During the period following the Second World War, in an economic boom known as the Wirtschaftswunder (economic miracle), Germany posted some of the strongest growth in its history. But as the accompanying chart shows, the country has since become sick. During the boom years of 1951-70, its economy grew at an average annual rate of 6.3%. During the following 20 years, growth fell to 2.5%; during the 1990s, it declined to 1.8%; and in the new millennium it has averaged 0.3%.
Today, Germany is in economic crisis. In response, after three years of zero growth, parliament is set to pass massive cuts in the country’s notoriously generous unemployment benefits. The government is also working to cut health care costs and bring pensions under control. Even these reforms are unlikely to be enough to shake Germany out of its economic lethargy.
If Canada follows the same policies that led to German decline, it risks ending up in the same dilemma. Germany, too, once recorded strong growth, but the foundations for that growth were gradually eaten away over the years.
The Wirtschaftswunder of the first period was due in part to reconstruction following the devastation of the economy during the Second World War. But the basic reconstruction had been completed largely by 1960, and the high growth rates in the following decade took place while the country still operated as a market economy, free from the burdens of the welfare state and pervasive regulations.
Reunification in 1992-93 resulted in a decrease in the new country’s per-capita income. But it should have increased economic growth, since it opened opportunities for reconstruction and the redeployment of previously underemployed and often wasted resources, much as occurred in West Germany between 1945 and 1960.
The main explanation of Germany’s poor performance since the 1960s, and its inability to efficiently draw into production the underemployed resources of the eastern provinces, is the government’s excessive interference in the economy.
One of the main influences that explains the reduced economic freedom is Germany’s high level of overall government spending. The country spends 20% of its national income on social benefits alone, twice Canada’s percentage. Another important factor reducing economic freedom is regulation, which is high and very pervasive in Germany — much higher than in Canada.
Canada’s economic growth rates since 1971 have averaged much higher than Germany’s, but there has been a pronounced downward trend, the causes of which resemble those used to explain Germany’s poor performance. Understanding these causes has important implications for the economic policies of the government Canada has just elected, which has promised increased spending on a wide range of programs and no new tax cuts.
The results of German policies are illustrated by the fact that the country holds four world records: It has the youngest pensioners and the oldest students; its workers have the shortest work week and the longest vacations. Germany’s regulation of the labour market is legendary. It imposes large payroll taxes and limits the ability of employers to fire workers, hire part-time workers and keep businesses open in the evenings and on weekends.
German government policies have produced results that make the hearts of socialists race. Germany has 50% greater income equality than the United States, and the risk of not receiving government benefits during unemployment, retirement and ill health is 60% smaller, in spite of Germany’s high unemployment rate — about 10% for many years. These socialist achievements have come at the cost of slower economic growth (as shown in the graph) and reduced levels of private consumption, now at 78% of U.S. levels.
Germans have accepted the fact that there is a link between economic growth and private consumption on the one hand, and social policies on the other. They also know that to get higher growth they need more flexible labour market policies, lower and less progressive taxes, fewer and less stringent regulations and less generous social insurance programs. Governments have put some of the needed changes on the legislative agenda, but the legislation has been stalled for several years.
There are a number of reasons for this stalemate. There is the well-known tendency of Germans to talk rather than act. A joke has it that Germans on the way to heaven encounter a fork in the road, one way leading to heaven, the other to lectures on heaven: they choose the latter. Voltaire said in the 18th century that Britain ruled the oceans, France the land and Germany the clouds, where all of its famous philosophers held court.
In fact, in a democracy it is difficult to reach political consensus on the appropriate government policies. Interest groups representing the beneficiaries of the redistribution and security policies have many opportunities to block changes. The more spending and regulation there is, the more people benefit and want to preserve the existing policies.
Adding to the problem is the fact that elections take place every two years, either for provinces or the federal parliaments. The results of these elections make politicians aware very rapidly of the effects of proposed changes on electoral outcomes. It does not help that in 2002, 54% of all legislators in the Bundestag had been employees of governments or political and social organizations before their election.
Many Germans are very pessimistic about the prospect for needed reforms. The deadlock may end at some point when a major crisis makes economic conditions worse and private consumption falls more noticeably behind that of the United States. But it is difficult to overestimate the ability of socialist politicians to find scapegoats, or the lasting power of the slogan, “We do not want Germany to be like the United States.”
Canada’s consumption is already 22% lower than in the United States, while its income equality is 26% higher and its social security 80% higher. All of the Liberal election promises can be summed up by the slogan, “We will continue our efforts to become less like America,” and therefore, implicitly, more like Germany and the rest of Europe.
The newly elected government needs to consider how much farther it wants to travel down the road Germany has taken, how much slower income growth it wants to impose for the sake of income equality and security. As the German example shows, once that road is taken far enough, it may not be possible to get off.
Herb Grubel is senior fellow at the Fraser Institute and emeritus professor of economics, Simon Fraser University.