Mandatory Credit: Photo by HENNING SCHACHT/POOL/EPA-EFE/Shutterstock (10667880d) German Chancellor Angela Merkel (R) and German Finance Minister Olaf Scholz attend the weekly meeting of the German Federal Cabinet in Berlin, Germany, 03 June 2020. Weekly cabinet meeting in Berlin, Deutschland - 03 Jun 2020
Chancellor Angela Merkel and finance minister Olaf Scholz at a meeting of the German federal cabinet in Berlin last week © Henning Schnacht/POOL/EPA

Mirror, mirror, on the wall, who’s the most Keynesian of them all?

Until last week, no one would have given “Germany” as the answer. But Berlin’s fiscal stimulus package, designed to start the recovery with a “ka-boom” in the words of finance minister Olaf Scholz, has wrongfooted everyone.

The €130bn programme, announced last week, combines tax cuts, direct payments to households and spending measures spread over the next two years amounting to more than 3 per cent of Germany’s annual gross domestic product. By any measure it packs a large punch of discretionary stimulus on top of the “automatic stabilisers” by which the government budget balance varies with the economic cycle to absorb economic shocks, even in the absence of special measures.

For some seasoned European budget-watchers, this has been a welcome Damascene conversion to Keynesian countercyclical policy by a country they have long accused of an obtuse “ordoliberal” denial of basic macroeconomic truths and an obsession bordering on fetishism with nonsensical rules. But that was always an unfair charge. 

Countercyclical policy is not a new discovery for Berlin. In response to the 2008 financial crisis, Germany enacted one of Europe’s biggest fiscal stimulus programmes — and that unfolded under finance minister Wolfgang Schäuble, seen around Europe as the ultimate economic policy hawk. While he did demand damaging procyclical fiscal consolidation from other eurozone countries, that was as much a matter of politics as economics. Domestically, fiscal Keynesianism was both swift and forceful.

In a second sense, Germany has been more Keynesian than its critics. In the decade after the financial crisis, Berlin was berated abroad (and to a lesser extent, by dissenting economists at home) for consolidating its government budgets. That deficit reduction was a product of overly rigid balanced-budget clauses in the German constitution and of a political culture that praises saving and frugality. But it was also precisely what proper Keynesianism prescribed. 

The principle of countercyclical fiscal policy is not limited to boosting domestic demand in downturns; it also requires pulling demand out of the economy in upswings. That is just what Berlin’s budget policy did during most of the 2010s, when deficits were turned into surpluses while output was growing steadily and unemployment fell to record lows. If this made things harder for Germany’s trading partners, it could not be faulted on domestic Keynesian policy grounds.

Where Berlin has been falling short, however, is not on countercyclical policy in downturns or upswings, but on a third aspect of what John Maynard Keynes taught about good macroeconomic policy. One of the crucial lessons the British economist drew from the Depression was that the private market mechanism could fail to generate enough investment in new, productive capital. 

Insufficient investment relative to desired savings is what can prevent the economy from fully utilising its resources, contrary to the view that markets equilibrate themselves efficiently. But insufficient investment can also be a problem in its own right, even when full employment is being achieved.

That’s a fair description of the German economy just before the coronavirus pandemic. While growth and jobs continued to improve, the current account surplus remained stubbornly high. As a current account surplus arithmetically entails an excess of domestic saving over investment, this shows Germans’ desire to provide for their own future is failing to find an outlet at home. The country’s economy has behaved as a rentier rather than an entrepreneur, sending savings abroad in the hope of a financial return rather than building productive capital at home. 

Keynes’s solution to insufficient private investment was for the government to take greater responsibility for the allocation of capital. This need not only mean direct investment by the state; it could also mean creating incentives for companies to increase their capital expenditure. Neither is something Berlin has taken much to heart in the past: over the past decade, public investment has been negative once you take into account the wearing out of the existing capital stock. This is particularly due to under-investment by local government. Net private investment, too, has been much weaker than gross figures might suggest.

The latest package goes some way to remedy this neglect of investment. There is aid for municipalities that should lighten their cash constraints, as well as direct investment outlays. Tax deductions for capital expenditure have been made more generous. And there are a number of measures to incentivise investment related to the green transition.

All this is good news. But as important as an investment-friendly, short-term stimulus package is whether Germany’s leaders will permanently adjust their budgetary policy to encourage much more private and public investment on a sustained basis. Only then can they claim the Keynesian crown on all counts.

martin.sandbu@ft.com

This article has been amended to make clear that Germany’s fiscal stimulus and Wolfgang Schäuble’s tenure as finance minister came after the 2008 crisis.

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