Why Germany’s Stimulus Works and Obama’s Doesn’t

Germany has become the world’s economic whipping boy. Liberal economists, including those in the Obama administration, criticized Germany’s choice to eschew the notion of a big-spending Keynesian model in favor of austerity measures. They argued that governments must spend, spend, and spend some more to mutually reinforce the economic growth needed to dig the world out of the crisis. If we keep digging deeper surely we’ll dig to other side of this problem, right?

No, Germany argued, we’ll just end up deeper in a hole. What is amazing is that Germany is one of the few nations who recognized the utter ridiculousness of this question. To be fair, they’ve answered this question wrong before. Germany attempted a large fiscal stimulus package as part of their attempt to spur the East Germany economy following the fall of the Berlin Wall. Despite some short-term gains, it was a long-term failure that led to a severe debt burden, enduring high tax levels, and very little economic development in the East. Stimulus had been tried and found wanting.

Germany’s personal experience with stimulus was likely part of the reason it chose a different path in dealing with the current crisis. That said, they didn’t completely shun the idea. Their $130.4 billion stimulus package wasn’t chump change, although the proportion of tax cuts to spending was about twice that of the U.S. stimulus. The main differences however come in implementation--something Germany learned and perfected since their last stimulus go-round. As online economics think tank e21 explains:

The focus since the early part of the year has been on reversing stimulus, enacting credible government spending cuts, and encouraging the rest of the developed world to do the same. The result (coincidental or not), has been a return to pre-recession levels of business confidence, a 2.4% annualized increase in households consumption expenditures in the second quarter, and more than a 20% annualized increase in business investment.

If those results aren’t enough to make you wonder whether they know something we don’t, consider that the German economy grew nearly four times faster than the United States’ in the second quarter. That’s about twice as fast as the United States economy grew under the boom years of the Clinton presidency! Why the growth discrepancy between our two great nations? Because Germany has put an emphasis on competitiveness while the United States has remained wedded, or if you prefer, shackled, to the idea of stimulating demand.

[Read more about the U.S. economy and the stimulus.]

The difference appears to be largely based on one’s perception of the long-term consequences of government stimulus. Germany believes that private consumption and public sector debt are inextricably intertwined. People are loath to spend their money while facing an uncertain fiscal future. To mitigate this insecurity, Germany followed its stimulus package with a detailed austerity plan, thereby boosting demand in the short term without the distortionary effect of lingering deficits.

[See a slide show of 10 wasteful stimulus projects.]

The United States on the other hand appears to have its blinders on, focusing solely on improving the here-and-now, without consideration of the future. They dismiss Germany’s approach by saying, in the words of Paul Krugman, “the whole [austerity] argument rests on the presumption that markets will turn on us unless we demonstrate a willingness to suffer.” That’s not exactly true. “Suffer” is Krugman scare-speak for “pay off our debt.” Nevertheless, under this paradigm, any worry of debt falls subordinate to alleviating the suffering caused by unemployment.

What this viewpoint fails to consider is that consumer and business confidence, whether rationally or irrationally tied to deficits, is tied to employment. The Obama administration has given little indication that they have a plan to alleviate the deficits caused by our current stimulative efforts. Instead, we are left with speeches like the one President Obama gave Monday, explaining how his “economic team is hard at work in identifying additional measures” to get the economy on track, but providing no indication of a plan to pay off our debts. Vague solutions to the unemployment problem do little to outweigh a lack of solutions to our deficit problem.

[Read more about the deficit and national debt.]

That is where we should learn from Germany’s example. If you truly want to spur demand with government dollars it must be coupled with a plan to show consumers your intent to pay it off. Decoupling these two necessary parts can have drastic consequences. For instance, while Germany’s business confidence has reached a three-year high, signaling continued growth and hiring, the United States’ small business confidence has declined for three straight months, reaching its lowest point in 18 months.

The German success story contains many lessons for the United States. Sadly, we have been content to criticize rather than study their methods. As our nation’s recovery continues to flounder and our policymakers further dig their heels into failed strategies, our government will have nobody to blame but its own hubris.

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