Ifo Viewpoint No. 102: Hands off!
Munich, 5 March, 2009
Germany has made 550 billion euros available to its banks, of which 100 billion is for Hypo Real Estate alone. Germany’s two economic stimulus packages will cost 80 billion euros, and the guarantee programmes for German industry amount to 100 billion euros.
In addition, the German federal states have made more than 30 billion euros available for individual state-owned banks. This sums up to about 760 billion euros. Even if only a third of the guarantees contained in this sum amounting to 570 billion euros end up costing the state, the total burden of all programmes would be 380 billion euros. This corresponds to some 127 maglev train routes to the Munich airport of about 3 billion euros each, to 200 five-year excellence initiative funding for all universities in Germany or to ca. 60,000 kilometres of new six-lane super highways.
Germany’s debt GDP ratio recently stood at about 64 percent, already above the 60 percent limit allowed by the Maastricht Treaty. And the interest paid on this debt stood at 69 billion euros or 6.3 percent of all government expenditures, or 2.8 percent of GDP. If the entire sum of 380 billion euros is financed on credit, the debt ratio will increase to 79 percent, and annual interest under the same conditions will increase to 85 billion euros, which will be 7.7 percent of government expenditures or 3.4 percent of GDP. With this interest burden in relation to GDP, Germany will be above the 3 percent limit for the maximum budget deficit allowed in the Stability and Growth Pact.
The collapsing economic activity, however, leaves us no other choice than to take on new debts. The rescue package for the banks is necessary, because without the banks the economy cannot exist; here there is no other alternative. The economic stimulus programme is also necessary in principle, in spite of all its deficiencies in detail. Some left-leaning economists wanted economic stimulus programmes in the midst of the boom years 2006 and 2007. That was absurd. But today the world is in a Keynesian crisis and needs the Keynesian medicine.
What Germany doesn’t need are structure-preserving policy measures, as are being increasingly demanded under the cloak of economic policy. The guarantee programme is in itself a serious lapse, and now policy-makers want to save individual enterprises. Opel, Airbus, Schaeffler, Rosenthal, Maerklin, and all the rest, are just the beginning, however. Many companies will face great difficulties and will ask for government help. The state cannot satisfy all these requests, since it doesn’t have all that much money. And even if it had the money, it would distort the natural selection process, which is one of the great strengths of the market economy. For every economic activity that takes place there are multiple technical variations and alternatives that also would have been possible but that are not economically efficient. Eliminating these variations and filtering out only the sensible solutions is why the market economy is superior to a centrally planned economy.
To be sure, companies need money to pay for their labour, the capital they use and their inputs. But this money must come from their customers. The customers decide what is produced and what isn’t. Putting the political process in the place of the customers means that the state takes money from its citizens and spends it in their stead. But this clearly overtaxes the state, as the communist systems demonstrated, which tried to do this for years. Politicians can neither digest the great amounts of information needed for objective purchasing decisions nor do politicians, businesses and those citizens affected by the structural policies have the necessary incentives to make efficient decisions. Not the ones who make the best products are saved in a government-run economy but those who make the most noise, who are the largest and who have the most political influence.
This does not mean that the market can manage everything. It cannot reasonably organise the provision of public infrastructure, for example. It also cannot comprehend specific information problems on its own or different types of externalities. But this is not what is involved in the rescuing of the companies that we are talking about. They all produce normal, marketable goods for which the state by means of a general economic stimulus programme cannot contribute anything to improving the purchasing decisions of its citizens.
Imagine what would have happened if, since the nineteenth century, politicians and not the market had determined economic structures and had prevented the structural changes that regularly occur in economic crises. Two thirds of all Germans would still be working in the agricultural sector, and we would still be as poor as we were then. The dynamics of the market economy stem from the process of the continuous creative destruction of individual companies that are no longer needed. The factors of production tied up in these companies are then freed for new things that would otherwise not exist. Precisely this small-scale creative destruction gave this economic form the strength to overcome communism and its resulting tyranny. For this reason, hands off the companies!
Professor of Economics and Finance, University of Munich
President of the Ifo Institute
Published as "Heillos überfordert“, WirtschaftsWoche, no. 10, 2 March 2009, p. 43.