Jump-Starting the German Economy
By Dr. John Starrels

The outcome of Germany's election last month remains in doubt. The need for economic reform - no matter who ultimately takes control in Berlin - is not in doubt. A successful reform strategy for the Federal Republic of Germany will redound not only to the benefit of its own citizens, but the global economy as a whole. Where should one begin?

There is an irony to today's so-called "German" economic problem. The irony derives from the fact that until the early 1990s, German economic prowess was the envy of its neighbors. Indeed, former Chancellor Helmut Schmidt was not above lecturing the United States on its alleged and real economic weaknesses. But Germany's situation has changed, largely for the worse over the past fifteen years since unification. While unemployment has increased, economic growth has declined; projections by the International Monetary Fund (IMF) predict a mere 1 percent growth in Germany's gross national product for this year, with the prospect of a bit more in 2006. To be sure, Germany's fiscal accounts are no worse than a number of other G-7 countries, but they are nevertheless a cause for concern. And what was once considered to be Europe's most dynamic labor market has increasingly become a major cause of worry for its coming generation of workers who are justified in wondering whether there will be enough employment to go around. Based on present trends, there will not be.

So what can Germany do to improve its short term economic prospects? The problem - both economic and political - is that little can be done to immediately improve Germany's economic prospects. Why? Because most of its problems are deeply imbedded within German social, economic, and political institutions. For one key example: unlike the United States, and to a lesser extent Great Britain, Germany's political commitment to a generous social welfare state - perhaps not cradle-to-grave security, but compared with the United States, for example, it comes pretty close - remains surprisingly strong in the midst of flagging growth and even as "the revenue base of the public sector is eroding," reports the IMF. Some progress has been made in making Germany's labor market more flexible and responsive to market signals. Compared with Margaret Thatcher, the Schröder government's efforts to tighten the country's generous unemployment compensation system appear relatively tame, but they have begun to bear fruit. The next major step on this front, according to the IMF, is to put in place a more effective "welfare-to-work program" that, over time, will provide sufficient incentives to clear the labor market. "If able-bodied participants are unwilling to work, [unemployment] benefits should be reduced further," argues the IMF. Even if the most ambitious steps on this front were taken today, however, the envisioned, likely beneficial results would not be immediately apparent. Experts disagree among themselves on the exact nature of Germany's economic malaise. They all appear to agree on the general proposition, however, that Germany's medium-to-long term salvation will only be achieved through a bold, well thought-out program of fiscal consolidation and labor market reform.

But does Germany have enough time to enact all of these necessary steps? Yes. It does, first of all, because the Federal Republic remains a very affluent country girded by a well-run bureaucracy and highly functional - and popularly accepted - political institutions. There is substantial unease today in Germany over stagnant economic conditions, even as a substantial gap remains amongst the public about how to address them. But there appears to be little popular support for short term, demagogic solutions to those problems. This is largely because the material conditions of most Germans today remain comfortable: complacency may be an enemy of reform, but relative complacency also provides policy makers with precious time to enact well-conceived, ameliorative policies to address those problems. The other major reason why Germany has enough time to undertake serious, longer-term, reform is that conditions in the rest of the global economy - unlike the dreaded 1930s - are, relatively speaking, congenial. Germans may save too much and purchase too little: luckily for its exporters, the external market for German goods remains healthy.

Germany's future economic challenge, then, is two-fold: to move forward on the domestic reform front as quickly yet as judiciously as possible; and to make sure that such domestic efforts complement and reinforce Germany's obligations to maintaining a healthy, open, global economy whose continued prosperity is key to everyone's future prosperity, including Germany's.

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Dr. John Starrels in a Senior Fellow in Residence at AICGS.
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This article appeared in the October 7, 2005 AICGS Advisor.