Sunday, 16 November 2014

Germany balancing its budget

The German economy has been buffeted by a perfect storm recently. Neighbouring European countries have grown only little or not at all, which depresses Germany's exports. Russia has decided to meddle in a bitter fratricidal war in Ukraine which raises questions about energy security and gas supplies. Plus, the World economy has run out of steam, with China, Brazil and the US doing less well than anticipated. This should spell impending disaster not just for the German economy but also for tax revenues and ultimately, the German budget. However, it was only this week that the German finance minister presented the first balanced budget to parliament in more than 50 years. If things work out as planned, the German government will not go to the financial markets in the next years to borrow money. In fact, it plans to make a start on paying back the enormous sums that have accumulated since the heydays of 1960s profligacy. So how come Germany eliminated its deficit when France and Italy struggle to meet even the (admittedly) lax deficit rules of the Euro zone?

There are two major factors that have contributed to this success story. The first one are rock bottom interest rates for older debt which allows Germany to reduce its liabilities. This is bound to continue with a European Central Bank that is unlikely to raise interest rates as long as other European economies are still struggling to exit the recession. Low interest rates lead to a weak Euro which in turn favours German exports. So, the German balanced budget looks more like the product of a serendipitous confluence of external conditions than self-made. Nothing could be further from the truth however.

The second factor reveals how much of the German balanced budget is down to laborious homework. Germany has escaped the recession of 2008 relatively unscathed. The reason is that it went into the economic crisis with a flexible labour market and a reformed welfare state. Both things that have been pushed through by a Social Democratic Chancellor after 2004. Labour market 'flexibility' however is not tantamount to 'hire and fire'. In Germany it is based on strong negotiating positions of trade unions on the board of companies which gives them a stake in the success of their firm. Unions were thus willing to make deals companies' directors to protect the workforce whilst companies went through the recession. It's this stakeholder model that creates the room for labour market flexibility.

None of this means that everything is honky dory in Germany. Infrastructure is in dire need of further investment and health care costs are still running away, requiring a long term funding solution and significant reforms to increase efficiency. Yet, remarkably, it's been the Social Democrats who pushed for welfare and labour market reforms under their Chancellor Schroeder and who are now in a coalition with the centre-right CDU and approved a balanced budget. It's this long term vision that is so painfully missing from British Labour.

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