Monday, September 18, 2023
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Economist: Germany’s tight fiscal policy, anti-inflation measures risk leading EU into recession

Europe is paying a lot of attention these days to the economic data coming out of Germany. The signs are troubling. A prominent German economist says a deep recession may result from monetary policies to fight inflation and keep a lid on debt.

(CN) — Germany's economy is teetering dangerously on the brink of a major recession and European and national leaders are woefully ill-equipped to halt the slide, a prominent German economist says.

For the past year, the economic data coming out of Germany — often dubbed the European Union's economic locomotive — has been dismal, and the slowdown is showing no sign of letting up for the world's fourth-largest economy.

“It's getting worse,” said Heiner Flassbeck, a German economist and former adviser to the German government and the United Nations, in a telephone interview with Courthouse News.

Industrial production is nosediving: For the year, it's down by 2.1% and off by more than 7% from its pre-pandemic level. Last month, industrial orders crashed by almost 12% from June. Retail sales are down too.

Most worrying, demand for the country's world-famous exports of cars, pharmaceuticals, chemical products and machines is shrinking, in large part due to a slowdown in China, its largest export market. As economists like to say, when world trade sneezes, Germany catches a cold.

“The third quarter will be definitely negative and nobody knows what happens afterwards,” Flassbeck said. “This is the risk. In economics, there is no rule that what goes down must go up.”

And there are troubling signs across the EU too. An index that measures the bloc's economic activity, the eurozone purchasing managers index, last month saw its biggest contraction since November 2020, when pandemic lockdowns were spreading, and one of its steepest declines ever measured.

“The whole eurozone is going into recessive territory,” Flassbeck said. “France is talking about recession coming immediately after the German recession, because France is very much dependent on Germany.”

A national relapse?

The storm clouds over Germany's economy have spawned a slew of gloomy headlines. With prices for energy and commodities soaring, middle-class Germans are telling reporters they can't afford small luxuries any more. And the poorest say they simply can't make ends meet.

Some factories have closed and talk of mass layoffs is in the air; labor strikes are common. New construction is sluggish at best. The International Monetary Fund projects Germany will be the only Group of Seven economy not to grow this year.

This economic gloom is, of course, reflected in surveys and opinion polls. German companies say they've never been this pessimistic about the country's ability to compete internationally. Two in three Germans say they want a new government. Germany is run by an odd mixture of social democrats, greens and pro-business liberals.

Adding to the angst is the steady rise in popularity of the far-right party Alternative for Germany (or Alternative für Deutschland), a development that sends shivers down the spines of many Germans. Nationally, AfD is polling at over 20%, making it the second most-favored party after the center-right Christian Democrats.

In August, the Economist magazine whipped up the debate about the malaise in Germany with a cover story that asked: “Is Germany once again the sick man of Europe?”

Its answer was affirmative — the same one it gave in 1999, when it first called Germany “the sick man of Europe.” At that time, Germany was dealing with double-digit unemployment and lackluster growth, a far gloomier picture than today.

To turn things around then, the German government slashed welfare benefits and cut wages, reforms that allowed Germany to undercut its European competitors. While those prescriptions helped Germany's economy take off, in turn they contributed to weakening the EU's other big economies like France and Italy. The eurozone has long struggled with slow growth.

Political solutions, not economic know-how

It's still unclear how Germany plans to turn things around this time, but the debates about what needs fixing are lively.


Last week, German Chancellor Olaf Scholz announced what he called a “Germany pact,” a plan to modernize Germany by speeding up bureaucracy. An overly ponderous bureaucracy, many experts argue, is a vexing problem holding the country back.

Also in the works are small incentives to boost corporate investments in renewable energy, construction and digitalization. Germany's future, its leaders vow, lies in making the country greener and more wired.

But for Flassbeck, the solutions offered by Scholz's government highlight the biggest problem facing Germany: the incompetence of its current batch of leaders.

“We have a funny mixture of politicians,” he said. “Some are in denial; some have no clue about economics — most of them, and obviously their advisers also.”

He lamented that Germany's economics minister, the Green party leader Robert Habeck, is too dedicated to “dealing with climate change and nothing else.” Habeck earned a doctorate in philosophy before entering politics.

Meanwhile, the finance minister, Christian Lindner, is not an economist either, and he's surrounded himself with lawyers, Flassbeck said. Lindner is the leader of the Free Democrats, a pro-business party that makes tax cuts and clamping down on public spending its core principles.

And then there's Chancellor Scholz, who's also weak on economic issues, Flassbeck added.

“The result is that there is total ignorance,” the economist complained.

“You have to change the politics totally around — 180 degrees — and not just say: 'Now, let's do a little here, and a little there, and spend a couple of billion euros and then everything will be fine.'”

He warned that Germany's leaders and those at the European Central Bank, the nerve center for the EU's monetary policies, are badly mishandling this new crisis because they are too focused on fighting inflation by keeping interest rates high.

“You have a global demand drop in the world, which hits Germany more than other countries because Germany is the most export-dependent country of the richer countries in the world,” Flassbeck said.

“In that situation, the only thing that would help would be falling interest rates — and what we have are rising interest rates due to a funny, foolish monetary policy that interprets the price increases as inflation,” he said.

He called the wave of price spikes felt in Europe and around the world a temporary phenomenon. In his view, European leaders are wrongly imposing a “restrictive monetary policy” that will end up deepening the recession.

Similar monetary policies are playing out in the United Kingdom and the United States, and with China's economy sputtering, Flassbeck said the world is at risk of a global recession.

“The most important thing is easing monetary policy as quickly as possible,” he said.

Interfering with the 'debt brake'

Eventually, he predicted the crisis will get so bad Germany and the European Central Bank will be forced to change course and start stimulating the economy with lower borrowing costs.

In Germany, that would mean taking on a sacred cow: the country's so-called “debt brake.”

The country has long enjoyed a balanced budget and surpluses because of government commitments not to rack up debt, limiting federal structural deficit to 0.35% of gross domestic product and enacting a policy of balancing the budget, the schwarze Null, or “black zero,” policy. It's even been enshrined in the constitution.

So far, Lindner, the finance minister, has refused to consider tinkering with the debt brake.

“You will see that the famous German debt brake will go away,” Flassbeck predicted. “It's ridiculous to believe that you keep it in such a situation.”

As for the European Central Bank, he said “enormous political pressure” likely will be applied to lower interest rates and encourage more spending.


The perils of de-industrializing

He dismissed as naïve a plethora of arguments being made by politicians and experts suggesting Germany's economic woes can be solved by shifting its economy away from an industrial export model, cutting away red tape and working to turn the country into a technology juggernaut.

Those calling for a transformation of Germany's economic model say the war in Ukraine and the West's confrontation with Russia and China must force Berlin to develop a new economy based around services, digital innovation, green technologies and less manufacturing. In 2019, as the clash with China heated up and Germany's economy sputtered, similar arguments were made.

Flassbeck said proposals to “de-industrialize” Germany are “extremely naïve.”

“How can you de-industrialize a country from today to tomorrow? And how are you doing that?” he said. “You kill your whole industry or what?”

Like many Germans, he expressed deep skepticism about the policy direction being taken by Washington and the EU to erect trade barriers with China, the world's second largest economy after the United States.

U.S. President Joe Biden has talked about “decoupling” from China, while European Commission President Ursula von der Leyen has said the EU is “de-risking” from Beijing.

“How do you do all these funny things like decoupling and de-risking? That's all nonsense in my view,” he said. “That is all just nonsense because nobody knows what a world order would be where the one guy says, 'You're too risky for me, I do not trade with you'; and the other guy says, 'Oh, you're an idiot and I'm not trading with you.'”

He added: “You know what the result would be? It would be a disaster. It would be the '30s of the last century.”

In such a scenario, the world economy would end up a mess, he continued. “They believe you can have — I call it free trade à la carte. But that doesn't exist. Either you go for free trade or you go for no free trade, you go for protectionism.”

What about Germany's bureaucracy? Is that the cause of the economic slowdown? Not according to Flassbeck.

“People have been talking about German bureaucracy for 30 years,” he said. “Meanwhile, we've had recoveries, we've had recessions. The German bureaucracy is maybe bad, but it has nothing to do with what happened in Germany in the last year.”

Averting a disaster

Though the situation in Germany is troubling, Flassbeck said the country remains in a good position to endure the economic headwinds with its budget surpluses, low unemployment, strong industries and talented workforce.

“To say that Germany is the 'sick man of Europe' because one quarter is worse than in France? It's ridiculous,” he said. “Germany is still in very good shape.”

But the dangers are real. “Europe still has an unemployment rate of 6.5%; Europe has not come out of corona in a recovery,” he said. “Europe has had slow growth for 10 years.”

To add a recession to this long economic anemia in Europe would be a disaster, he said.

“We would be looking at long-term stagnation and no growth, increasing unemployment,” he said. “It would be very bad.”

An economic slowdown, he added, would also set back efforts to rein in global warming, one of the EU's chief ambitions.

“People who believe this will be good for climate change are totally wrong,” he said. “It will be bad for climate change because people will concentrate on fighting” the economic problems and not global warming.

Courthouse News reporter Cain Burdeau is based in the European Union.

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