Stimulus vs. Austerity: Is Germany Saving Itself to Death?

By Gustav A. Horn and Michael Hüther

German Chancellor Angela Merkel has chosen the path of austerity to push her country out of a debt crisis that threatens to weigh on generations to come. Two German economists debate the merits of the government's savings program on SPIEGEL ONLINE: Should Berlin cut back or spend to ensure economic health?

Are the German government's savings measures a burden or a crutch for the economy? Zoom
dpa

Are the German government's savings measures a burden or a crutch for the economy?

DPA

Austerity Is Bad for Business

Gustav Horn, director of the
Macroeconomic Policy Institute (IMK) in Düsseldorf

The financial sector is to be blamed for the current crisis, but ordinary people are being forced to pay for it. That is not only unjust, but it will damage the economy. The German government is setting a course that will stifle growth.

"We have lived beyond our means," German Chancellor Angela Merkel has been fond of saying in explaining her chief motivation for pushing through her government's austerity measures. But that line of thinking is false. After all, it is not "we" who have lived beyond our means, but rather a financial sector that, in its search for ever higher profits, assumed ever greater risks in deals that eventually collapsed. "We" have bailed out the financial sector with billions of euros, and "we" have stimulated the economy -- and all this after "we" sacrificed over the years by exercising restraint in wage increases in order to boost the economic competitiveness of German business. And how are "we" rewarded for all this? With increasingly precarious work conditions, which have led to only moderate increases in jobs even during an upswing, diminishing purchasing power for broad swaths of the population and fast-growing inequality within our society. And with the global financial crisis.

To put it bluntly: Against this backdrop, even a savings package that was socially balanced would still be a scandal. But it is particularly scandalous if a savings package leaves the perpetrators largely untouched and distributes the burden amongst the people who had absolutely no part in creating the financial crisis. Yet that is precisely that blatant injustice of this savings program.

But that's only one aspect. The program itself will also have a negative impact on the economy. It won't be felt too much this year or next -- the initial volume is too small for that. For 2011, the drag on growth will be slight and amount to less than 0.5 percent of gross domestic product. But it's a different picture for the subsequent years starting in 2012. The volume of savings will increase sharply year by year, and the planned savings will have a massive slowdown effect on the economy which could only be absorbed if there is a really strong and self-sustaining recovery.

Too Soon to Burden the Fragile Economy

Will this resilient economic recovery actually materialize? There are serious doubts it will. The economy may be on a marked recovery path thanks to generous stimulus programs around the world, and also in Germany. But the pre-crisis production levels have not yet been reached in Germany or the rest of the euro zone. In other words, it is too soon to put too much of a burden on the economy.

One also has to take into consideration the fact that the national economic stimulus programs expire in 2011. That's not only true for Germany, but also for the entire euro zone, where certain problem economies like Greece have had to institute extremely harsh austerity measures. That alone could slow down the speed of recovery considerably, even if the heavy devaluation of the euro amounts in welcome momentum for German exports. Austerity measures are a hazardous undertaking because all other euro-zone members have simultaneously instituted broad savings packages, too.

It would be better if one would use intelligent economics in lieu of the austerity logic of Chancellor Angela Merkel's government. Then savings measures would be formulated in a way that would be both fair and, one would hope, largely harmless to the economy in the coming two years. In other words: The German government should implement its financial transaction tax -- even it if the country is forced to go it alone without international support -- and, at a later time, a bank levy. Additionally, the country's former wealth tax should be reintroduced and inheritance taxes increased. At the same time, inconsistencies in value added tax must be fixed. Those steps would be a lot more reasonable, and they would ensure that "we" all don't live beyond our means in the end.

IW Köln

Austerity Is Not Bad for Business

Michael Hüther, director of the
Cologne Institute for Economic Research

The austerity package passed by German Chancellor Angela Merkel is not all bad. Government savings can even produce economic growth. But Berlin didn't go far enough.

It's like a reflex: As soon as Chancellor Angela Merkel's governing coalition introduced its austerity program, critics complain that it is socially unbalanced and will hinder economic growth. The same thing has happened before. When former German Chancellor Helmut Schmidt introduced a far-reaching package of spending cuts in the early 1980s in an effort to stabilize the federal budget, the so-called experts hastily calculated that the already troubled economy would lose one half of a percentage point of growth. They were wrong. Shortly thereafter, the long-lasting boom of the 1980s began.

International studies can easily explain why this was so: If the burden of national debt is perceived as oppressive and if a state's financial flexibility becomes endangered by its need to service that debt, then citizens see every serious effort at cost cutting as a relief. In other words: A growth-oriented consolidation of the national budget results in confidence in the future.

Growth-oriented, in this respect, refers to a strategy that shuns broad tax increases and avoids drastic cuts to investment-focused budgetary expenditures. But austerity measures must be bold in order to trigger consumer and investor confidence. Timidity doesn't work. History shows that such an austerity package can even provide the economy a boost on the short term. Consumers see a bright future and make their purchasing decisions accordingly -- which boosts growth. This effect more than offsets reduced government spending.

Subsidy Reduction Didn't Happen

How are we to judge the austerity measures just passed by the Merkel government? There are no far-reaching tax increases, which is good news. Furthermore, spending on education, science and infrastructure will not be cut, also a positive. Most of the cuts lie in the realm of fixed payments for welfare and unemployment, which has resulted in accusations of social imbalance. But the changes made to the benefits for the long-term unemployed will in fact increase their motivation to find work. That ensures fairness in the welfare system and unburdens the labor market. In addition, cuts aimed at placement services and training schemes were long overdue, with several studies having found that they were only marginally successful.

The coalition's austerity package certainly raises questions as well. Some €5.6 billion is to be saved through "global spending reductions" -- though nobody knows where those cuts are to be made. That is hardly an expression of confidence. Also, the planned changes in the energy tax are unfortunate, potentially endangering the survival of the industry. It's additionally disappointing that no broad reduction in subsidies was undertaken. There is still vast potential for further savings.

Still, this package will not have the negative impact on the economy its detractors fear. The problem is rather that it is too fragmented, making it unlikely that citizens will regain confidence in the country's fiscal policy. More courage, more consistency and more sustainability would have been possible.

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