markets, especially when it comes to stabilizing the economy. Many economists and institutions that had once lashed out against government interventions are now calling for the state to play a more active role, especially in Germany.

There are increasing appeals for the German government to use large sums of money to initiate countermeasures. EU Commissioner for Economic and Monetary Affairs Joaquín Almunia -- whose position obliges him to limit spending -- has asked the Germans to take a more determined approach. The President of the European Central Bank, Jean-Claude Trichet, has been less direct in his comments, but his message has been equally emphatic. Dominique Strauss-Kahn, the Managing Director of the International Monetary Fund, also feels that Germany should contribute. “Where's Angela?” asked The Economist last Friday.

Nonetheless, the domestic political debate will perhaps be most significantly influenced by the change of course made by the German Council of Economic Experts, a highly influential independent advisory body. Contrary to previous publications, in its most recent report the council has advocated financing growth-promoting measures by incurring a temporary deficit.

There are, in fact, many reasons to change course. Earlier economic stimulus programs failed because they tried to cure structural faults, such as the 1973 oil price shock, with additional government expenditure. This proved to be the wrong therapy.

But the current situation is marked by a massive drop in demand that could worsen. Banks are approving fewer loans, companies lack money for investments, and consumers are holding back on purchases. Carmakers have already been hit by this development. Daimler, Opel, Ford and others have laid off temporary workers, sent employees on forced holidays and curbed production.

Automotive suppliers have also felt the ripple effects of the financial crisis. This sector employs 320,000 workers, representing nearly half of the jobs in the German automotive industry. Bosch has reduced working hours at a number of plants, and German supplier Hella has also laid off temporary workers and cut back on employees’ working hours.

The downward trend has spread to other industries. As fewer cars roll off production lines, demand lowers for "downstream" materials like paint or plastic, as well as whole items like catalytic convertors. This also hurts the German chemical industry. Last week, market leader BASF announced that it would halt or curtail production in 180 of its plants.

Some 20,000 of the 95,000 workers at BASF have been affected. They have to take time off work to eliminate accumulated overtime and vacation time. Working hours may also have to be reduced.

Similar cycles have been observed in other industries, and German economist Peter Bofinger sees an alarming downward spiral. “There was no way to foresee that we would be hit this hard,” he says, adding that the German government should boost its “limited” economic program. Bofinger, who has close ties to trade unions, has been advocating such measures for a long time. What is new is that such points of view in Germany have become mainstream.

“In such a situation, marked by weak demand, it is perfectly advisable to intervene with a stabilizing government capital injection program,” says Clemens Fuest, a German professor of economics at Oxford University. Fuest’s opinion is important. He's the chairman of the academic advisory board to Steinbrück’s Finance Ministry -- and his message has apparently already been embraced by the Economics Ministry.

“It is necessary to react to the looming drop in demand -- in a targeted and non-partisan manner -- with initiatives that boost demand,” wrote Fuest's team of experts. Now is the time for the government’s fiscal policy to play a more active role “because, in the current climate of general mutual mistrust, monetary policy only has a limited degree of effectiveness among financial market players around the world.”

In other words, although the central banks have significantly lowered their key interest rates, banks are lending less money.

“In a situation like this the government has to step into the breach,” says Fuest, who adds that Germany can afford a stimulus package because its budget is largely balanced.

Fuest, 40, comes from a younger generation of German economists who have rediscovered the impact of fiscal policy on the economy. For years, proponents of stimulus programs were not taken seriously among German economists.