The Time for Change is Now!
By Dr. Jackson Janes and Dr. Tim Stuchtey
 

Over the last year, all open economies have caught the cold from America and are suffering from negative growth rates and the destruction of capital assets, all of which was brought on by the meltdown of the financial markets. Governments are frantically trying to stop the slide or even reverse it into a self-supporting recovery through Keynesian demand programs. We are still far away from recovery, but on the way there, many established principles of regulatory policy (or so-called "Ordnungspolitik") have been thrown overboard, with the plight of the economy being used as an excuse. Germany - generally regarded as a principled country with a sound commercial tradition - is particularly vulnerable at the moment. The country is currently being governed by the forced marriage of Christian Democrats and Social Democrats, and both parties are eagerly awaiting the divorce date in the fall. In the meantime, both sides are trying to win the favor of voters through generous gifts so that they can gain control of the nation for the next legislative period.

With the two German economic stimulus packages, every ministry got its share of the pie, mostly so that none could appear to steal the show from the others. The question of the meaning of some of those programs seems to have fallen by the wayside. Germany is actually holding back on its economic stimulus packages; the 80 billion Euros from both economic stimulus packages lead to additional spending per capita in the amount of 975 Euros. The $787 billion of Barack Obama's stimulus plan alone - depending on the point of view, a great plan or a disastrous one - increases spending by slightly more than 2,000 Euros per capita. But in order to be able to evaluate the value of each stimulus package for the economy and the people, one has to take into consideration what the resources will be used for. From the perspective of the government, three types of assistance can be distinguished:

1. Increased expenditure for the provision of public goods (e.g. construction of roads);
2. Increased government spending resulting from increased transfers to the citizens (e.g. stimulus checks to consumers); and
3. Reduced government revenue because of a decreased burden on the citizens with lower duties and taxes (e.g. reduction of VAT).

From an economic point of view, each of these alternatives has its advantages and disadvantages. Sensible investments in public goods can increase the productive potential of an economy in the long-term. In reality, though, many bad investments are made, without any long-term positive effects. It is also often the case that individual projects take very long until they affect output, so that the impact on the economy occurs well after it is intended. In contrast, higher transfer payments, such as the Abwrackprämie (the bonus given for trading in old cars for newer ones) in Germany, quickly stabilize the business cycle, but at the same time often result in significant windfall gains. Tax cuts increase the disposable income of households and thus generally consumption as well. But when a portion of this higher disposable income - or the transfer payments for that matter - is saved, this money in turn does not directly stabilize the business cycle.

The analysis of a specific economic stimulus program is also hindered by the aggravating reality that in politics, the political leaders always choose a mixture of all three forms of assistance. But all three alternatives have something in common: The debt financing and the associated interest payments and amortization constrict the financial scope of the governments as well as the citizens in the future, and thus burden future generations. This effect is mitigated, however, if the assets of households increase as a result of higher savings. The effect may even be overcompensated for if the measures undertaken as part of the economic stimulus package raise the efficiency of an economy, for example through an increased level of education or better public infrastructure.

Apart from the general statements about the effects of these three types of economic assistance, the starting position of an economy must also be taken into consideration. In recent decades, the United States has emphasized low taxes, but has obviously neglected the public infrastructure. The streets, railroads, and the power grid in the United States are in such dire condition that most Germans would not expect to see in a country with a higher GDP per capita of about one third. In contrast, most Americans regard German households as quite modest, be it for the relatively low levels of consumption and disposable income. The government spending ratio, which is consistently higher in Germany than in the United States, is also an indicator: In recent years, this ratio has dropped from nearly 50 percent to about 44 percent in Germany, whereas the government spending ratio in the United States has remained at only 38 percent despite the two wars in Afghanistan and Iraq. From this analysis, it seems quite logical that according to a recently published study by the Brookings Institution in Washington, the United States has allocated two-thirds of its economic stimulus package to increasing public expenditures while Germany has allotted two-thirds of its stimulus package for the reduction of the tax burden.

But will the German tax reductions lead to a higher efficiency of the German economy? The results will arguably only be small because the measures to compensate for the cold progression or the slight increase in the allowable tax deduction are piecemeal in a basically ailing tax system. It is therefore exasperating that the grand coalition is not able to use the current crisis for indisputable structural reforms, but instead prefers to postpone them indefinitely. All reputable political parties have advocated a simpler and fairer tax code, which has long been called for by academic research. Proposals that could be implemented quickly and which have similar contexts (in parts) are waiting for action in the drawers of the offices of ministries, political parties, and research institutes. The implementation of these proposals failed in the past mostly due to concerns about how fiscal consolidation should take place first and the high start-up costs associated with their introduction. It is exactly such a fundamental reform, though, that could not only provide the citizens with more money in their pockets for consumption, but could also be a good investment of the resulting short-term debt in order to strengthen the basis for lasting growth. It is of crucial importance to use the crisis as an opportunity and not to use the fiscal measures to ignite only short-lived brush fires. Or in the words of Barack Obama: "The time for change is now!"

....................................................................................................
Dr. Jackson Janes is Executive Director of AICGS and Dr. Tim Stuchtey is Director of the Institute's Business & Economics Program.

This essay appeared in the April 17, 2009, AICGS Advisor. A version of this article appeared in the April 15, 2009, edition of Frankfurter Allgemeine Zeitung and is available here. It was translated into English by Marianne Schneider.