The author is chief European economist at PGIM Fixed Income
When someone always gives the same answer, no matter what the question, there is reason to be suspicious. Take German fiscal policy, for example. The answer after the global financial crisis? Austerity. The European sovereign debt crisis? Austerity. Russia’s invasion of Ukraine? Once again, the German finance minister’s answer seems to be: austerity.
But unlike other countries in the EU, Germany’s problem was not one of over-investment or capital overhang. That’s why austerity simply magnified the country’s under-investment and made its economy less resilient to the latest energy shock. Giving the same answer repeatedly does not just betray a lack of creativity — for Germany today, more austerity is also the wrong path.
Successive episodes of turbulence since the 2008-2009 global financial crisis had already blown German gross domestic product growth off course. To this day, the economy still hasn’t regained its pre-crisis trend. Even before Russia’s invasion of Ukraine in February, the pandemic exposed the vulnerabilities arising from Germany’s under-investment. Together with an ageing population, this shortfall contributed to weak growth.
Russia’s invasion is the latest shock to German supply and demand. The Bundesbank and finance ministry seem to feel that this blow to the economy should simply be accepted. But the tighter fiscal and monetary policies they advocate would further suppress demand.
Moreover, there are signs that Germany’s trend growth continues to decline. Halting this “death by a thousand cuts”, where multiple crises add up to a disturbing larger picture, will require bold action and a rethink of the country’s economic model.
Internationally, German austerity risks worsening trade imbalances and straining transatlantic unity. Tensions between the west and China — a key export market for German products — had already put the brakes on Germany’s export-led economy. China’s push for self-sufficiency alongside global supply chain fragmentation will further challenge Germany’s business model.
That’s why Germany must embrace the fact that trade with the EU is seven times larger than with China, and recognise that it needs to invest at home and in its key trading partners first. The EU is the world’s largest and most open trading bloc. But the full benefit of the union will remain unexploited unless Germany steps up to a leadership role.
Instead of austerity, to actively offset the damage to supply and mitigate the impact of inflation from the war in Ukraine, German policymakers should engineer a positive shock.
German industry relies on cheap fossil fuels from Russia. In a worst-case scenario of a sudden stop in Russian energy flows to Germany, we estimate that the cumulative impact of inadequate policies pursued since the great financial crisis could approach a staggering 15 per cent of German GDP.
Such a shock requires a complete overhaul of the country’s energy supply. Some will want renewables to take centre stage, but complementary sources will be needed if Germany wants to have secure and consistent supplies. Investing in fossil fuels and nuclear energy domestically is likely to be part of that picture. The conclusion is clear: existing domestic supply will not be able to plug Germany’s demand gap.
Instead, Germany could invest in public infrastructure, on a scale reminiscent of the Marshall Plan. In particular, investment in energy infrastructure, like the Next Generation EU plan that Germany supported during the pandemic, would enhance the country’s security, accelerate its green transition and generate positive innovation spillovers.
More fiscal spending across Europe could also provide further impetus for common eurobonds. German public opinion would be less reluctant to embrace such an initiative because some of the funds would be spent at home. It would also be a step towards fiscal union in the euro area.
Self-interest favours investment as well. Given Germany’s large economy, higher spending at home would boost the entire EU. In turn, the country’s deep integration with the EU economy would see those economic benefits flow back to Germany itself.
Germany has the talent and resources needed for the investment we propose. Its leaders should set out a confident vision of its future and trust that investing in their country will deliver a good return. Yes, higher spending means more debt, but future generations stand to inherit the assets built by that debt. Not investing will lead to a permanent loss of GDP — cold comfort to any generation.
Source: Economy - ft.com
