Germany’s modern economic miracle ‘built on sand’

Marcel Fratzscher is a man in a hurry. When the economist took over as head of Berlin's German Institute for Economic Research (DIW) last year, the institution had let competing economists steal the limelight and shape Germany's euro crisis debate, notably Prof Hans-Werner Sinn and his Munich-based Ifo institute. Now the 43-year-old hopes to boost the DIW's fortunes, and his own profile, by challenging Germany's self-satisfied status quo with The Germany Illusion, a book that warns Germany's current economic strength is far from a long-term certainty.

Shattering illusions

In 16 punchy chapters, Prof Fratzscher challenges the established narrative of how Germany got where it is now in the hope, he says, of nudging Germany off the path of rising self-interest and back towards the common European good. Doing this, he says, means shattering three illusions.

The first is that Germany’s economic future is secure, having taken bitter but necessary reform medicine a decade ago. The second is that Germany’s reform-resistant EU neighbours are a millstone around its neck and future economic growth lies beyond Europe.

The final illusion, the logical consequence of the first two, is the rising view in Germany that its neighbours “just want our money, that we are the paymasters for Europe and what’s good for Europe is bad for Germany”.

Prof Fratzscher argues that the opposite is the case and Berlin will have to accept responsibilities commensurate with its economic size, including acting “as a motor for growth” in Europe. That Germany’s modern economic miracle is built on sand, he argues, is visible from how the country that sells cars to the world has allowed its own road infrastructure – particularly in western Germany – to crumble into a perilous state.

According to DIW calculations, Germany is spending one-eighth of what it needs to renovate and modernise its road and rail network and bring it up to scratch – an economic risk to itself and its neighbours.

Add in future risks – the immediate cost of the EU standoff with Russia and medium-term uncertainty over a rapidly-ageing population –– and Germany faces unenviable challenges.

After the recent crisis, Fratzscher says Germany is, at best, treading water. It has yet to recover from the slump a decade ago and illusions about its strength could be roadblocks to future economic sustainability, in particular deeper economic integration of European economies.

Financial crisis

Germany’s recent success was a mixture of good policy and good timing, the economist suggests, with the financial crisis hitting just as the “Agenda 2010” economic and social reforms of Gerhard Schröder’s government kicked in.

Berlin reacted with a public investment programme and “short-time” working rules to help firms. This, along with previous reforms and the absence of a property bubble meant Germany was buffeted by the crisis, but didn’t go into a tailspin.

Its export-driven recovery left Berlin in a position of economic and political strength to dictate the terms of rescue packages for crisis-hit countries.

Being out of sync with its neighbours is a characteristic that extends to German economic policy. Prof Fratzscher points out that Germany’s export boom has not been matched by a rise in imports, much to the annoyance of its neighbours. Germany is also “extremely isolated” in its response to the recent crises.

“[Germany] is the only larger country that argues fervently that spending and debt should not be reduced in the long term but immediately,” he writes. This is painfully obvious to Germany’s neighbours, in particular Troika targets such as Ireland, but is something rarely discussed in the Germany debate, dominated by supply-side economics that demands public spending cuts before state stimulus is even considered.

Though the DIW is more pro-Keynesian than most German rivals, Prof Fratzscher declines to take sides in what he calls the “emotional” austerity-stimulus debate. On the one hand, he criticises making Berlin the austerity scapegoat, pointing to the influence of finance markets and the IMF in forcing crisis countries onto a drastic fiscal diet.

Such countries as Ireland and Greece didn’t find themselves at the brink because of Germany, he says, but because of expansive fiscal policies, unsustainable pay progression and questionable banking industries.

On the other hand, he says it is short-sighted to view Germany’s balanced budget as the natural consequences of the fiscal medicine it prescribed, nor is it transferable to other countries.

Many unique factors have played a decisive role in Berlin balancing its books, he says, such as historically low interest rates on German sovereign debt. And, rather than save the money for a rainy day, Berlin politicians have ploughed billions into expensive pension giveaways rather than crumbling infrastructure.

It is in this infrastructure investment that Prof Fratzscher sees Germany's Achilles heel. The investment shortfall is not just visible in rusting bridges and cracked autobahns, he says, but in the infrastructure yet to be built for Germany's ambitious Energiewende – Angela Merkel's post-Fukushima goal of being nuclear energy-free in a decade.

What makes The German Illusion so refreshing is how it describes the view from both sides of the euro crisis looking glass. In particular he points out how, while Germany was the scapegoat in many crisis countries, Berlin's political and media mainstream painted Germany as a victim.

Prof Fratzscher sees Germany as largely a profiteer of recent EU decisions and attacks a framing here of Berlin’s crisis assistance as tax transfers to Europe’s periphery. “German institutions merely provided loans,” he writes. “With very few exceptions Germany . . . provided neither financial transfers nor take over a neighbour’s debts.”

His reminder that Germany turned a profit on its crisis loans is timely given Ireland’s crisis loan repayment plan is up for a vote in the Bundestag in mid-October.

In the final section of his book, Prof Fratzscher says Germany’s illusions – or delusions – about itself and its neighbours have fired up a “renationalistion” of German politics with “large and real” risks for the EU.

Economic integration

Berlin should be pushing further economic integration, private investment at home and an investment programme around Europe to stimulate crisis-scarred economies.

The chancellor should come clean with voters that the banking union she demanded will require a “credible European backstop” with “pooling of liability risks”.

Instead, he warns, Germany’s political and economic illusions are roadblocks to progress on all fronts.

Though he offers coherent analysis and argument on how Germany became both the EU's dominant player and a chief policy beneficiary, The German Illusion fails to answer why Germany feels so vulnerable. Why is post-crisis German politics in the thrall of prosperity chauvinism, as indicated by the rise of the anti-euro Alternative für Deutschland political party?

Prof Fratzscher notes that Germany is in hegemony denial but struggles to say why – beyond hazarding a guess that it “may have historical reasons”.

Either way, The Germany Illusion is a timely reminder that, as he notes, Germany's "transformation from relatively weak to relatively strong can just as easily be reversed". The German Illusion is published in Germany by Hanser