Germany's approach to crisis lost in translation

Thu, Mar 1, 2012, 00:00

AMERICA’S FIRST Nobel Prize winner for economics, the late Paul Samuelson, was fond of saying that God gave economists two eyes and it was up to them to use them. The euro zone crisis is, among other things, an academic argument between two economic traditions, each accusing the other of limited vision while themselves having only one eye open.

Dominating the English-language debate is a Keynesian tradition, which believes that anti-cyclical stimulus is key to reviving euro zone growth. When Germany rejects this thinking, few bother to ask why. Germany is not very good at arguing its case, nor can it fall back on syndicated economists to make its case. And so Berlin is written off as “difficult”, its economic thinking misguided or even malicious.

Yet Germany’s strategy in the euro zone is informed by an economic school as legitimate, it believes, as Keynesianism: ordoliberalism. Its core idea is that the state provides an overall economic framework but keeps out of economic development.

Ordoliberalism is, in one sense, anti-Keynesian, and shares the neo-liberal objection to expansive fiscal and monetary policy to steady recession-hit economies. But Germany’s postwar application of ordoliberalism – Soziale Marktwirtschaft(social market economy) – departs from neo-liberalism in giving the state a role in income redistribution, hindering cartels and monopolies and managing a robust welfare safety net.

This economic model is the foundation of post-war German prosperity and is embraced by almost all German economists and politicians. Understanding ordoliberal thinking is key to understanding – if not accepting – Germany’s euro zone crisis strategy.

The starting point of ordoliberalism is the focus on an economy’s supply side as the key to output, growth and employment. Markets always work smoothly but if shocks come, and demand falls below supply, wages and prices will automatically adapt to correct this – unless barriers such as a minimum wage get in the way.

Thus Berlin’s reluctance to support bailouts was not simply motivated by a hard heart, but by a deeply held belief that the state should stay out of economies as far as possible.

Critics say ordoliberalism is overly rigid, with an in-built blindness to how economic decisions in one country have a knock-on effect in another. For instance, well-intentioned German reforms a decade ago – cutting costs and promoting wage restraint – dramatically drove down the cost of its own products, critics say, while strangling domestic demand and creating a huge trade surplus.

Their demands that Germany intervene to reverse this trend, however, simply do not compute in Berlin. Drawing on their own economic tradition, Germans argue that boosting German wages would only harm its own competitiveness. The solution, they argue, lies with those who have the problem: welfare reforms, wage restraint and pay cuts to boost exports while reducing domestic demand, imports and deficits.

The ordoliberal conviction that growth can be generated by cutting budget deficits and public spending defies all logic, the Keynesians cry: throw money at the problem!

Ordoliberals shout back that more debt will only make the problem worse. Balancing the budget will steady the economy: lower deficits require lower taxes to service the loans, something that will unleash economic growth. If everyone adopted ordoliberal ideas and kept their economic house in order, economic disturbances would not be triggered, requiring Keynesian-style interventions.

This is the thinking behind the fiscal compact, viewed by many outside Germany as an unwelcome imposition of alien economic thinking with little practical use in the immediate situation. But wishing away ordoliberalism isn’t a realistic option. Angela Merkel needs a European nod to German ordoliberal principles to sell the pact to her own voters who feel that, from bailouts to ECB bond-buying, Germany has made one ordoliberal compromise after another.

Analysts in Berlin suggest that, to end the stand-off in the crisis, Germany’s partners should focus on issues where movement can be expected in Berlin.

“Instead of attacking excessive [German] austerity . . . a more promising strategy would be to demand pan-European growth and investment programmes,” write Sebastian Dullien and Ulrike Guérot of the European Council on Foreign Relations in a recent paper, The Long Shadow of Ordoliberalism. “Instead of opposing balanced budgets, asking for more time in reaching them might be met with more understanding from Berlin.”

The proposal for a euro zone debt redemption fund, made by Germany’s so-called economic wise men, would offer low-interest loans to indebted euro zone countries in return for a strict, fixed repayment plan.

In finding a path forward, German willingness to compromise its ordoliberal principles should not be underestimated. Neither should Berlin’s deep-rooted belief in the economic ideas that have served it well for six decades.