German cutbacks could amplify crisis

Europe needs Germany to step up and spend more, but the country has proposed spending cuts and tax increases.

By Jim J. Jubak Jun 7, 2010 4:09PM

Jim JubakIn gauging the dimensions of a crisis, you have to make certain assumptions. 

One thing I've assumed about the current euro debt crisis is that no politician there would do something unusually stupid. Venial. Short-sighted. Duplicitous. Sure. But not something so really stupid that it would raise damage from the crisis by an order of magnitude.

Well, I'm seeing exactly that level of “really stupid” starting to gather momentum. And the source is Chancellor Angela Merkel's government in Germany.

Merkel's government has proposed a $97.5 billion package of spending cuts and tax increases for 2011-2014, just when the struggling economies of the euro zone need its strongest economy to step up and spend more. The threat is not only that Germany will cut spending and reduce an already slow growth rate in Europe even further, but also that Germany's economic prestige as Europe's most fiscally prudent economy will encourage other countries in the European Union to cut spending too.

Those spending cuts would ripple out across the global economy -- remember that in aggregate, the European Union is the world's largest economy -- at a time when growth seems very shaky in the United States and in some parts of the developing world.

Way back when this global financial crisis was younger -- that is, in September 2009 -- I wrote a post called “We have nothing to fear but a replay of 1937 itself” about how premature spending cuts in 1937 derailed a promising U.S. recovery from the Great Depression until the onset of World War II. 

I wrote then that I hoped U.S. politicians wouldn't do anything stupid that could lead to a replay of the disastrously premature attempt to balance the budget. And I noted that Federal Reserve chairman Ben Bernanke at least was thoroughly familiar with the history of 1937 and determined not to preside over a U.S. replay.

To paraphrase Mark Twain, history doesn't repeat itself, but it does rhyme. The danger of a replay of 1937 has reared its head again, but the source of the danger isn't some U.S. politician, but Germany's Merkel.

Rejecting arguments by U.S. Treasury Secretary Tim Geithner that Germany in particular and Europe in general do more to promote “stronger domestic demand,” Merkel's government has proposed what the Chancellor has called an “unprecedented” round of budget cuts. The program includes new taxes on air travel, new fees on electric utilities that operate nuclear power plants, and a financial transaction tax on banks. 

Budget cuts include cuts to investments in infrastructure and spending on construction, reductions in child support, cuts of 10,000 government jobs, elimination of some extended unemployment benefits, and cuts of 40,000 from current troop levels of 250,000.

Interestingly, the government has not proposed any cuts to the retirement or pension system. (For why those kinds of changes are the most necessary budget cuts in the long run, see this post.)

The cuts, taxes, and fees add up to about 2.7% of Germany's GDP in 2009.

The government's argument is that it has to cut a deficit projected at 5.5% of GDP in 2010. “The last few months showed, in connection with Greece and other euro countries, the overriding importance of solid finances,” Merkel said in explaining the plan. “2011 is the first year of the exit strategy.” The government plans to reduce the deficit to 0.35% of GDP by 2016.

Economists who are critical of the plan say that, at worst, budget cuts in Germany are exactly the wrong way to pull Europe out of its crisis, and at best, way too early.

Germany needs to be spending more -- it especially needs to be raising wages to increase domestic consumption -- if countries like Greece, Spain, and the United Kingdom are going to climb out of the hole that they've dug for themselves, critics say.

These countries got into trouble by spending money that they didn't have, but Germany is making the European Union's economic problem worse by not spending money that it does have. Germany runs an incredibly successful export economy -- the country exported $1.12 trillion in goods in 2009, second in the world only to China's $1.19 trillion in exports. 

But Germany's consumers prefer to save rather than spend. In 2007, Germany's savings rate was 16.7%. (In the U.S., the savings rate has recovered to 3.6% in April after bumping along near 0%.) At the least, that high German savings rate says that the country remains able to pay its modest (in comparison to 11% of GDP in the United Kingdom) budget deficit.

What's wrong with savings? Nothing when the world isn't struggling to recover from a collapse in global demand. Or when Europe's weakest economies don't need a few consumers to buy their goods or vacation on their beaches.

Commerzbank economist Eckart Tuchtfeld pooh-poohed Treasury Secretary Geithner's worries in an interview with Bloomberg. “Mr. Geithner needn't be perplexed about this program denting economic growth,” he told Bloomberg. At most, it would cut 0.5 percentage points from growth each year.

Doesn't sound like much -- except that the Organization for Economic Cooperation and Development (OECD) projects that the European economy will grow by just 1.2% in 2010. And that's an increase from earlier projections.

And if more of the world's richest countries adopted Germany's tactics? The International Monetary Fund (IMF) estimates that efforts to cut budget deficits in the richest countries now could cut as much as 2.5 percentage points off of global growth and put 30 million people out of work.

Budget cuts, at some point, the IMF said, will be a good idea, but in the next year or two, the world economy needs more stimulus, not less.

As St. Augustine would have said if he had been an economist, “O Lord, help me to cut the budget deficit, but not yet.” 

Jim Jubak doesn't own shares of any company mentioned in this post.

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