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, Germanys 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. Whats 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. Fuests opinion is important. He's the chairman of the academic advisory board to Steinbrücks 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 governments 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.
In contrast to their German colleagues, economists in Anglo-Saxon countries have long recognized the importance of such fiscal policies. One of these economic experts is Larry Summers, a Harvard professor and the last Secretary of the Treasury under US President Bill Clinton. Summers was one of the leading candidates for the post of Secretary of the Treasury under US President-elect Barack Obama, and he sums up his knowledge from theory and practice as follows: A fiscal stimulus can be of decisive importance.
However, aid packages must be designed for a specific objective. For cash injections to have the greatest possible impact, they should be rapidly implemented and limited to a specific time frame, to avoid burdening public coffers with endless new debt. According to the latest research, if the wrong criteria are targeted, government programs can cause more harm than good.
Researchers have studied which measures are most likely to be effective, and their results run contrary to opinions in Germany that are held as iron-clad truths.
Who to Stimulate?
In Germany, increasing government expenditure -- for example, by investing in infrastructure projects -- is generally seen as the most effective means of boosting the economy because money directly enters the circular flow of income.
This has proven to be only a second-best solution, roughly on par with giving tax breaks to companies. The most effective solution recommended in a study by the Brookings Institution, a Washington-based think tank, involved reducing taxes for low-income families.
Low-income earners can be relied upon to spend the extra money and stimulate the economy. The experts found that the least effective approach was to introduce sweeping tax cuts that are financed with borrowed money.
It goes without saying that experts in the German ministries are familiar with these findings. For a long time they have prepared further steps, despite the fact that the heads of the ministries, with the exception of Economics Minister Glos, have officially rejected such additional measures -- at least for the time being.
What the experts are considering is a mixture of additional investments and short-term tax relief measures, primarily for low and middle-income families. The problem is that only half of all households in Germany still pay any income tax whatsoever. The other half earns so little that they are fully exempt.
The burden on these workers could be reduced by lowering their social security contributions. In return, the state would have to subsidize social welfare programs, which would be financed by increasing government debt. This could also conceivably be done by temporarily lowering the value-added tax.
Alternatively, the pro-business wing of Germanys conservative parties proposes relieving the tax burden on companies. We must do more to adequately respond to the current financial and economic crisis, says Josef Schlarmann, who heads the small and medium-sized business alliance of the CDU/CSU. While there is now some movement on the question of a government economic stimulus program, the fronts in the debate over government protection for individual sectors or companies remain unchanged. Proponents and opponents are as irreconcilable as ever on issues such as whether the state should rush to the aid of Opel, the entire automobile industry, or other sectors.
The crisis has polarized opinions. However, it will take a more nuanced approach to solve these problems, at least in the case of Opel, where the situation is far less straightforward than many believe.
'A Serious Mistake'
For years, there has been excess capacity in the European automotive industry. If one manufacturer goes under, it would be a bitter development for tens of thousands of workers who lose their jobs. But perhaps this would make the jobs at other carmakers more secure -- at least that's the main argument put forward by those who reject giving Opel aid, such as the €1.8 billion loan guarantee that the company has requested. Whats more, supplying the market with Opel models is not vital to the economy -- in contrast to supplying the market with loans, which is why banks need to be saved, but not a car manufacturer.
Nevertheless, this argument has a flaw: Should Opel fail, Europe would not lose one of its weakest carmakers -- as purely economic principles would normally dictate -- but rather one of its best.
Opel currently has virtually all the characteristics of a successful carmaker. The plants are efficient, the models are cutting edge. Opel workers require on average 20.8 hours to assemble a car, Renault 22.5, Fiat 26.8 and VW 35.2 hours.
The looming bankruptcy of its parent company, General Motors, is the only reason Opel is now struggling to survive. GM still owes Opel over €2 billion for engineering services. If the US company goes bankrupt, it wont pay off its debts. And as a 100-percent subsidiary, Opel can't loan this money from banks. Financing for the company would dry up, and it would be doomed to fail.
These are all reasons why the German federal government and the states could help out with a loan guarantee to allow the carmaker to obtain the necessary line of credit. It would also be legally possible to ensure that this money does not evaporate in Detroit.
But a loan guarantee alone would not be enough to save Opel. The brand will have to be freed from the embrace of its ailing parent company, not only to survive the coming year, but also to enjoy ongoing success.
General Motors is hardly inclined to give up its European subsidiary. Opels engineering center in Rüsselheim has what GM desperately requires: It can design fuel efficient cars. By the same token, GM Europe would be unable to survive alone without its parent company. Over 6,000 workers are employed in the engineering center, and the work that comes from Opel alone would not keep the order books full. Opel also uses platforms from GM subsidiaries Daewoo and Suzuki and supplies technology to other GM brands.
The only realistic solution would be to slowly extricate Opel from the GM corporate alliance, a process that has to begin with a greater degree of independence for GM Europe. Opel also needs an investor that would pay GM billions of dollars to take over its European subsidiary. Perhaps this would be a carmaker from China or India looking to get a foothold in Europe. For that to happen, though, the company first has to survive.
In this situation, supporting Opel might be the right thing to do. But it would be another story altogether if the government started to provide aid to individual companies across Germany. Economists warn that such extensive bailouts would be a serious mistake.
Economists argue that the government generally cannot differentiate between problems caused by the economic crisis and those created by mismanagement. In some cases, government aid would merely postpone inevitable bankruptcies.
Another argument against individual measures is that they run the risk of triggering a chain reaction of subsidies. After government aid is approved for one company, its competitors naturally call for financial backing. Once a bailout package has been approved for the automotive industry, the chemical industry will also start demanding government aid.
Should the economy slide into a recession, subsidies for individual companies or sectors would be the wrong approach. In this case, government institutions will have to stem the tide with nationwide measures. The central bank will have to maintain low interest rates while the government launches bold economic initiatives. In this exceptional crisis situation, it is the job of the state to build confidence in the economy, says Economic Minister Glos, which is why he says the government must proceed with greater determination.