Mises Wire

Home | Wire | What Germany Must Do for a Speedy Recovery

What Germany Must Do for a Speedy Recovery

  • german stimulus package debt ecb socialization
0 Views

Tags Corporate WelfareEconomic FreedomTaxes and Spending

07/07/2020

Listen to the Audio Mises Wire version of this article.

On June 29, the German parliament reacted as parliaments normally do when there is a problem, namely, by allowing the government to spend more. In order to respond to the economic difficulties due to the corona epidemic and the government restrictions, it passed a typical Keynesian stimulus package in order to boost aggregate demand.

The self-set goal of the economic stimulus package is to lead the German economy back to a "sustainable growth path…that will secure jobs and prosperity." I interpret the term "sustainable growth" here as growth that individuals really want and would support through their voluntary actions in a market economy. It is therefore a growth that is not based on fiscal subsidies and growing public debt and that would collapse without these subsidies or in the event of public overindebtedness. To wit, state funding of new structures that are only kept alive by continuous state subsidies cannot be described as sustainable growth.

The Initial Situation

The corona epidemic and the political reactions to the epidemic have led to a worldwide supply and demand shock. On the supply side, production had to be stopped due to disease, lockdown, and disruption of supply chains. In addition, there are problems of overindebted companies with insufficient liquidity. Since many companies could not and cannot produce any more, global production has collapsed.

On the other hand, there have been drastic changes on the demand side. First of all, less production naturally means less demand (Say's law). A worker whose working hours have been reduced produces less, earns less, and therefore also demands less in real terms.

Moreover, the composition of "aggregate demand" has changed. There is less demand for tourism, transport, and leisure activities that imply physical contact with other people. In contrast, demand for digital leisure activities and services and products that increase health safety (e.g., masks) has increased. Some of these shifts in demand will accompany us in the long run. For example, a long-term decline in air travel and an increase in digital learning and working from home could lead to structural changes in demand.

Demand will also change in the long run, because there has been a massive redistribution due to the corona crisis and corona restrictions. While, for example, government employees have not suffered any financial losses, entrepreneurs and employees in the free economy have lost enormously. The profiteers of the corona crisis increase the demand for their preferred products relative to the products demanded by the losers.

As a result of the supply and demand shock, production factors have to adapt to the new circumstances. A restructuring of the production structure is necessary. Some firms and sectors have to shrink; others have to expand. Some companies need to be recapitalized, especially those that have a profitable business model but were forced to lock down. Some companies should disappear altogether. In a market economy, consumers decide which companies and sectors these are through their purchasing decisions. It would be a presumption of knowledge for the state to decide centrally which sectors and companies should receive new capital and which not.

The necessary restructuring means a reallocation of resources. Restructuring is essential for the desired return to a sustainable growth path. Reallocation of production factors depends, on the one hand, on economic institutions, which can facilitate or hinder recovery, and on the other hand on government intervention, which always runs the risk of putting the economy on an unsustainable path and creates dependencies that are difficult to revise. This reallocation must also take into account the financial fragility of the economy.

What Can Facilitate a Recovery?

What must be done to speed a recovery?

First, all regulations that impede production must be ended. These include, of course, first and foremost the corona restrictions. Moreover, there are many regulations that make the German labor market, the most important factor market, inflexible. In the energy sector, the healthcare sector, and the automotive sector there are many regulations—some of them quite new—that impede production severely in Germany.

It is economic freedom, which makes use of market-based adjustment mechanisms, that reduces the negative effects of supply and demand shocks and facilitates a rapid economic recovery. This theoretical insight can also be illustrated empirically. Economic freedom accelerated the return to a growth path in the case of the Spanish flu of 1918: countries with a greater degree of economic freedom suffered less from the consequences of the pandemic in the long run. This finding is consistent with other empirical studies that show that economic freedom is associated with less severe recessions and faster recoveries.

Second, there is the problem of recapitalization. Without it, some firms will disappear because their capital is exhausted or because demand has shifted. In order to reactivate sustainable growth, private investment is therefore needed to recapitalize companies with long-term profitable business models or to create new companies in the more promising sectors due to the shift in demand. In other words, it requires the recapitalization of profitable companies and the creation of new companies.

Two conditions must be met in order for these investments to materialize. First, new profit opportunities must be discovered by competing entrepreneurs. This is where the deregulation I mentioned earlier helps. Secondly, it is necessary that private savings increase (tantamount to a reduction in consumption) without being absorbed by the state through increased public debt.

Both conditions must be met. If private savings increase but there are no new profit opportunities, then investment flows into unproductive assets such as government bonds. If, on the other hand, new profit opportunities are discovered but there are no savings, then these cannot be realized either.

There is a danger that taxes and public debt will absorb private savings. Therefore, if a sustainable growth path is to be achieved, taxes on capital and profits should be reduced. However, the German stimulus plan is not going to reduce these taxes, but rather will reduce the value-added tax (VAT) temporarily, which invites increased consumption, i.e., less saving. Reductions in capital gains taxes, inheritance taxes, gift taxes, and corporate income taxes, or loss carry-back schemes, encourage saving and capital accumulation. These measures would also increase Germany's attractiveness in international comparison and could attract savings from abroad.

To achieve a sustainable growth path, the private sector should also be supported by reducing the government deficit and government spending. Lower government spending makes resources available to the private sector that would otherwise have been seized by the state, and can help with restructuring.

Unfortunately, government spending is increased, and it has increased a lot. And everything with which the state spends more it has previously taken away from the private sector, for the state does not create new resources. It is not Santa Claus.

There are several ways that the government can get control of these resources that it later spends. It can take them, first, through tax increases, which is not the case with this stimulus program. The stimulus program is financed through deficit spending.

Increased government borrowing can be financed in two ways. First, it can be financed by real private savings, leading to a crowding out of private investment that is so important for restructuring at this time. As an alternative to financing public debt through private savings (crowding out), new public debt can be financed through the printing press. Financing through the printing press also means that the state gets access to additional resources that would otherwise have been available to the private sector at a lower cost. When money supply increases, the state drives factor prices up. Resource prices are higher than they would have been without government demand. Private enterprises have fewer resources available at these higher prices. The real possibility for private investment shrinks. In order to achieve sustainable growth, therefore, government expenditures such as transfer payments or subsidies must be reduced. This would ensure a faster recovery, as the ailing private sector would thus have more resources at its disposal and its costs would fall.

Through its additional expenditure, regardless of whether it is financed by tax increases, crowding out, or money supply increases, the state takes resources away from the private sector and inhibits a quick recovery.

Subsidies and Redistribution

Structural reforms, deregulation to promote adjustment, and restructuring of the production structure are not included in the stimulus package. Tax cuts that stimulate private savings are also not planned. Rather, a temporary reduction in VAT is included, which tends to stimulate additional or earlier consumption rather than additional private savings. Government debt and government spending will not decline either, the latter rising by nearly 43 percent. Almost half of government spending is financed by issuing new debt. Germany's solvency is also endangered in particular by the threatened socialization of government debt at the European level through the channels already in place. If the financial markets become nervous in the future because of a European economic crisis and high levels of national debt, they will look at German national debt.

Most of the measures in the stimulus package simply subsidize certain interest groups. They create a redistribution among the population but do not serve to achieve a sustainable growth path.

Subsidies include government funding for the purchase of electric cars, a child bonus of €300, subsidies for cultural institutions, federal states, and municipalities, the promotion of child care, the public railway company, the promotion of certain regions and green energy, as well as development aid. These are all pure redistribution measures. They take resources from some market participants and give them to others. This redistribution weakens Germany as a business location in the long term, for it promotes unprofitable enterprises, thereby making the costs of profitable German companies higher and preventing the establishment of new companies.

Conclusion

The stimulus package does not fulfill its official purpose. In fact, it is detrimental to it. Government spending will not be reduced. There will be no tax cuts or measures that allow for more private saving. Deregulations are not included. Instead, the package contains industrial policy; state innovation and central economic planning; and subsidies and redistribution measures.

Author:

Contact Philipp Bagus

Philipp Bagus is professor at Universidad Rey Juan Carlos. He is a Fellow of the Mises Institute, an IREF scholar, and the author of numerous books including In Defense of Deflation and The Tragedy of the Euro, and is coauthor of Blind Robbery!, Small States. Big Possibilities.: Small States Are Simply Better!, and Deep Freeze: Iceland's Economic Collapse.

Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.
Image source:
Getty
When commenting, please post a concise, civil, and informative comment. Full comment policy here

Add Comment

Shield icon wire