Forget Keynes. Germany Has the Solution for American Unemployment

Forget Keynes. His theories, used to help the United States out of the Great Depression, have a questionable track record. Plus, there doesn’t seem to be a clamoring for more stimulus money after the first trillion dollars failed to budge the unemployment needle.  Fortunately, there are other historical examples that may provide a way out of this fiscal hole we’ve dug ourselves into. Let’s train our gaze across the Atlantic, where Germany’s history of fiscal stimulus may solve our unemployment puzzle.

In the early 1990s the newly “unified” Germany faced a unique fiscal situation that required massive federal deficits: reuniting Eastern and Western Germany after the fall of the Berlin Wall. In 1991 and 1992, with the hopes of raising the productivity of former East German workers, Germany ran large federal deficits in transfer payments and infrastructural investment in the former East. Well over DM350 billion were spent in eastern Germany during the first three years after economic, or monetary, unification.

“The final sum of private and public funds flowing into eastern Germany during the half-decade between 1990 and the end of 1995 would probably amount to at least DM750 billion and perhaps as much as DM850 billion. Between one-fifth and one-fourth of those funds were private, and the remainder were government funds.”

These “stimulus” funds were used in hopes of balancing the two economies and overcome the negative fiscal consequences that resulted from the unification. The results, in terms of employment, were less than magnificent.  The stimulus boosted measured GDP growth in the short run, but eventually Germany fell into economic stagnation. The higher taxes and debt then kept the German economy down for many years.  Few Germans were happy with the economic fallout from this “stimulus.”  And that was with a relatively well-functioning financial system and a reasonable amount of initial 3:59pm via Web optimism. Does this sound familiar to you?

Of course, many of you will list off the dissimilarities between German unification and the current U.S. situation. Still, as historical examples go, I believe this one has some relevance. Unsurprisingly, so do the Germans. Germany’s finance minister, Wolfgang Schaeuble, rebuffed President Obama’s call for more stimulus, telling reporters, “Nobody can seriously dispute that excessive public debts, not only in Europe, are one of the main causes of this crisis.” German Economy Minister Rainer Bruederle added that it was “urgently necessary for monetary stability that public budgets return to balance. This is something we should also tell our American friends.”

The German American Chambers of Commerce explains their hesitation,

Continuing to run big deficits could backfire here, [German Chancellor Angela Merkel] said, because of Germans’ angst over their aging society and rising public debt. Fear that the German welfare state could run out of money leads individuals to save their income as a precaution, she said. If Germany cuts its budget deficit instead, “then the citizen is more willing to spend money,” she said, “because he knows that he can count on the pension, health and elderly-care systems.”

Germany’s recent decision to embrace long term fiscal prudence is no doubt colored by stimulus’ less than pristine track record. Has the recent history of government spending really been any better here? Perhaps we should drop the Keynesian parade and learn something from the German example.

The European Commission’s Directorate-General For Economic and Financial Affairs published a 106-page document back in 2002 that shows what they learned from their experience.

“Economic theory suggests that a fiscal expansion financed by distortionary taxation could potentially generate substantial adverse growth effects after the initial positive demand stimulus dies down.”

In fact they estimate that the negative economic impact from their stimulus may explain up to one-third of the growth gap between Germany and comparable European nations.

Translating the gobbledy gook: people crave stability. We, as investors and your average Joe consumer, want to know that the country not only has a plan for our nation to get out of this recession, but a long term plan for our fiscal health. Huge deficits followed by huge taxes don’t exactly inspire confidence.

Germany’s economy is far from perfect, they have learned from their past. Today, they have instigated robust austerity measures to fix their economic problems. They know that adding to the debt through government spending is not going to help.

Otto von Bismarck said, “Only a fool learns from his own mistakes. The wise man learns from the mistakes of others.” Will we remain the fool? Or will we be wise?

by Brandon Greife, Political Director of the College Republican National Committee