Can Germany Be Saved? The Malaise of the World's First Welfare State

Press echo, The Business Economist, 01 Jan 2008

Hans-Werner Sinn, MIT Press, June 2007, 504 pages, f 18.95. On the face of it, this book should be a joy to review. Not only is the subject matter important, but the author is a very well known expert on the EU's largest economy, being Professor of Economics and Public Finance at the University of Munich and the President of the IF0 Institute for Economic Research. What's more, publication coincided with growing confidence that the German economy may be set to continue surprising on the upside, something that seemed unimaginable to many two or three years ago. That makes the central thesis of the book - namely that without fundamental reform the ageing German economy will go on to become an under-performer again on the world stage - more controversial than would otherwise have been the case. Certainly, one cannot imagine that Professor Sinn has made himself popular amongst trade union leaders in Germany.

Perhaps something may have been lost in translation, but this is not an easy book to wade through. The reader is left with the distinct impression that Professor Sinn could have made the main points of his argument in far fewer pages. Arguably, the book also suffers from too little acknowledgement that German growth has consistently been surprising on the upside for some time now, with the labour market tightening and fear of unemployment receding.

Moreover, no mention was made of two of the more important factors that had been holding hack growth in Germany, namely the construction overhang following unification and on-going problems in the German banking sector. Part of the improvement seen in Germany in recent years is due to a strong bounce-hack in construction. It has not just been a story about exports and investment. However, bank lending has been conspicuous by its absence, a highly unusual development and in contrast to what had been seen virtually everywhere else globally.

Nonetheless, anyone wanting to find evidence of Germany's deep-seated structural problems will find much to draw from here. Professor Sinn's prognosis is that wide-ranging reforms are needed rapidly. Otherwise, once the recovery runs its course, growth will disappoint and unemployment will resume its upward trend again. Central to his thesis is Germany's very high labour costs and a welfare state that discourages work and employment.

Although the author does not fall into the trap of the fallacy of the 'lump of labour' (the argument that there is only a fixed number of jobs to go round), his focus is clearly on manufacturing. But globalisation and EU enlargement will ultimately result in the economy becoming ever more skewed towards high value added manufacturing and, probably increasingly, services. And the reality of economic clusters is that in such sectors high labour costs and expertise often go together. Otherwise London would not now be Europe's financial centre; finance too would be migrating to Central Europe.

His solutions include fundamental changes to collective bargaining, reduced union power, less help from the state when made unemployed, wage supplements for the low paid, less help for migrants, a leaner tax system, policies to improve the birth rate and co-ownership in exchange for wages. Baroness Thatcher would be proud.

David Owen
Chief European Economist, Dresdner Kleinwort