Learning from German Reforms
The sovereign debt crisis in Europe has dominated international news cycles for more than two years and an end to the turmoil and uncertainty does not appear likely anytime soon. The popular debate within Europe has become highly polarised around the two positions of ‘growth versus austerity'.
On one side the ever-dwindling number of fiscally secure European ‘donor' nations, led by Germany, continues to insist that any bailout money made available to ailing countries is strictly conditional upon them drastically restructuring their economies. This restructuring is to be brought about through high dosages of austerity measures aimed at cutting social spending on items like pensions, public sector pay, welfare and increasing retirement ages with the ultimate aim of reducing the financial deficits of all 27 European Union member states to a maximum of 3 percent of GDP by 2014/15.
The other side of the argument, recently significantly strengthened by the election of François Hollande as French President and the somewhat chaotic election results in Greece, postulates that harsh austerity measures are actually making the situation worse in countries like Greece and especially Spain, which has vigorously implemented the proposed adjustments without any marked improvement in outcomes like unemployment levels, which remains stubborn at over 25 percent.
Economists sympathetic to left-of-centre approaches argue that austerity is in actuality undercutting growth, which is fundamentally worsening the crisis and that measures such as interest rate cuts and inflation increases are required. Above all, in the words of Paul Krugman, ‘unlimited Euros need to flow out of Germany'.
The fact is that the latter statement is so unrealistic at this stage that it borders on the absurd. Angela Merkel, supported by the majority of German citizens, is simply not prepared to - from the German perspective - throw their hard-earned money down a bottomless pit, where the irresponsibly spendthrift countries receiving the bailouts will continue to spend it on social welfare programmes that are inherently unsustainable and downright irresponsible.
Germany is not prepared to assume responsibility for the lack of discipline exhibited in the past by the societies and politicians of countries like Portugal, Ireland, Italy, Greece and Spain (summed up in the acronym PIIGS, probably not unintentionally inducing visions of the animals by the same phonetic name feeding uncontrollably at the trough).
From this perspective, the only option is for these countries to swallow the austerity medicine if it wants to receive bailout funds from the EU (with Germany being by far the largest source of these funds). Merkel and co clearly believe that providing bailout funding in this manner will solve two problems at once: it will keep the struggling economies from defaulting and allow them to remain in the Eurozone, while the accompanying reforms, although extremely painful in the short-term, will put them on much firmer footing in the future, enabling them to avoid a repetition of the crisis and ensuring the prosperity of the entire European project.
Despite the sometimes deafening calls for a move away from this position towards ‘growth', despite the riots in the capitals of many European countries and despite election results which clearly indicate electorates' disdain for austerity in countries like France (where it must be noted that the generally repulsive personality of Nicholas Sarkozy certainly contributed to the socialist victory) and Greece, Germany has stood firm. Despite some tentative recent evidence that Merkel is prepared to make small pragmatic concessions, it remains highly unlikely that Germany will be swayed in its conviction. Like it or not, austerity is the way Europe is going.
But what allows Germany to so spectacularly maintain its position in the face of mounting (and often unfair and even disgusting) popular criticism? A cynic would respond that it is very simple: Germany has the money, so it makes the rules. While this is undoubtedly a very important factor, probably even the most important factor in the ascendency of austerity in Europe, there is another argument that Germany employs very successfully in justifying its position. It is an argument, indeed an example, which I believe is highly relevant also within the South African context. It is the lesson offered by German adjustment during the early 2000s that is so powerful in sustaining the austerity drive.
The fact is that the German economy was reeling at the turn of the century. The costs of reunification were tremendous, with the west effectively subsidizing the east at a staggering rate of 5 percent of total GDP between 1990 and 1999. Levels of public debt were very high, especially in the eastern Länder, economic growth was anaemic and even contracted occasionally, while unemployment stubbornly remained above 10 percent. Germany was popularly known as the ‘sick man of Europe'. The Economist loudly declared in 1999 that ‘the biggest economic problem for Europe today is how to revive the German economy'.
Germany has managed to do just that - it has spectacularly revived its economy to the point where it has snuck up on a world endlessly obsessed with the unsustainably authoritarian rise of China and the waning of American influence to become, right now, arguably the most important country in the world.
The extent to which the fate of the entire world economy depends on one woman - Angela Merkel - is truly astonishing. For you see, if Germany mismanages the Euro crisis, the effects would be disastrous. The Eurozone could break up, leading to an even deeper recession than in 2008 (and perhaps even a global depression) and a veritable worldwide doomsday scenario. Stunningly, even the fate of Barack Obama's chances of re-election depends largely on Merkel's ability to save the global economy. But I digress.
So how did Germany do it? The answer to that question is tremendously relevant to South Africa and although it is difficult to imagine the fate of the global economy ever depending on the decisions made by one Jacob Zuma, my belief is that adjustments similar to those undertaken by Germany to propel it to prosperity could yield even more spectacular results in South Africa, which starts from a much lower economic base.
The first step in healing the sick man of Europe was the recognition that despite the ‘once-off' and isolated economic pain caused by reunification, Germany's problems were essentially structural in nature. The social-market economy it devised following the end of the Second World War featured a bloated welfare system; excessive, rigid and unaffordably high labour costs; too much red tape; and an inefficient tax system.
Following the longest economic stagnation in the history of the Federal Republic - from 2000 to 2003 - then-German Chancellor Gerhard Schröder announced a series of sweeping reforms to address these structural shortcomings, entitled ‘Agenda 2010'. In a series of bills passed by the Bundestag, the German government systematically proceeded to cut taxes (including a spectacular 25 percent cut in the income tax rate), reformed the tax system to make it more streamlined and cut red tape by making it easier for entrepreneurs to start businesses in certain crafts without undergoing stringent apprenticeships. Most of the measures were also aimed at reducing spending, resulting in 2010 in an even bigger current-account surplus than China's.
Most decisively of all, however, were the reforms to the labour market and social security system. As part of the process in the development of Agenda 2010, the Kommission für moderne Dienstleistungen am Arbeitsmarkt (Commission for modern services in the labour market), commonly known as the Hartz commission after its chairman, Peter Hartz, was set up to investigate labour and social reforms. Its recommendations would go on to become the Hartz reforms.
Hartz I and II essentially introduced greater flexibility into the labour market, specifically by making it easier to create certain jobs. Flexible and part time arrangements such as ‘Minijobs' and ‘Midijobs', as well as a grant incentivising entrepreneurs to start their own businesses was created by these reforms, while Hartz III restructured, reformed and increased the number of Job Centres in the country. This was followed by the implementation of Hartz IV on 1 January 2005, which reformed the German social welfare system by merging unemployment and welfare benefits.
Unemployment benefits were reduced by firstly cutting the maximum duration of eligibility for the more generous Arbeitslosengeld I (Unemployment Money) from 36 to 12 months. After these 12 months, a claimant is allowed to apply for Arbeitslosengeld II. However, the qualification requirements are strict, while benefit levels are significantly lower than for Arbeitslosengeld I.
Taken together, the reforms brought about through Schröder's Agenda 2010 has completely revolutionised the structure of the German economy. It has shrunk the welfare system, introduced labour market flexibility, cut red tape and reformed the tax system. And it has worked. Unit labour costs fell by an average of 1.4 percent every year between 2000 and 2008, while labour costs rose in countries like Britain and France. Unemployment is steady at 6 percent at a time when record numbers of people are unemployed in much of the developed world.
It also has its fiscal house in order, partly because of impressively high savings levels, with comparatively low levels of public debt and a deficit of 2.2 percent, safely within the proposed EU limit of 3 percent. Most obvious of all, its economy continues to grow (albeit at a slow rate) while most of Europe is in a deep recession. Indeed, German economic growth is the only thing keeping Europe out of an official recession.
It is exactly these reforms and their spectacular success which enables Germany and Angela Merkel to resist populist calls for a relaxation of austerity measures and greater spending. Germany's approach is vividly captured in this most telling quote from Schröder's speech at the introduction of Agenda 2010 in 2003: ‘Either we modernize ourselves, and by that I mean as a social-market economy, or others will modernize us, and by that I mean unchecked market forces which will simply brush aside the social element'.
Germany recognised that it needed to change its unsustainable ways if it was to prosper. It also recognised that it was better to bring about the adjustments internally than to let the market dictate the adjustments through a crisis.
One cannot help but admire the tremendous foresight of Schröder and his government. At a basic level, there is a very real argument in Europe that while other countries within the Eurozone were irresponsibly spending their money without any regard for its future implications, Germany recognised the dangers and voluntarily underwent a painful adjustment.
And while it is now reaping the benefits, other European countries are paying the price by having the market (dressed-up in Lederhosen) forcing them into the adjustments they were too short-sighted to undertake themselves. Germany realises that it is painful and perhaps even cruel, but Merkel believes it to be the only way. Given the enormous successes brought about by Germany's own painful adjustment, who can blame her?
While it is very important to note the vastly differing contexts between South Africa and Germany, there are clearly some general lessons that South Africa would do well to learn from Germany. Most obviously is that labour markets must be made more flexible in South Africa, while labour costs need to be brought down in order to attract investment. Just as in the German case, fresh and innovative approaches are required to make the labour market more productive and competitive.
It is in this regard that the potential introduction of a Youth Wage Subsidy could be helpful, although it is certainly no panacea and needs to be part of much broader reforms. Clearly the sheer extent of poverty and inequality in South Africa warrants a different approach to social welfare and German reforms cannot be ‘cut-and-pasted'. But innovation is possible, especially by making social welfare in South Africa less passive and more participatory.
Cutting red tape is perhaps the most straightforward reform that is required, as it is directly responsible (especially when combined with the inflexible labour market) for preventing entrepreneurs from starting businesses. Finally, reform of the tax system would become easier once expenditures are reduced through wasteful red tape, passive welfare, labour market inflexibility and growing employment.
Elements such as centuries-old cultural differences and the obvious differences in levels of wealth between South Africa and Germany prevent one from drawing specific conclusions. South Africa does not have an established Mittelstand or a culture of saving and innovation like Germany. But they can be encouraged within the South African context. The German system is not appropriate for South Africa in its wholesale form. But its general implications are. What is required are structural reforms along similar lines, but which are customised to South African realities.
But finally, there is a catch. The political costs of the Schröder government's wise reforms were tremendous. Schröder became Chancellor through a coalition between the Sozialdemokratische Partei Deutschlands (SPD - Social Democratic Party) and Bündnis 90/Die Grünen (B90/Grünen - Alliance 90/The Greens) which are both left-of-centre parties. At the time of the Agenda 2010 reforms, many leftwing parties in Europe were undergoing a transformation towards the Third Way, which involved an embrace of certain market forces which they had previously denounced.
It is thus very interesting that the decidedly market-friendly reforms of Agenda 2010 were undertaken not by the right-of-centre Christlich Demokratische Union Deutschlands (CDU - Christian Democratic Union) but by a leftwing coalition. This fact makes the adoption of Agenda 2010 even more impressive because Schröder's government was prepared to do it despite the fact that they knew it would be very unpopular with their traditional support base. But they did it anyway, because they knew it was the best thing for the German economy. The results have clearly vindicated their belief, and many observers directly credit Agenda 2010 and the Hartz reforms for Germany's spectacular success. However, the political costs were devastating. Criticism against the reforms was tremendous, especially from within the SPD itself.
Many people resigned from the party, perceiving the reforms as a betrayal of the party's 2002 election campaign. The crisis even got to the point where Schröder threatened to resign if the reforms were not passed. Trade unions that were traditionally allied to the SPD roundly criticised the reforms as well and there were demonstrations across the country (although politically motivated strikes are constitutionally prohibited).
Eventually Schröder was forced to resign as party leader in 2004 and the reforms had negative implications at the polls for the SPD. After a series of poor results in regional elections, the SPD lost to the CDU by a slim margin and after negotiations establishing a grand coalition between the SPD and CDU, Schröder was forced to step down as Chancellor in favour of Angela Merkel of the CDU.
The political costs of implementing the reforms were clearly significant for the SPD, who have struggled against the CDU ever since. It took foresight and a certain amount of political bravery for a left-of-centre party to implement Agenda 2010 in the knowledge that it would have negative political implications. But it was undoubtedly the right thing to do to heal the sick man of Europe. Despite the powerful lessons offered by German adjustment it is unfortunately highly doubtful whether the political leadership in South Africa will be able to make similar sacrifices to heal its own economy.
*Leon Schreiber is a South African PhD student in Political Science at the Freie Universität Berlin in Germany. The views expressed are his own. This article first appeared on his blog at http://theschreiberei.wordpress.com/. He can be followed on Twitter here.
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