The Riddle of German Neo-liberalism

In late 2008, when the OECD countries had only just been hit by the credit crunch and Keynesians were arguing for a large stimulus package to offset private deleveraging, the German Finance Minister Peer Steinbrück launched an unprecedented attack on Gordon Brown, accusing him of ‘crass Keynesianism’ and claiming that economic stimulus would merely ‘raise Britain’s debt to a level that will take a whole generation to work off’. A year later, Steinbrück helped draft the Merkel government’s infamous debt-brake law (Schuldenbremse) effectively outlawing counter-cyclical deficit spending — which Ms Merkel currently wants applied to the whole Eurozone (EZ).

One might dismiss all this as right-wing madness, were it not for the fact that Peer Steinbrück was an SPD (German social democratic party) Minister and the party’s Deputy Chairman. Not only does he have a degree in economics from Kiel University, but he may well be the SPD’s candidate for Bundeskanzler (Chancellor) in the federal elections scheduled for late 2013.

The point is not so much about Herr Steinbrück’s personal views, but rather serves to illustrate a deeply conservative vein of economic thinking that seems to stretch across nearly the whole German political spectrum. Why are Germans, including many ‘social democrats’, so economically conservative? (One might quickly add that there is no lack of neo-liberal economists in the English speaking world, but that few of these would call themselves social democrats). Are Germans changing, or are they in the words of one recent LRB commentator inexorably tied to the neo- or ordo-liberal faith?

The stock answer is that the German folk memory of hyper-inflation runs deep; hence any form of deficit spending or money creation (eg, QE) triggers a negative response. But this is hardly a satisfactory reply. For one thing, German hyper-inflation happened nearly 90 years ago under the pressure of meeting the enormous reparations imposed by the Versailles Treaty in a country still recovering from a war which had left the economy in shambles. For another, in the 20^th Century alone, there have been various other European experiences of hyper-inflation which are not trotted out to justify conservative policies. Take the Hungarian case in 1946: whereas the average monthly inflation rate in Germany was 332 per cent, Hungary recorded an average monthly figure of 19,000 per cent.

Understanding economic conservatism in Germany involves looking minimally at three historical factors. First, the roots of the stakeholder model and its social insurance provisions, go back to Bismark and the New Confederation of 1871. Unlike the UK, the German industrial and financial sectors were closely integrated, with skilled labour incorporated as a secondary ‘partner’. Moreover, the drive to ‘catch up’ industrially meant prioritising exports over domestic consumption.

Secondly, Germany had no Keynesian revolution in economics, nor any politician comparable to Roosevelt in the US. What revived Germany after the deflationary policies of the Brüning government (1930-32) was rearmament under the Nazi Economic Minister Hjalmar Schacht — between 1933 and 1937 German unemployment fell from 6mn to 1mn.

In the postwar period, however, few professional economists concerned themselves with the causes of the Great Depression or German rearmament under the Nazis. Indeed, by the mid-1950s, economic thought was dominated by the anti-state Freiburg school whose ‘ordo-liberalism’ combined the market fundamentalism of Friedrich Hayek with the Bismarkian tradition of social insurance. In particular, Germany’s ‘framework’ policy — the view that the state should provide a supply-side framework for economic growth rather than adopt an active fiscal stance — together with the rising wages accompanying successful reindustrialisation produced a centre-right consensus around the ‘social market economy’ (Soziale Marktwirtschaft) personified by Adenauer and Ehrhard. (pdf)

Hayek, a leading member of the anti-Marxist ‘Austrian school’ and Professor at Freiburg, was of course extremely influential throughout the post war period — particularly amongst the Free Democrats (FDP) and the right of the Christian Democrats (CDU/CSU).  In 1950, he took his libertarian brand of market fundamentalism (dubbed neo-liberalism) to the University of Chicago. It is often thought that his closest American counterpart was Milton Friedman, although unlike Friedman, Hayek rejected the notion of macroeconomics altogether, preferring to think of the economy as the aggregation of individual micro-markets (for labour, capital and so forth). Today, Hayek’s libertarian neo-liberalism, arguably, has greater purchase in much of US academia than in Europe.

It was not until the entry of the SPD into the ‘grand coalition’ in 1966 that Keynesianism found traction, mainly because the FRG’s growth rate was faltering badly. ‘Global steering’ was enshrined in the ironically-named ‘Stability and Growth Act’ of 1967 (Gesetz zur Förderung der Stabilität und des Wachstums der Wirtschaft) and pursued in the Brandt period (1969-74) by his Finance Minister, Karl Schiller. But Keynesian spending was severely constrained by the Bundesbank, and the flirtation with Keynesian demand-side policies was short-lived. Schiller was replaced in 1972.

If the 1973 oil crisis and the period of ‘stagflation’ which followed it served to strengthen anti-Keynesian ideology in the Anglo-Saxon world, this shift was far more pronounced in Germany. Under Helmut Schmidt’s coalition (1974-82), Keynesian demand management disappeared. By the 1990s under another SPD Chancellor, Gerhard Schröder, a serious row over ‘neo-liberal’ policies between Schröder and the Keynesian economist and Chairman of the SPD, Oskar Lafontaine, led to the latter’s resignation and eventually to the formation in 2007 of a new party to the left of the SPD, Die Linke.

In short, if the right and centre-right in Germany were always neo- or ordo- liberal, the centre-left was only Keynesian very briefly in the postwar period. This helps explain the conservative consensus in economics which has not only been dominant in Germany, but in Brussels and the in EU as a whole, of which Germany is of course the dominant member.

And so we return to Herr Steinbrück (who could be the next German Chancellor) and the many social democrats who agree with him. As Paul Krugman argued at the outset of the current slump, counting on individual EU member states to reflate their economies on a piecemeal basis is inefficient because the leakages into imports from other EZ member states are far too high. A co-ordinated reflation effort by Europe as a whole would be far more effective because:

the multiplier on fiscal policy within any given European country is much less than the multiplier on a coordinated fiscal expansion. And that in turn means that the trade-off between deficits and supporting the economy in a time of trouble is much less favorable for any one European country than for Europe as a whole. (Krugman, NYT 11/12/08)

Today, while a decade of stagnant wages and a stable euro have boosted German industry’s profits, inequality has increased greatly. As the recessionary impact of German-led ‘expansionary contraction’ (ie, austerity-led growth) becomes daily more obvious, will the neo-liberal consensus finally be challenged?

1. The German Hour
2. The End of the Franco-German Axis