More State Intervention

Stagnation, Recession and Deflation. Radical Change of Policy Necessary to Avert Downward Spiral

By Rudolf Hickel

[This article originally published in: Freitag 29, July 11, 2003 is translated from the German on the World Wide Web, http://www.freitag.de/2003/29/03290101.php.]

The German economy in the last two quarters has skidded into a recession after almost three years of stagnation. Production shrivels. In addition, many businesses must expect lower prices. Given dwindling profit expectations, the readiness to invest diminishes. In winter 2002, the number of registered unemployed reached the five million mark. Will stagnation, recession and even deflation occur, a downward spiral of falling incomes and falling prices that can hardly be mastered economically as shown in the example of Japan?

What is wrong in Germany? How should the great crisis of confidence be explained that we are experiencing? Other nations have come to terms with a rapid drop of the stock market and the economic consequences of international insecurity. In Germany there is also a special factor, the total failure of politics. Neither the government nor the opposition has a viable concept. Even worse, while both are helpless, the impression of competence is proffered while the rivals sink in wild actionism. “Agenda 2010” is sold as a contribution to the stabilization of social systems although it paralyzes the economic climate and programs new rounds of social cuts. The pension system will be repaired again. Nevertheless the insecurity rises with every repair. The permanent turning of the set-screw of the social system is accompanied by a chaotic tax policy that hardly allows business to calculate investments.

Germany needs a credible blow of liberation at last. The economic power for solving the challenges of labor, environment and social justice exists. The society doesn’t live economically above its means but far below its production possibilities. In a recession, the state must take a leadership role in solving the main problem, inadequate demand. Complaining about excessive labor costs and excessive regulation would quickly disappear when the sales- and demand expectations are met. Who can bring this about if not politics standing outside economic competition?

Foreign- and domestic demand should be distinguished. The export motor doesn’t bring deliverance on account of the ailing world economy and rising Euro prices. The German government gradually seems to understand that domestic economic demand is increasingly central. However the planned relief in the income tax amounting to 21.5 billion Euro is hardly the suitable method. This relief concentrates on high-income persons by lowering the top tax rate from 48.5 percent to 42 percent. The tax reduction amounts to 1542 Euro monthly for single persons with a taxable income of 300,000 Euro. In this income group, tax gifts are not used for more private consumption but flow into wealth formation. For the lower income groups, the advantages are very moderate with the elevation of the basic tax allowance to 7664 Euro and the lowering of the entrance tax rate from 19.9 to 15 percent. The monthly relief for taxable income of 20,000 Euro comes to 33 Euro. If other tax advantages – the special treatment of bonuses for night shifts, Sunday- and holiday work – are cancelled, nurses will be one of the losers of this policy.

Instead of relying on “Voodoo economics”, domestic demand should be stimulated directly by a state expenditure program designed for the needs of communes. The European central bank could set another important signal of trust for consumers and investors with a parallel lower interest. If the central bankers are not adequately are not future-oriented, the country, territories and communes must finally accept their responsibility.

The overdue blow of liberation through expansive state expenditures has several components. Firstly, cyclical deficits owing to falling tax revenues and rising crisis costs must be accepted. The economy loses contracts through cuts in spending. Secondly, a future investment program oriented in the infrastructure needs of cities and communities should be financed by public borrowing which would be reduced in the upswing. This policy opposes the Maastricht criteria and the stability- and growth pact of June 1997. These guidelines for limiting state deficits are simply “stupido” in economic policy according to the EU (European Union) commission president Romano Prodi. No inflation dangers presently exist. On the contrary, we are in a growth- and employment crisis with a deflationary tendency. Thirdly and lastly, an expansive fiscal policy should be coordinated within the EU. Member states together should tackle trans-European infrastructure projects that cross over countries.

Let us free ourselves from ideological prejudices and dare the blow of liberation. The sooner the better. Deflation can be best held in check preventively. Even zero-interests and massive state programs cannot help any more when businesses dismiss more employees and compete with one another over dumping prices, if the struggle over a shriveling demand flares up, if banks hardly forgive credits and if everyone only has negative future expectations.