The coming year will present many serious risks for the world economy, two of Germany’s leading economists warn.
There’s a lot that could go wrong, they say: Among the major concerns right now are potentially protectionist policies from out of the U.S. and fears that the euro crisis is about to spark up again, with Greek debts and upcoming elections in France, Italy and the Netherlands.
As a result, German companies are not investing much. “They are extremely unsettled,” said Gustav Horn, a professor and director of the Macroeconomic Policy Institute, or IMK, part of the Hans Boeckler Foundation, a think tank with ties to the German labor unions.
“They are asking themselves as to whether the euro zone is even going to exist in a couple of years. That’s preventing them from building up their own capacity. The European Central Bank is – rightly - holding down the inflation rate in the hope that businesses will invest more as a result.”
Unless changes are made, the euro zone will remain a fragile entity. Stefan Kooths, Economist, Kiel Institute for the World Economy
“Unless changes are made, the euro zone will remain a fragile entity,” added Stefan Kooths, a German economist who heads the Forecasting Center at the Kiel Institute for the World Economy. “The euro zone suffers because there is no common frame of reference on the [financial] rules. Germany wants the rules to be binding but countries like France and Italy reject some of them because they want more scope for intervention. This phase of economic weakness shows that countries are suffering from structural problems that you cannot fix with any stimulus package.”
Not that Germany doesn’t have the money for a stimulus package. The government, and the country’s finance minister, Wolfgang Schäuble, are sitting on yet another budget surplus, this time amounting to around €6 billion ($6.39 billion).
Mr. Horn would like to see that money invested in improvements to public infrastructure because he believes that will motivate private businesses to invest more as well. “The worst thing to do would be to cut taxes,” he argued. “The surpluses won’t be there forever, whereas tax cuts are permanent and carry the seed of new deficits.”
Tax cuts were tried and failed in the 1990s, Mr. Horn continued. Taxes were reduced and that opened the door for cuts to social welfare spending. “In the end those who could least afford it had to pay for the cuts. They didn’t get any of the benefits of the lower taxation, they were only impacted by cuts in social spending,” he said.
As it is, a decrease in the government’s income and government spending, to fulfill various expensive promises made to voters, is already likely to wipe out a large part of 2016’s budget surplus; this was announced in a presentation to German cabinet members at the beginning of this month.
Mr. Kooths also believes that Germany’s budget surpluses are going to diminish further over the next decade, due to demographic changes in the country. “We’re going to have to get rid of international assets and import more goods,” he noted.
The German budget surplus has been criticized by both friends and enemies.
The richest country in the E.U. is often condemned for getting wealthy itself at the expense of other countries within the euro zone. Some of that criticism is justified, Mr. Horn conceded. “The fruits of our export successes have not been fairly distributed,” Mr. Horn said. “They have ended up as company profits and in the pockets of the most prosperous. If they had flowed down to the masses, that would have stimulated demand for imports and reduced the imbalance in our current accounts. This imbalance in incomes is one of the reasons for the strength of populist forces, in Europe and in the U.S.”
In international terms, Mr. Horn suggested, “the surpluses are coming at the same time as deficits in the other countries. If the imbalance is too great, they create debt crises, a race to devalue currencies and protectionism.”
Which brings the two leading economists to the new U.S. president, Donald Trump, and his stated aim of “America first.”
“What Trump has announced is likely to gain a majority in the U.S. Congress and it includes reform of enterprise taxation,” continued Mr. Horn.
This new tax system would cut rates for businesses inside the U.S. while imposing a value-added style tax on everything coming into the country from outside. Which would, supposedly, encourage more manufacturing in the U.S. and a lot less imports from countries like Germany.
“But this kind of politics harms supply chains, which add value, causes price increases and inhibits innovation. Europe must react,” argued Mr. Horn, who is of the firm opinion that the new U.S. president is about to start a very serious trade war.
In terms of an appropriate response, Mr. Horn suggested that the E.U. flex its trade muscles and demonstrate intention.
We need tools of trade policy that cause fear. Gustav Horn, Director, Macroeconomic Policy Institute
“We could raise customs duties on imports of aircraft – which would probably see the Boeing boss on the next flight to Washington. We could order Facebook to shift data centers to Europe. Not that I like these kinds of things,” he noted. “But we need tools of trade policy that cause fear and that even things out, that make it clear to Mr. Trump that he is hurting his own country by sealing it off.”
Mr. Kooths sees things a little differently, arguing that economic adjustments will do more than threatening gestures. “In a national economy with almost full employment, the tax cuts and expenditure Mr. Trump has announced will drive up interest rates,” Mr. Kooths suggested. “The U.S. Fed is already behind with interest normalization. If the interest gap between the U.S. and the rest of the world widens, the dollar will become even stronger. And then the opposite of what Trump wants will happen: Increased imports. But I’m very worried how someone with Trump’s character reacts when the outcome of his policies run counter to his intention. We may be threatened with a protectionist rampage.”
Mr. Kooths is opposed to European retaliation and wants Germany to take the high road, so to speak. “We should let Trump do what he wants and bet on the man being a passing phenomenon, even though that will be politically difficult. If we get caught up in a sanctions spiral, the global economy faces disaster … I believe that if a protectionist course is being instituted, and if it only goes in one direction, then large U.S. corporations would want to talk to Mr. Trump about that. Their influence will be far more effective than threatening gestures from the E.U. No other economic region of the world is as tightly interwoven through direct investments as the trans-Atlantic one,” he concluded. “Any barriers would also damage U.S. firms trading in Europe.”