“Austerity is not a growth strategy, neither is demand stimulus”

Question: We see a great improvement of German companies and consumers’ sentiment. Some research institutes forecast growth between 1.3% and 1.9% this year and between 1.6% and 2.0% in 2016. Berlin is more pessimistic. Where do you stand?

Answer: Germany’s economic growth is robust and sustainable. I expect a growth rate for 2015 closer to 2%. Low oil prices and a favorable Euro support exports and private consumption. However, there are a number of global risks and international conflicts that may threaten Germany’s economy. These include, for example, the development of the Eurozone and the conflict in the Ukraine. Although one should not overestimate the likelihood that these risks further evolve, it is certainly true that they entail the potential to exert relative large negative consequences for economic growth in Germany. Such considerations may affect Berlin’s forecast, which thus appears in my view as rather pessimistic. In the longer term, global trade will grow slower and the demographic change will affect Germany so that the German growth perspectives will shrink.

 

Q: According to Germany, Europe would be worse off without Germany. But German’s gain in competitiveness during the last decades also means that wages grew at a slower pace than productivity relative to other Eurozone countries. Is that trend changing? Is Germany acting as a locomotive?

A: Real wages in Germany grew by 1.7 percent in 2014. This increase is partly due to higher nominal wage growth, but also due to relatively low inflation. It looks like that real wages in Germany will also rise in the near future. Wage moderation in the past was determined by the social partners and supported by governmental measures to reduce non-wage labor costs.

It is still the case that instead of “austerity”, Germany’s economic philosophy – in the government and private sectors alike – focuses on fiscal prudence. German policy makers and voters generally believe that excessive public spending does not help to generate economic growth in the European crisis states who also suffer from high debt levels. This is by no means an argument against raising public investment levels. It is an argument for the effectiveness of additional expenditures, whether debt-financed or not. Investments must make the national economy more productive over the medium to long term, however.

In this context, it is important to stress that spending cuts for their own sake were never the “German style.” It is true that the country has been on a very moderate growth path in terms of government expenditures in the early-2000s. But expenditures have substantially increased during and after the crisis – and although Germany’s labor market has hardly been affected by the Great Recession. Due to automatic stabilizers built in the tax and transfer systems, German government spending would have much more strongly increased if the crisis had resulted in a more severe unemployment shock. The lack of austerity would thus be more transparent if there had been a stronger need for anti-cyclical measures.

 

Q: This is an eternal debate. But let me know in a nutshell what you think: Should the German taxpayers pay to help Greece?

A: It is the spirit of the European Union to jointly grow and develop. It is, therefore, of vital interest of Germany that the partner countries become competitive and grow. For this purpose, it is in the interest of the German taxpayer that Greece develops. Further credits are only useful, however, if effective structural reforms are undertaken. These reforms take time to be implemented and to get them to work, but they have to be implemented now. Just to continue the historical process of overspending the public budget and continue with an unproductive organization of the economy would just deepen the crisis.

Many Germans do understand the need for fiscal flexibility under certain circumstances – whether or not this money comes from Germany. Real structural reforms can be costly over the short to medium term. Governments should not be prevented by myopic budget considerations from undertaking reforms that will generate more growth, and therefore more revenue, in the future. Hence, while it is true that Berlin has advocated consolidating government expenditures in other European countries, including Greece, the importance of strengthening useful investment has been always stressed at the same time. Germany has advocated for structural reforms and investments that lead to balanced budgets in the medium-term. Regaining trust and creating an investment-friendly environment to boost employment are the aims underlying this advice.

 

Q: Germans have often been criticized for their excess of savings and lack of investment, which is below their European partners and still lower than appropriate for Eurozone’s recovery. Is 2016 budget strong enough in that regard?

A: On the one hand, the calls for Germany to abandon its supposed “austerity policy” are best understood as a distraction. Faulting Germans for their fiscal prudence is becoming the method of choice for governments anxious to divert their voters from the consequences of bad economic policies at home.

On the other hand, Germany has indeed some room to increase public investments without denting its national finances. However, a general public spending program would not be the right policy. Given that Germany is facing demographic changes and sees its population aging and shrinking, it is now even more important than before to evaluate any infrastructure investment on the basis of its effects.

There are indeed a number of promising measures that likely meet this criterion and would also stay within the bounds of prudence. Targeted tax cuts are one option, but they should be combined with less red tape. To encourage private investment activity, it seems moreover vital to ensure a reasonable amount of reliability in planning with respect to energy production and prices as well as environmental standards. This has not been the case in recent years.

And finally, and despite recent successes, there are still options for reforming labor policies, where the focus should be on education and family policies that offer growth potential even in times of demographic change and reducing long-term unemployment through individual activation programs.

 

Q: Germany has the biggest surplus since year 2000. Berlin plans to reduce public debt to below 70% in 2017 and below 60% by the end of 2023. Is that and the zero deficit compatible with fiscal solidarity at a European level?

A: This is just the way back to the Maastricht treaty. Anything else would look like providing the incentives to celebrate a party in the bar of the “Titanic”. The discussion boils down to the seemingly endless debate about “austerity” and “fiscal flexibility”. While it is certainly true that austerity is not a growth strategy, a demand stimulus is also not a growth strategy. I think that policy is well advised – by the way not only in recessions – to regard fiscal consolidation and growth-oriented structural labor market reforms as two integral parts of a successful economic package to stimulate the economy. Implementing an intelligent combination of these two elements could certainly improve the current shape of the Eurozone.

In any case, I hope that the current debate about “austerity” and “fiscal flexibility” will be promptly replaced by a more helpful debate about policies that do make sense or not. I thought that the time for ideological views dominating economic policy had already ended. But maybe I was wrong and the era of “evidence-based policy making” is yet to come. In my opinion, such an approach would certainly lead to better policies that could increase overall economic welfare.

 

Q: The euro at its lowest levels in 12 years has benefitted German exporters: Germany’s trade surplus for 2014 was a record 216.9 billion euros. Most analysts expect an inevitable correction USD-EUR. Are firms ready for when this happens?

A: Most German firms are prepared for any corrections in exchange rates. Exports were already high with a rather strong currency and they are likely to continue increasing under the current monetary policy. But domestic demand also seems to increase in Germany, in particular driven by private consumption. There are also plans to increase public investment spending. This is a rather important development for the stability of the entire Eurozone, if nothing else. Germany has also  increased pensions and introduced a general minimum wage which is one of the highest in Europe.

However, I would like to stress that Germany’s success story is not only based on exchange rate developments, but primarily results from a steady improvement in the country’s and individual firms’ competiveness. The country initiated a process of structural reforms in the mid-2000s (including important reforms on its labor market) which ultimately pays off.

 

Q: As read in Handelsblatt, “there are worries in Germany about Spain’s level of poverty and financial weakness and extreme external debt”. What is your take? Do you think further reforms are needed or are we on the right track?

A: Reforms in Spain generally go in the right direction. They tackled the most pressing issues, including labor costs and working time flexibility, employment protection and dismissal protection, unemployment insurance, retirement legislation as well as training and apprenticeship systems. Although, for example, it is a positive development that activity rates have recently increased, the overall outcomes are at least so far not yet satisfying.

While it generally takes time before structural reforms fully unfold their effects, it therefore appears useful to initiate now additional reforms. These reforms should, for example, improve the efficiency of employment services and stimulate labor demand via entrepreneurship programs and other measures. Policies should also stimulate labor mobility across the borders, the out-migration of unemployed workers is still not high enough. It could generate remittances and a flow of information backwards, and return migration of experienced workers at the time of further recovery of the Spanish economy.

One should not forget that economic difficulties are the friend of labor market reforms. Key to these reforms is “benchmarking” – that is, comparing the effectiveness of certain policy approaches across borders. The successful reforms in Germany are a prime example for the power of evidence-based policy making. Spain and other countries should thus closely investigate successful policies and adopt them to their own needs.

 

Q: Volkswagen made more than 200bn euros last year and yet they have presented a plan to save 5bn. But the firm’s committee insisted they could even save more! Do you consider this an example to follow? Shouldn’t they be investing more instead?

A: These are not alternatives. Cost reductions are a basis for competitiveness and for providing the financial resources to invest, which also strengthens again the company product.

Nevertheless, I am rather reluctant to comment on the strategic decisions of individual firms. Any firm – including Volkswagen – is well advised to constantly rethink and update its policies in a rapidly changing environment. For instance, the car industry is fundamentally challenged by the ongoing digitalization and computerization of our world. Concepts like car sharing and the self-driving, autonomous car exert substantial pressure on established firms to innovate. This certainly requires sensible investments, but also the effective use of finite resources.

That is all not too different from the challenges that countries are facing: Optimizing the use of (public) resources makes long-term sense only if it comes with a similar overhaul and optimization of (labor market) policies and (infrastructure) investments. All these aspects are vital to the economy, which – not unlike the human body or any private company – requires constant exercise and monitoring to get and stay in shape.

 

Q: What do you think of Silicon Valley giants recruiting German automotive and mechanical engineers for their new IT enterprises?

A: It is a good sign when people migrate between two countries because open and flexible labor markets foster growth and increase welfare. However, with migrant flows globally on the rise, the impact on both sending and receiving countries is becoming very noticeable. A “protectionist” mentality that spreads is thus not surprising – but as a growing trend, it is worrying. Our aim, ultimately, should be to separate facts from fiction to encourage a debate that is informed by evidence and to dampen fears held by policy makers and the general public. Those fears are primarily present in the receiving countries, but there are also fears in sending countries that typically focus on the so-called “brain drain”.

There are two main reasons not to worry about this phenomenon, which do not only apply to the example of German engineers moving to the United States. First, people who leave their country of birth are nowadays by no means gone forever. In fact, the contemporary trend of migration, properly understood, is best thought of as “circular migration,” implying onward or return migration. In a world with many affordable transportation options, ever more people want to stay connected to their place of birth. They do not just want to go back for visits every five or ten years. The difference from a few decades ago is that now migrants can remain rooted in their place of birth. This is the second main reason for not being concerned by the threat of a “brain drain”: the skills, job experience and contacts gained by migrants in their overseas deployment effectively travel back home or elsewhere with them.

 

Q: Let’s talk about the German corporate governance model. Has allowing workers to participate in the management of the companies that they work for proved effective in terms of productivity?

A: Germany’s approach to codetermination in industry has indeed proven to be a pro-competitive force. Crucially, it has made German companies more nimble in reacting to global circumstances. A prime example has been given during the Great Recession when the behavior of social partners helped cushion the crisis’ labor market impact. Trade unions were exercising wage restraint and, more importantly, they were using the collective bargaining process to arrive at much more flexible labor arrangements. Hence, firms that were affected by the crisis could react mainly at the intensive margin and adjust working hours to retain their workers. Next to the reduction of overtime hours and other instruments of working time flexibility if available at the firm level (for example, working time accounts), short-time work was the instrument through which this could be managed at reasonable costs.

 

Q: I find it surprising everyone seems to be getting inspiration on US companies such as General Motors, which had to be bailed out. German firms have overcome the economic crisis in excellent shape and yet no one tries to convince the world about that German model. Why is that?

A: Germany’s success story covers largely the export-oriented companies which typically are medium-sized, and hence attract less attention.  People around the world also talk about Volkswagen or Siemens, to name just two of the large companies. However, the global interest about Germany is probably absorbed by the excellent performance of the country.

Policy makers in other countries, especially those in neighboring European countries, increasingly realize that much time for crucial reforms has already been wasted and that aging demographics and other factors will soon make it impossible to change. Labor market reforms and stable public finances are essential to securing the Euro while improving growth and employment prospects in national economies.

In this context, explicit references to the validity of the “German model” are being made, for example, in France and in Italy – despite media attention that tries to suggest a deepening intra-Europe divide. For example, Italy is open to the idea of introducing activation strategies for the unemployed, combined with reshaping its Public Employment Service. Similar developments can be observed in France. The German model is explicitly referred to in this context as the incentives to take up a job and stay employed should be increased, while more elements of flexibility should also be introduced in the notoriously rigid French labor market.

To follow Germany’s lead in this regard does not signal blind imitation or subservience. Germany’s own reform path a decade ago was inspired by other, mostly Northern European nations. But there is no one-size-fits-all solution. Each government must find its own way to reform, no matter what inspirations it draws from elsewhere.

 

Q: Despite what many research institutes’ warnings, the minimum wage doesn’t seem to have resulted in the loss of thousands of jobs. Were those forecasts simply wrong or, as unions claim, employers are getting creative for not paying the minimum established?

A: There is still a wide agreement among economists that Germany’s minimum wage is a risky experiment with potentially vast consequences. However, causal effects cannot be measured yet. It will take a few years before the consequences can be well evaluated. The current debate is purely theoretical, based on anecdotal evidence and not based on the relevant empirical comparison with the counterfactual situation. We do not know (yet) what would have happened without the introduction of the minimum wage. In addition, a number of specificities of the legislation – mainly introduced because negative employment effects had been anticipated – may have minimized negative consequences, at least so far. For example, there is a transition period of two years for industries with negotiated wages between the social partners. These sectors are exempted from the minimum wage, which means that in certain jobs such as hairdressers and butchers, workers can still be paid less than the minimum wage. Finally, it is certainly true that the timing for introducing the minimum wage was nearly optimal as the German economy is booming with record employment, substantial economic growth and low inflation.

 

Q: More than 20 years after the German reunification large wage differentials in East and West Germany still persist. Does this seem like a system failure to you?

A: Convergence between East and West Germany has happened during the past 25 years. But it has not been as strong and as quickly as expected, and relative large gaps still persist – not only with respect to wages. Convergence also seems to have slowed down during the last years, albeit not to the same extent in all sectors and industries.

However, a comparison of mean outcomes between East and West Germany is misleading because this neglects a substantial amount of heterogeneity across sectors, industries and regions. For instance, the industry structure is not the same and does not have to be the same.

Moreover, one needs to take demographic changes into account. Many more regions in East Germany are among those heavily affected by a shrinking and aging population. This ongoing process contributes to intensifying regional disparities within Germany – for example, also between Northern and Southern Germany. It is only one reason why measures countervailing demographic change and measures cushioning the impacts of a shrinking and aging population are crucial in Germany. Education, family policy and immigration are certainly key areas where policy urgently needs to act.