Architect of Austerity: Schäuble's Search for a Way Forward

By Ullrich Fichtner and Alexander Smoltczyk

Photo Gallery: What Makes Schäuble Tick? Photos
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Part 2: The 'German Ideology'

A generation of economists has studied the trauma of the 1929 panic that led to the Great Depression. It dominates their theories and pervades their models. The lessons of that great crisis led to the emergence of two schools of thought that remain hostile to each other to this day, and that can quickly transform discussions of fiscal and economic policy into an ideological minefield.

During the crisis and as a result of its dissection by academics, London currency speculator John Maynard Keynes and Friedrich August von Hayek, the son of a Viennese doctor, became the champions of the two camps. Keynes assigned responsibility to the government, while Hayek, despite everything, continued to argue that markets should be as unregulated as possible.

To this day, controversies in economic theory can still be interpreted as variants of the contradictions between Keynes and Hayek, even if today's debates are conducted with the sophisticated mathematical models of econometrics. For Keynesians, the market is an animal that requires taming. Students of Hayek, on the other hand, prefer to see the state as a night watchman, establishing a loose framework and allowing the markets to run their course. Instead of battling a crisis, the best approach is to weather it like a storm. "These categories are too simplistic for my taste," says Schäuble. "I have a disdain for them shaped by experience. I'm beyond that."

The Flexible Approach

Perhaps that is why he and his advisors end up periodically changing their positions. In the endless corridors of the Finance Ministry, the dispute between the two schools of economic thought has broken down into a question of the right timing, with "Keynes" sufficing for the short term and "Hayek" for the longer and long term. Their goal is to maintain a balance between the rapid stimulation of a tired economy and the long-term achievement of a reasonable level of debt. They call it the "flexible approach to regulatory policy," which the rest of the world tends to describe, and deride, as the "German ideology."

Even when Schäuble sounds like former Chancellor Gerhard Schröder, who once casually decreed that there is no left-wing or right-wing economic policy, but merely a modern and an outmoded economic policy, he still imposes a policy on Germany's European neighbors that their governments see as conservative, at the very least, and substantially inspired by Hayek.

Someone who seeks to enshrine debt limits in the constitution, thereby strapping a chastity belt of fiscal policy onto the government, who advocates stability pacts and for whom a low debt level is more important than high unemployment figure, is staking out an ideological position.

This is the view critics, from France's Socialists to US President Barack Obama to Left Party politician Sahra Wagenknecht, hold of the new "German ideology." Schäuble finds such criticism "ridiculous" and believes that the dispute over "austerity" boils down to a "misstatement of the issues." Anyone who seriously considers the problems of countries, he says, can only conclude: "In many cases the economic foundations have become fragile, and this doesn't work in the long run. That's why simply injecting more money doesn't do any good, and why improving the underlying economic conditions is so important."

Establishing a Threshold

It is a very German and very Protestant view, which, until 2010, could easily have been dismissed as moral nonsense because it lacked strong scientific evidence. But during the course of 2010, that evidence was supplied just in time for the Greek crisis, when economists the world over were able to prove that high levels of government debt stifle growth.

In a short, elegant paper, Harvard Professors Rogoff and Carmen Reinhart even established a number, a "threshold," or magical limit: They wrote that growth suffers when government debt exceeds more than 90 percent of a country's gross domestic product. It was the kind of knowledge that could be used to shape policy.

It also helps to explain the interplay between policy and science. Since their 2010 bestseller "This Time is Different," the names of the two authors, Rogoff and Reinhart, have become a quality seal of sorts. The 90-percent mark quickly became a welcome tool for all those politicians who had always believed austerity was better than borrowing.

Throughout 2011, European Commissioner for Economic and Monetary Affairs Olli Rehn used the expressions "90-percent rule" and "90-percent threshold." They were now being quoted whenever the time came to cut budgets, admonish habitual debtors and intervene in the policies of other countries. Olivier Blanchard, chief economist of the International Monetary Fund (IMF), called the 90-percent threshold "a good reference point." And as soon as the Rogoff-Reinhart paper was published, officials at the German Finance Ministry recognized its potential value in furthering their agenda.

All Hail the Cash Injection

From all corners of Europe, there were growing calls to finally inject more money into the heart of the economy and to put an end to austerity -- with its side effects of the elderly begging for money, young people being deprived of opportunity and burning barricades in Athens and Madrid -- and to finally stop taking debt more seriously than the destruction of the European project.

At the time, the economic policy division supplied Schäuble with ammunition to fend off this attack. It argued that confidence in a sound government has historically carried more weight in Europe than in the United States. It also argued that high debt levels impose a far greater burden on Europe than on the United States, home to the world's currency, and where the government also has the option of simply printing more money. During the various conferences of the period, Schäuble argued that taking on even more debt was not the way to fight existing debt, as Rogoff and Reinhart had stated in their paper.

The Harvard professor was summoned as a crown witness of sorts against the kingdom of the dollar, on the one hand, and against the tendencies on Europe's periphery to ease off austerity, on the other. In a speech to the German parliament on Jan. 17, 2013, Schäuble mentioned Rogoff directly, saying: "We now know -- as even the former chief economist of the International Monetary Fund, Mr. Rogoff, has demonstrated -- that at a certain level of government debt, a further increase in debt no longer stimulates growth, but in fact hinders it in the medium term. This is precisely why we don't do that."

The Keynesians Strike Back

Last April, three years after the publication of the Reinhart-Rogoff paper, a student at the University of Massachusetts Amherst made headlines when he claimed to have refuted the Harvard professors' numbers. Thomas Herndon, a 28-year-old graduate student in economics, concluded that the 90-percent study was filled with embarrassing typos, was based on incorrect data and compared apples with oranges. According to Herndon, key figures in the study were wrong and essentially worthless. Before long, Herndon's conclusions had been reported in every newspaper, blog and tweet from Alaska to Tierra del Fuego, and from London to Tokyo.

Rogoff suddenly found himself confronted with a digital mob instead of the civil academic community. Rogoff, a scholar who has been a chess grandmaster since the age of 25, talks about the incident in his office at Harvard University. He has withdrawn from the public eye and has stopped giving interviews, fearing that anything he says will only be used against him. He agreed to an interview with SPIEGEL in an effort to defend his credibility.

Rogoff says that at times he was receiving up to 10 emails every five minutes, that he was called a filthy pig and a murderer, and that some people even suggested he should die. He says that he will never forget some of the attempts to assassinate his character on television. Some of his colleagues, he says, have called him the victim of an outrageous and even fascist campaign. He insists that he isn't telling us these things so that we will publish them, but instead to help us understand him.

"Our 90-percent thesis doesn't mean that everything is fine up to 89 percent and that everything becomes catastrophic starting at 91 percent," says Rogoff. "But something happens at this threshold. Perhaps we haven't understood it fully yet, but no one can seriously believe that it isn't a problem that some countries are reporting their highest ever national debt levels in times of peace." So is Rogoff truly the premier advocate of rigid austerity, as his critics and enemies claim? Rogoff laughs out loud -- bitterly and almost despairingly -- at the question.

Dragged Through the Mud

He can present entire binders of newspaper clippings that demonstrate how perfectly balanced the arguments he and Reinhart presented publicly have been; how they warned against radical austerity; how they advocated adjusting government budgets in a sustainable and reasonable manner, and with a sense of proportion; how they even advocated Keynesian ideas so as not to stifle growth; and how he, Rogoff, campaigned for a little less stability in Europe and a little more inflation in order to find a gentle path of transition. But none of it did very much good.

"How much unemployment did Reinhart and Rogoff's arithmetic mistake cause?" asked the British newspaper The Guardian. Rogoff is appalled by such reductive arguments. He, who prides himself on being nonpartisan and describes himself as a "centrist," whose works were cheerfully appropriated by all sides in the US presidential election campaign and quoted as proof of the validity of their opposing programs, feels like a victim of collateral damage in the old war of ideologies. "What can an academic do when politicians pepper their speeches with his name? Should I have issued a denial each time? To whom?"

In the Keynesian camp, the no less renowned New York Times columnist and Nobel laureate Paul Krugman wrote about the "Rogoff-Reinhart saga," depicting the economists in a highly unflattering light. Soon the two economists were appearing in cartoons as a pair of bunglers who, out of sheer stupidity, had the prosperity of entire nations on their conscience. As recently as this June, a major article in the German newspaper Die Zeit erroneously claimed that the 90-percent mark had been disproven and that austerity policy was wrong.

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1. optional
peskyvera 09/26/2013
He certainly is creating a lot of enemies. Looting the poor for the benefit of the rich.
2. Great Politician, Great Man?
Jim in MD 09/26/2013
This is a nice attempt to heroize Germans through a supposedly great man. He is a fantastic politician, but Herndon's real insight was that most economies that went bust at 90% debt/GDP were small with financial markets that were least transparent. Schauble knows that Greek debts are held by German banks. He also knows that Greece could not pay back its debt in a decade with even moderate growth! Germany is playing a dangerous game in choosing to keep zombie countries going in its own back yard. Schauble's self-righteousness would be tolerable, if he got good results. People are suffering, but reforms are not being made even in France. For a politician of his stature, it is a real failure.
3. optional
danm 09/26/2013
First I would like to thank Herr Fichtner for a fantastic article. Truly first rate journalism. Second, I agree wholeheartedly with the conclusions of Schauble and Rogoff. People can quibble over the exact point of the threshold, but anyone who believes unfettered debt levels and unrestrained government budget deficits will not eventually work against economic growth are morons. And Schauble is exactly right when he says throwing more money at a broken system will not magically fix it. The underlying problems must be addressed first or the money will be largely wasted. Until southern European countries start collecting taxes, cutting their bloated public sector job rolls and cutting their social services back to at least German levels, any talk of solving their problems with massive loan guarantees from Germany is nonsense. Third, what Schauble and Rogoff are saying is very similar to what the Republican party has been saying in the USA since 2008 when this crisis began. Heck, this observation about government debt being a harmful thing to an economy was one of the very reasons the Tea Party was created in the USA. We may not have had the scientific approach to the problem that Rogoff has supplied, but we intuitively understood these truths based on simple observation well ahead of Rogoff’s publications. After reading this article, I feel not only agreement with these men but also the sympathy one gives to a kindred spirit. I sincerely admire both of these men and I wish them well. Fourth, the way Rogoff was treated is disturbing but all too familiar. The press has always been an advocate for the hard left and when voices speak out against their agenda these people are attacked viciously. Their character and intelligence are questioned. Threats are made. You used the term “facist” while I tend to think of it with a specifically American term, “McCarthyism”. Too many people in the press are like Roy Cohen in tactics and temperament and they will try to destroy anyone who does not conform to their leftwing orthodoxy whether we are talking about austerity or climate change or immigration. And that is why I view the press, in it’s current incarnation, as the single biggest threat to democracy.
4. optional
mjk 09/27/2013
danm. Excellent points. The article is extremely informative and well written. Font need to be a Tea Partier to understands Rogoffs main point.
5. Up to now the Euro has brought only problems
Inglenda2 09/28/2013
How many roads must a man walk down, before he admits he is lost?
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