German lessons on managing economy in times of recession

Germans have fared much better than Americans, as the bounty of their growth has been shared

When Germany has grown faster than the United States, stimulus sceptics like to point across the Atlantic Ocean and say that austerity works.

When it has grown more slowly, people who think the stimulus made a big difference – including me – return the favour. But the full story is more interesting than any caricature. In the past decade, Germany has succeeded in some important ways that the United States has not. The lessons aren’t simply liberal or conservative. They are both.

With the US economy weakening once again – and with Chancellor Angela Merkel of Germany visiting the White House this week – now seems to be a good time to take a closer look.

The brief story is that, despite its reputation for austerity, Germany has been far more willing than the US to use the power of government to help its economy. Yet it has also been more ruthless about cutting wasteful parts of government.

The results are intriguing. After performing worse than the US economy for years, the German economy has grown faster since the middle of last decade. (It did better than the US economy before the crisis and has endured the crisis about equally). Just as important, most Germans have fared much better than most Americans, because the bounty of their growth has not been concentrated among a small slice of the affluent.

Inflation-adjusted average hourly pay has risen almost 30 per cent since 1985 in Germany, the kind of gains US workers have not enjoyed since the ’50s and ’60s. In the US, hourly pay has risen a scant 6 per cent since 1985.

Germany also managed to avoid a housing bubble, unlike the United States, Britain, Ireland, Spain and other countries. German children have stronger math and science skills than of the US. Its medium-term budget deficit is smaller. Its unemployment rate is like a mirror image of of the US: 6.1 per cent, well below where it was when the financial crisis began in 2007. The US rate has risen to 9.1 per cent.

I’m not saying that the US should want to become Germany. Americans remain considerably richer. The US has the innovative companies – Wal-Mart, Google, Apple, Facebook, Twitter – that make other countries swoon and the country remains the world’s immigration mecca. Yet for all the US strengths, almost nobody claims that the economy is in especially good shape. It so happens that the current out-of-town guests could teach the US a few things.

The first lesson is that it’s really possible to make government more efficient. Like much of western Europe, Germany long had a unemployment benefits system that discouraged work. But almost a decade ago, it began to make some changes.

It cut many benefits, in both duration and level, and it reduced the incentives to retire early. It also began trying to move the long-term unemployed into the labour force. Specifically, the government took a fresh look at people who had not worked in years to determine who could and couldn’t work. The able and healthy were matched with potential employers. If they took a low-paying job, which was often the case, they would still receive a small portion of their benefits for a time. If they refused to work, their benefits were reduced anyway.

“The incentives to take up work were strengthened,” says Felix Hufner of the Organisation for Economic Co-operation and Development, “and also the sanctions were strengthened.”

Sure enough, the reforms have nudged more people back into the labour force – and work tends to beget more work, as people develop skills and have more money to spend.

In the United States, short-term jobless benefits are not generous enough to be a major problem. But the Social Security disability programme, which is one reason why nearly 20 per cent of working-age American men are not working, would benefit from some German-like reforms. So would those public sector pensions that encourage people to retire at 55 or 60.

Beyond the job market, Germany has also made a big effort to improve its education system. Eric Hanushek, a Stanford University economist, notes that Germany’s performance on the main international math, reading and science tests have become such a matter of national concern that the name of the tests – Pisa – is now a household word.

“In the US,” he says, “Pisa is still a bell tower in Italy.” The math scores of German students have risen significantly since 2000, extending their existing lead over US students. Germany’s national average is now higher than the average in Massachusetts, this country’s top-performing state. And there is obviously a connection between strong technical skills and a strong manufacturing sector.

But the German story is not merely about making government more efficient. It’s also about understanding the unique role that government must play in a market economy. That role starts with serious regulation. US regulators stood idle as the housing bubble inflated. German banks often required a down payment of 40 per cent.

Clout of German unions
Unlike what happened in the US, German laws and regulators have also prevented the decimation of their labour unions. The clout of German unions, at individual companies and in the political system, is one reason why the middle class there has fared decently in recent decades. In fact, middle-class pay has risen at roughly the same rate as top incomes.

The top 1 per cent of German households earns about 11 per cent of all income, virtually unchanged relative to 1970, according to recent estimates. In the United States the top 1 per cent makes more than 20 per cent of all income, up from 9 per cent in 1970. That’s right: Only 40 years ago, Germany was more unequal than the United States.

Finally, there are taxes. Germany does not have a smaller budget deficit because it spends less. Germany, you’ll recall, is the original welfare state. It has a smaller deficit because it is more willing to match the benefits it wants with the needed taxes. The current deficit-reduction plan includes about 60 per cent spending cuts and 40 per cent tax increases, Hufner says. It’s like trying to lose weight by both eating less and exercising more.

As I suggested before, the US economy’s strengths may still be greater than the German economy’s. But Germany sure does seem more serious about dealing with its weaknesses.

And us? Well, lobbyists for the mortgage bankers and the NAACP have recently started pushing for less stringent standards for down payments. Wall Street is trying to water down other financial regulation, too.

Some Democrats say Social Security and Medicare must remain unchanged. Most Republicans refuse to consider returning tax rates even to their 1990s levels. Republican leaders also want to make deep cuts in the sort of anti-poverty programmes that have helped Germany withstand the recession even in the absence of big new stimulus legislation.

There is no getting around the fact that financial crises wreak terrible damage. It’s too late for the US to prevent that damage, and it will take a long time to recover fully. It is not too late to learn from the mistakes.

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