Dismal Science 'Germany Is Investing Wrong'

Is Germany failing to invest in its future? The new head of the Halle Institute for Economic Research, Reint Gropp, told Handelsblatt what Chancellor Angela Merkel’s government is doing wrong.
Happy about the dismal science: IWH's Reint Gropp

Reint Gropp takes over the reins of the troubled Institute for Economic Research (IWH) in the eastern German city of Halle on Monday. The financial expert said more must be done tame unregulated markets.

 

Handelsblatt: Congratulations on your new position as IWH president. Your institute is in very bad shape. Have you taken on a suicide mission?

Reint Gropp: You are right. Three years ago the IWH was almost closed by the Leibniz Association.

With the evaluation coming up now it is do or die. If the IWH fails, the public funding will be cancelled and with it the business model will fail. Do you have a plan B?

I am very confident that a plan B will not be necessary and that we will pass the evaluation.

And if that doesn’t happen? Do you have a return ticket to Frankfurt?

Again, in the past few weeks I have been involved in a great many discussions and I am very optimistic for the IWH. Otherwise I would not have come to Halle.

This week, you will speak about the 25th anniversary of the fall of the Berlin Wall. Are you positioning the IWH more as an eastern German institute?

Naturally, we are also advocates for eastern Germany. The income per capita here is still 30 percent under the western level. The process of catching up has come to a standstill. It is especially painful when the potential for growth lies idle. At the same time, just looking at the east is too narrow a focus for me.

What does the new IWH stand for then?

Germany needs an agenda for growth, but one that needs to come from the private sector. We know too little about that interplay of financial markets and the real economy. Regulation should, for one, make the financial system more stable, that is clear. But really the interesting question is, how the financial system reacts to regulation, and how as a result, that influences the ability of the financial system to direct money into productive projects. In this area, our new finance division will work closely with our macroeconomists and structural economists. This combination of expertise is unique in Germany.

Other institute presidents have a message that can be boiled down into one or two words. The German Institute for Economic Research (DIW)’s president Marcel Fratzscher stands for investment, the Ifo Institute for Economic Research’s president Hans-Werner Sinn is the prophet of the euro crisis. What is your trademark?

Mistakes in capital allocation…

… you won’t get on a talk show with that.

Okay, I need to hone down the concept. Let’s call it a growth gap. What I mean to say is that in Germany we possibly invest too little. But that is outweighed by the fact that we invest too much in unproductive projects.

Overregulation frightens off activities in unregulated areas, in the shadow banking system. Reint Gropp

Can you be more specific?

We invest billions in the energy transition and support the solar industry. At the same time, we are closing highly efficient gas-fired power plants, which don’t have a chance on the market because of the subsidies for renewable energies. And that is only one example of many.

The current economic outlook…

… is grim.

The institutes have therefore questioned the political goal of a balanced federal budget. Must the German government take action?

The balanced budget may be nice, but there are many things that are more important. It is more critical to know the answer to the question of what the state is spending money on, rather than how much it is spending. Spending reviews and breaking even are not mutually exclusive.

It is true that the German government does not have a revenue problem. On the contrary: the public spending ratio is too high. That restricts action by the private sector. The government should therefore save money with its consumption expenditures. Then it would have some money left over, to do things like lower taxes.

And to invest more?

Yes, but I don’t mean first and foremost in streets and bridges. It is much more important for future prosperity that we invest more in education. My impression is that currently, despite the balanced budget, there is a redistribution taking place from the young to the old.

Investments in Germany-France-USA-OECD-average-Nov3-2014

 

If one considers the financial and euro crises together, then Europe is already in its sixth year of crisis. Now Germany is breaking down as the motor of the economy. Is there a risk of a further setback?

I am optimistic that Europe has overcome the bulk of the crisis; I don’t see conditions like in Japan. However, I would not consider the financial and euro crises as one crisis. The financial crisis clearly originated from the U.S. and its bad real estate loans and overly indebted private households. The origin of the euro crisis was the catastrophic budgetary politics of individual euro zone countries…

…that admittedly resulted from the rescue of the banks.

The bank bailout was very expensive, but in my eyes it was not the reason for the crisis, but rather structural reform deficits in many countries. Still, it is important that the taxpayer does not get stuck with the bill for financial crises.

Politicians see things similarly these days. They have tried many ways to restrain the financial markets. Do we need further rules, or are the banks already over-regulated?

Both! The banks are highly regulated with above all many requirements. Higher capital requirements, liquidity rules, the regulation of banker bonuses, and the banking union are all pointing in the same direction. But with all of the well-meaning rules, it is currently completely unclear how they will interplay with one another. Examining these questions, especially with an eye on the real economy, will be one of the top priorities of the IWH.

What will the result be?

Overregulation frightens off activities in unregulated areas, in the shadow banking system. We possibly magnify the part of the financial system that we don’t regulate, and that we would like to keep small. In this respect, we have too little regulation. I would like to see uniform rules for all participants in the financial markets.

Has regulation made the financial markets more secure?

Each banking crisis is different. One therefore cannot say in advance if and what one did correctly or incorrectly. I currently don’t think we will have a new financial crisis in the banking sector in the short-term. However, I could have also said that in 2007. The danger today is coming primarily from the unregulated sector.

Last week the stress test of the ECB created headlines…

Do you think? I thought there was remarkably little commotion. And there was no reaction on the stock exchanges. The result was almost perfect, from the ECB’s point of view. Do results that are too perfect arouse suspicion that first the results were already clear, and then were tested accordingly?

The suspicion is obvious.

So was the stress test a waste of time?

No, on the contrary. The ECB got a look at the balance sheets of the banks that they otherwise would never have been able to have, especially so quickly. It also appears to be the case that some banks only did their homework and got new equity capital because of the notification of the stress test. However, there are indications that at least part of the new equity capital came from public sources.

Does the cheap money threaten the stability of the financial system?

There currently is no alternative to the policy of cheap money. The countries have breathing room to implement the relevant structural reforms. One can only hope that they make use of the time.

 

Axel Schrinner covers finance for Handelsblatt. To contact the author: [email protected]