Why Does Angela Merkel Hesitate?

Hans-Werner Sinn
Internet article by Hans-Werner Sinn, Project Syndicate, 29.12.2008

MUNICH – “Where is Angela?” is the question The Economist asked when Nicolas Sarkozy, Gordon Brown, and José Manuel Barroso met to prepare a European economic stimulus plan without Chancellor Merkel being present. Indeed, Germany is currently the spoiler in the competition to provide billions to prevent a breakdown of the world economy. Why is Germany so hesitant when it comes to economic stimulus programs?

One popular theory is that, given the supply-side orientation of German economists, there is little sympathy for Keynesian, demand-oriented prescriptions. But no German economist has come out against an economic stimulus program, and many favor one. Whereas Keynesian theory has largely disappeared from economic textbooks in the United States, it continues to be taught everywhere in Germany. German economists, in contrast to their American colleagues, never abandoned Keynesian policies as a means to combat demand deficits. Moreover, German politicians rarely heed the advice of German economists.

A second hypothesis is closer to the truth: the decline of economic activity in Germany thus far has not been as strong as in other countries. Germany did not have a real-estate bubble that threatened to burst, as did Great Britain, Ireland, Spain, and France. Germany has only been indirectly affected – by the decline in worldwide demand for German products – which explains an important timing difference in the business cycle.

Whereas unemployment in the US has been rising for one and a half years, Germany currently is enjoying its lowest unemployment rate in 16 years. The German construction industry and retailing are still stable, as the latest survey of the Ifo Institute shows, and the whole world is profiting from this stability, as Germany is the second largest importer of goods and services after the US. While US imports are declining sharply, German imports are holding up –without any economic stimulus plan. This is why many Germans wonder whether the foreign criticism is fair.

To be sure, the world recession will hit Germany with full force. The Ifo Institute has forecast that GDP will contract by 2.2% in 2009. But the contraction will be primarily because of declining exports, a large portion of which consists of investment goods, as well as the drop in domestic equipment investment.

These are areas where there is not much that the state can do to help. It can cut taxes to stimulate consumption and it can invest in construction, but these sectors currently need little help, except perhaps for the automobile industry. This could, of course, quickly change. When the second-round effects hit the domestic sector in the course of 2009, a stimulus program will be needed. From the German perspective, the best timing for such a program would be the autumn of next year. If the money is spent now, the economy in some sectors could overheat, helping no one.

Paul Krugman, who has aimed massive criticism at Germany’s government, should keep this in mind. Krugman is an excellent economist. He is right in principle in demanding a major economic stimulus package from the German government that goes beyond the €35 billion already planned. But he should not ignore the time lags between the American and the German economic cycles. Germany should prepare its economic stimulus program now and implement it when the time comes.

A third hypothesis to explain Germany’s hesitancy is suspicion of the European Union’s redistribution machinery. When Sarkozy and other EU leaders demand Germany’s participation in an economic stimulus and rescue package, one reason is that they expect Germany to again bear the lion’s share of the costs. For example, of the €5 billion extension of the Cohesion Funds approved by the European Parliament in December 2007, Germany received nothing, but it bears 20% of the costs.

Germans have always been enthusiastic proponents of the EU, not least because they hoped that a European identity would help compensate for their damaged national identity. So, whenever it came to restructuring the EU, they always accepted a level of influence that was small relative to their country’s size. Although Germany’s share of the EU population is 17%, it receives 13% of the voting rights in the EU Parliament. Its share in the more important Council of Ministers is only 8%, the same as that of the French, whose population share is 13%.

Former French President Jacques Chirac did not hesitate to justify this imbalance with a reference to World War II, which the Germans accepted. But their enthusiasm has limits. After all, aside from political under-representation, Germany’s annual contribution to the EU budget (most recently €7.4 billion) makes the country by far the largest net contributor. Germany finances 20% of the EU budget but receives only 12% of EU spending. Willingness could be exhausted if the EU budget is further expanded without reducing Germany’s net contribution and narrowing the gap between its financing and voting rights.

For these reasons, German reservations also extend to the European economic government that Sarkozy advocates, and that, again, would be financed more than proportionately with German money. Sarkozy regards an EU economic government as a way to preserve his leadership in the EU beyond France’s Council presidency, which is now ending. Although the Czech Republic will assume the EU presidency in January, this has not prevented the French President from convening a new EU summit under Sarkozy’s leadership in the first half of 2009.

This affront will put not only Czech tolerance to the test, but also that of Merkel. In the end, she will probably give in to Sarkozy’s wishes in order to avoid endangering her chances of re-election in September because of a conflict with the French. But she will surely do so with clenched fists.

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