When, in April, Wolfgang Schäuble, Germany’s finance minister, sharply criticised the policies of the European Central Bank, he was expressing a distinctive macroeconomic approach which shapes the views of German economists and policymakers alike. It is based on the strong conviction that problems of aggregate demand are of secondary importance as long as prices are sufficiently flexible. This explains the German insistence on structural reform as the solution to almost all economic problems and the quasi-religious fixation on the “black zero”, the balanced fiscal budget with no red ink.
On the face of it, this German exception in macroeconomics is difficult to explain. Students in Germany read the same textbooks as their counterparts in other countries, and in advanced studies the same economic models are used. But behind the textbooks and models lies an economic philosophy called “Ordnungspolitik” which is not found outside Germany. Its guiding spirit is Walter Eucken, who taught at Freiburg university until his death in 1950. In a recent speech marking what would have been Eucken’s 125th birthday, Angela Merkel, the chancellor, insisted that the principles of the “Freiburg school” remained relevant.
There were two aspects to Eucken’s economic philosophy, one positive, the other negative. On the positive side was a commitment to freedom of contract, open markets, private property and robust antitrust policy. On the negative side was a rejection of Keynesianism.
From the experience of the Great Depression, John Maynard Keynes drew the conclusion that active demand management is necessary. Eucken, by contrast, believed that “full employment” policy of the sort advocated by Keynes would lead to a centrally planned economy. And while Keynes saw the Great Depression as the result of the inherent instability of the market economy, Eucken attributed it to an insufficient flexibility of wages and an inadequate monetary order. In his view, flexible prices and wages and an adequate monetary order were a reliable antidote to market instability.
In his aversion to the pursuit of full employment through fiscal policy, Mr Schäuble is an obvious heir to Eucken. This is also true of prominent German economists who, during the eurozone crisis, have ignored the effects of austerity on demand, out of a deep-seated belief that structural reforms can solve all problems.
How has such a narrow economic paradigm survived for so long in Germany? The answer is simple: German economic policy using this approach has been quite successful. But this is only because Germany’s economy, despite its size, is extremely open. The ratio of exports to gross domestic product is 46 per cent. In Japan, the figure is 18 per cent and 13 per cent in the US.
This openness allows Germany to pursue a passive macroeconomic policy at home and benefit from active demand-side policies pursued in other countries. About 60 per cent of the German current account surplus is with the US, the UK, France and Italy, which all have relatively high fiscal deficits. In short, Germany’s economy is supported by the demand management policies of countries that are heavily criticised by German academics and policymakers.
From a global perspective, this freeriding on the demand policies of other countries is questionable enough. But the German approach becomes positively dangerous when politicians try to apply policies which can work in isolation in a very open economy to a large and not very open currency area like the eurozone. In the present situation of chronic demand deficiency, insisting on the “black zero” for large currency areas, or even at the global level, would create a black hole in the world economy.
Peter Bofinger is professor of economics at Würzburg university and a member of the German council of economic experts