The G20 Summit in Toronto on June 26 and 27, 2010, exposed very different opinions about the role of government spending in the near future. Whereas the German and — surprisingly — the French governments seem determined to reduce their public deficits, President Obama is demanding more deficit spending from the European countries.
It seems odd to demand more government spending in a country running enormous public deficits. Besides, the German government has just agreed on some €150 billion worth of guarantees for the euro members if they fail to raise new funds for their debts.
|If Germans spend German savings via investment, other people in France, Greece, Spain or the United States cannot borrow the German savings.|
This is a remarkable fiscal package. And one should mention that the fiscal austerity package the German government has announced does not mean that it will stop spending — it reduces spending increases and the deficit. Germany is still far from a fiscal surplus, so the term "Sparprogramm" is slightly misleading!
So why should Germany run another deficit spending program? According to Paul Krugman, it is first of all necessary to avoid U.S. sanctions: Burn your money or we will impose trade barriers!
Now let us come to the serious part of his claim. If Germany opposes another expensive public spending program and saves €80 billion in the next four years, so his main argument goes, it hurts the world economy severely. Not only is domestic demand in Germany too little, but the world economy may also be missing a locomotive.
Without more deficit spending, the world is on the brink of another recession, if not a second great depression (even with similarly severe political consequences).
Another argument is the availability of cheap money. Currently, Germany can indeed borrow at historically record low interest rates. In my opinion, the cheap money is the true trigger of the next crisis, if it is to come. It is too cheap to borrow, and it gives the impression that spending is costless.
However, spending even with low interest rates today may prove to be expensive, particularly if the money is not invested but rather consumed. Given that the government will repay the debt, future generations have an ever-increasing burden.
|The German government has just agreed on some €150 billion worth of guarantees for the euro members if they fail to raise new funds for their debts. This is a remarkable fiscal package.|
This burden will be even higher if interest rates increase in the future — a very likely scenario. One has to consider that the interest payments today already make up 12% of federal public spending.
Instead of helping the world economy, Professor Krugman laments further, Germany is trying to weaken the euro to boost its exports. It remains unclear as to why austerity and fiscal stability is a recipe to weaken the euro. Conventional wisdom would suggest that a weak fiscal position encourages investors to leave a country (or a currency area for that matter), which then weakens the currency.
This is exactly what has happened over the last few months. International investors observed fiscal problems at the periphery in Euroland, which in turn endangered also the core, and then they left the euro. In addition, the reduced demand for German exports contributed to the euro depreciation.
Now consider the worst case: If the €750 billion guarantee fund is indeed needed, the fiscal position of Germany and its partners in Euroland would really be under stress. This would probably weaken rather than strengthen the euro. Add another fiscal package and expect a euro appreciation!
There has been the additional claim that Germany's export orientation is a curse rather than a blessing — not only for the country itself, but especially for its EU neighbors and the United States. This is also a flawed argument. Rather, German exports increase its GDP and thus, German imports. The more the country exports and imports, the better for all. Even if Germany runs a current account surplus, this is not a problem.
It also has nothing to do with unfair competition. Professor Krugman himself has shown the intertemporal logic of trade and current account surpluses in several papers. The trade balance is indeed the result of intertemporal decision-making. Germany's population invests less than it saves — this is the simple reason for the trade surplus.
|Cheap money is the true trigger of the next crisis, if it is to come. It is too cheap to borrow, and it gives the impression that spending is costless.|
Obviously, Germans fear higher taxes and lower social protection in the future due to high government debt, leading to high savings and low investments. So higher debts rather increase the imbalance. If domestic demand should be increased, two methods — apart from additional budget deficits — can be thought of: Either we save less or we invest more.
An aging population like Germany's is probably difficult to convince to save less — in particular in uncertain times, under unclear economic policy conditions. This leaves us with domestic investment to support the demand side: Demand is not restricted to the consumer, however.
If investment in Germany picks up, which is strongly recommended against the background of mass unemployment, the difference between savings and investment decreases, demand for domestic and imported investment goods increases and the export surplus is reduced as a side effect.
However, it should also be clear that if Germans spend German savings via investment, other people in France, Greece, Spain or the United States cannot borrow the German savings, which implies that they cannot spend them. Every euro can only be spent once.
This is another argument against increased government borrowing. If the German government borrows additional money, it cannot be spent by others. Assume that Chinese savings are spent in Germany by our government (because Chinese reserves are spent in euros rather than in dollars or any other currency).
Then, investment in the United States — or say, in Africa — is reduced. The same holds if the German government borrows German savings. Despite low interest rates, crowding out is still there. The money we borrow must have been earned before, unless it is freshly printed, which cannot be a serious suggestion by Professor Krugman.
|Professor Krugman remains unclear as to why austerity and fiscal stability is a recipe to weaken the euro.|
Finally, an attempt to stabilize fiscal policies in Euroland is not killing a moderate upswing. It rather helps to restore trust in governments and their economic policy.
More trust implies more long-term investment — and therefore more growth. This holds all the more, as much of the past spending in Euroland was used inefficiently and ineffectively. It is possible to get the same provision of public goods with less spending.
So, we do not simply face a business cycle problem, but also serious structural problems, which cannot be tackled with more government spending. They can only be overcome by reforms — and the German fiscal austerity program is a moderate step into that direction. It would be silly to abandon this step.
Editor’s Note: This feature has been adapted from an essay that was originally published in the AICGS Advisor on June 24, 2010.