Hamish McRae: The German vote makes economic sense

While reform is necessary, it would be much better to introduce it at a time of buoyancy
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The Independent Online

Angst for them, schadenfreude for us? Or some lessons that are both more subtle and more interesting?

German political paralysis is being presented as some kind of disaster not just for the German economy but for the European economy as a whole. For some Britons there may be a certain wry pleasure in seeing Germany dubbed "the sick man of Europe", but the country is our second biggest export market after the US, so British business at least has little reason to cheer. The decline of the euro since the election shows that the market's conventional wisdom is indeed that this is bad news for Europe, and that is also the opinion of the German business community. Insofar as the election signals that the country cannot make up its mind about economic reform, that is probably right.

But I think we should be suspicious of the "it's a catastrophe" view. Were the political paralysis to continue for several years, that might well turn out to be the case. But that is not going to happen. Something will change.

When an electorate is divided down the middle there is no point in pretending otherwise, and a pause for thought may be no bad thing. There are three reasons for this. One: in the short-term, reform would have a negative impact on growth, not a positive one. Two: you really want to get things right, and the CDU programme carries some real concerns. And three: German business is marching on anyway, irrespective of what the politicians say or think.

The short-term loss/long-term gain point is easily made. Take the Christian Democrat plan to cut taxation on income but increase it on VAT. If the experience of other developed countries is any guide, after a time-lag cuts in income tax rates do help to stimulate the economy. They also don't cost as much as the crude arithmetic would suggest, because they encourage people to take more of their income in increased money instead of increased leisure and they reduce tax evasion. But that takes time. Meanwhile after any pre-increase blip, higher taxes on consumption unsurprisingly tend to cut consumption, which is the last thing the German economy needs right now.

Much the same point applies to the labour market reforms suggested by the CDU. These go further than the Hartz reforms introduced by the Social Democrats, and in the medium-term they would help to create more jobs. But in the short-term they would give employees less security, which would make people in jobs more fearful for the future and would encourage them to spend even less.

So while reform is necessary, it would be much better were they introduced at a time of some economic buoyancy, rather than the meagre 0.8 per cent that Germany seems likely to achieve this year. You need reforms to stimulate growth. But you also need some growth to ease the pain of the reforms.

That leads to the second point: are these the right reforms? Here economists have to be careful, for there is no clear "right" or "wrong" set of policies. What works at one time in one society does not work at another time in another.

We do know that some economic policies are really destructive. We know, for example, that some European nations, including Germany, have the highest unemployment rates in the developed world, with all the misery that this brings. That is a grave policy failure, and as Tony Blair told the European Parliament this summer, a serious indictment of "social Europe".

But undoing destructive policies has to be done carefully. My instinct, for what it is worth, is that it would be better to press on with deregulation of financial and product markets (shops' hours, mortgage restrictions, planning controls and the like) before embarking on too radical a reform of labour markets. And tax reform should come after that, once there is some buoyancy of revenues, and the emphasis then should be on simplification, rather than trying to create incentives for this and that form of behaviour. Taxation should be to raise money, not to re-engineer society.

The third reason to be unfazed by political paralysis is that these people are only politicians. Germany is bigger than its politics. It has a huge and wonderful embedded company base. Its companies have in a sense left the politicians behind. They have been racing on in recent years, cutting costs, improving quality, shifting production offshore to lower-cost countries to the east, buying firms abroad, and so on.

There is a good example of this right now. The German Post Office, which is of course privatised - yup, tell our blinkered politicians that - is creating the world's largest logistics group. It is seeking to buy the British company Extel for £3bn. Now it may be that some other bidder will emerge, the US firm UPS perhaps, and there has been criticism that Deutsche Post is paying too much. But the fundamental point stands that German companies are looking far beyond their slow-growing homeland. Indeed, the fact that the growth performance at home has been so poor has forced them to go global perhaps faster than they otherwise might have done. And it is ironic, is it not, that this particular focus of expansion has been the result of a financial reform in Germany that politicians here have been unable to achieve.

So commercial reform has taken place, even if political reform in large measure has not. Such reform has by and large helped the company sector, rather than German citizens, but there are even some signs that corporate competence is starting to benefit the domestic economy too.

The German stock market has done very well in recent months, and talking to foreign investors in Germany I have caught the feeling that commercial and residential property is starting to recover. People whose judgement I respect are putting money into the country. If German asset prices continue to rise, the owners will start to feel more confident and start to spend more money. Better growth will result.

It is, of course, chicken and egg. The key point is that better growth could create circumstances where it becomes easier to sell reform. If the politicians fail to do so, well, the most energetic Germans, people and companies alike, will continue to look overseas for opportunities.

None of this means that Germany will become a particularly dynamic region. The ageing nature of its population will inevitably hold it back. Nor does it mean that political paralysis is a benign condition, for if that carries on too long it will lead to instability. If you stop pedalling the bicycle, it falls over. However, it does mean that in a world of global opportunities, politicians are domestic creatures - and they are not quite as important as they used to be.