[OUTLOOK]Worries about German stagnationWith near-zero inflation and little growth in sight, concern is growing that Germany might fall into Japan-like stagnation -- an extended period of sub-potential growth, accumulating nonperforming loans and public debt, and persistent deflation. The concern is justified.
Japan’s decade of decline is the worst fate suffered by an advanced economy since the Great Depression. Japan’s measured unemployment rate and public debt have both doubled, and the actual size of these problems is larger still. The underlying fragility in Japan’s financial system portends further losses of jobs and taxpayer money, and presents an ongoing risk of outright crisis.
It takes more than a bubble bursting, however, to become Japan. There are four factors that have rendered Japan unable to take the steps needed to return to growth after its 1990-92 stock market crash. The first is keeping too many banks open, particularly too many with public-sector backing, thereby eroding profitability and discipline in the banking system. This leads to banks rolling over bad loans and failing to make new ones.
The second is an overly restrictive monetary and fiscal policy in a time of declining demand and rising debt. The third is political and financial passivity by citizens, who simply save more and re-elect poli-ticians in the face of policy failure. And fourth is a lack of op-enness ― to new ideas, competition, or international pressure.
Germany clearly shares the first two aspects of Japan’s syndrome. As has become evident this year, Germany’s banking system is in deep trouble. The private banks are short of capital and so fail to create credit in response to what few rate cuts the European Central Bank makes. The Sparkassen and other government-backed banks are encouraged to expand their lending on nonmarket criteria. This combination generates more bad loans, less lending to new firms, lower returns to savers and bank owners, and additional pressure on asset prices from distressed borrowers.
Macroeconomic policy has not responded sufficiently to Germany’s situation. The Euro-pean Central Bank puts too little weight on the risks to the eurozone and the global economy from German near-deflation, even after suggesting that the bank’s inflation goal is closer to 2 percent than zero percent. The deservedly ridiculed Stabi-lity and Growth Pact asks for fiscal austerity when tax revenues are markedly declining due to near-zero growth. Alth-ough a eurozone macroeconomic policy is not actively contractionary, as Japanese policy was in the 1990s, it is allowing negative reinforcement between declining demand and banking problems making both get worse.
On the third count, German savers and voters have become increasingly passive in recent years. Due to the unfortunate timing of the collapse of share prices for widely held Deutsche Telekom, risk-averse Germans have increased their savings in the banks that squander that money, and accepted diminished returns. Election turnout was down in both last Septem-ber’s national election and February’s Hesse and Nieder-sachsen state elections, making politicians only accountable to the special interests.
The key difference between Germany and Japan, and the likely source of its salvation, is Germany’s international integration. As a member of the European Union, an open economy that imports and welcomes foreign direct investment, and a committed multilateralist na-tion, Germany is subject to constructive pressure from the outside. The German government may confront its banking problems and redesign eurozone macroeconomic policy in its efforts to fulfill its international obligations.
The current context, however, also threatens German openness. German public-sector bankers, and the politicians who use them, are trying to protect their interests by claiming that banking consolidation is a plot to replace the German Hausbank system with Anglo-Saxon finance. Yet having too many banks with too little capital and too much government protection is a recipe for disaster in any financial system -- just look at U.S. savings and loan institutions in the 1980s.
These financial and macroeconomic policy failures are not the source of Germany’s ongoing unemployment challenge. The Schroeder government’s Agenda 2010 rightly makes it a priority to reduce the duration of unemployment benefits and other labor supply problems.
The danger is that the current combination of crashed stock markets, overbanking, and a macroeconomic slowdown may turn the German economy Japanese before the benefits of reform are felt -- and as welfare reform in the United States demonstrated, the benefits of changing worker incentives are only reaped in a growing economy. The Schroeder government should not risk trapping Germany in stagnation by its plan to try to meet the 3 percent deficit target and to increasing public lending to already indebted companies. Instead, it should provide a solid footing for its labor reforms by resolving Germany’s banking problems and by demanding more expansionary eurozone macroeconomic policy.
* The author is a senior fellow at the Institute for International Economics in Washington. His book “Germany in the World Economy” will be published this fall.
by Adam S. Posen