Today’s situation in the capital markets is extraordinary; some economists even describe it as a once-in-a-lifetime opportunity. What was for a long time considered impossible in advanced economies is now reality: Interest rates are not only at historically low levels but sometimes even negative. Instead of having to pay interest for sovereign debt, some governments actually receive interest when issuing these bonds.
These low interest rates along with prolonged economic stagnation have led to recurring demands for deficit spending, above all in Germany. This would result in debt-financed public investment programs with the goal of boosting economic growth – and paying back the additional debt with the projected returns on those investments. Opportunities for these types of investment are assumed to be plentiful: They include roads, bridges, schools and universities as well as – maybe most urgently – digital infrastructure such as broadband networks that can create growth opportunities in the 21st century.
Looking at the international reactions of academics and policy makers to the need for deficit spending, one sometimes gets the impression of a German Sonderweg (“special path”). While Anglo-American pundits and others around the world agree that boosting public investment by issuing government bonds is the way to go, only Germans appear obstinately reluctant to follow this path. Why? Is it a lack of insight? Or are there reasonable economic arguments for this German point of view?
Upon scrutiny, Germany is in fact not alone in looking askance at deficit spending. (Some countries in northern and eastern Europe are more “German” than the Germans in this respect.) Moreover, it is far from clear whether today’s economic stagnation is in fact due to a secular weakness in demand. An alternative explanation for low growth is the unsustainable debt levels all over the world that have steadily accumulated over recent decades. The American economist Ken Rogoff has called this trend a debt “super cycle”.
Debt has built up in all major economies. Germany is no exception: The development of its public debt in recent decades evokes a song title: “The Only Way Is Up.” Public debt stood at 20 percent of GDP in the early 1970s, then steadily increased to 40 percent in 1990. As a consequence of German unification, it rose further to 60 percent, before peaking at 80 percent after the 2008 financial crisis.
Public spending rose by more than public income, which itself rose more than economic growth. Put differently, the German government grabbed an ever increasing share of economic output as tax income, but this share was still not sufficient to cover even faster-growing public spending. It is obvious that this pattern of overburdening public finances cannot persist if the current generation wants to maintain a government that can act whenever it is needed and does not want to mortgage future generations.
The principle should be: Don’t just spend more, spend wisely.
One may argue that deficit spending can in fact help to reduce public debt levels, by priming the economy to grow even faster than government debt. But for this to be the case, the government would have to find excellent investment opportunities that indeed foster growth. One salutary example is Germany’s spending during the 2008/9 financial crisis — in effect a cash-for-clunkers subsidy — which arguably rescued the economy. But this was a short-term measure to avert an imminent crisis.
Can public spending also be expected to work as a long-term plan? Most Germans have their doubts, because they immediately think of the “new” Berlin airport that has a great future and probably always will. Under construction since 2006, it was meant to open in 2010 and is now, after several delays, slated for takeoff in 2019 at the earliest. Germany is dotted and scarred with such failed or failing public investment projects.
Yes, deficit spending was necessary in 2008/9 to prevent a global meltdown of the financial system. But while financial regulation has subsequently improved, it is no guarantee that a crisis of this magnitude will never happen again. In Germany and other countries, there are increasingly strong indicators that bubbles have inflated in real-estate markets, which, if popped, could cause the next crisis. It would be helpful at that point to have sufficient fiscal breath left to reflate.
These considerations show that it is not clear at all that governments should now resume deficit spending. The principle should rather be: Don’t just spend more, spend wisely. Too many spending initiatives in too many countries are launched to satisfy the clientele of ruling parties rather than to stimulate economic growth. Germany, for example, topped up public pensions — by allowing workers to retire earlier when they have worked for 45 years or granting additional benefits to mothers – despite its demographic aging.
One lesson should be to give investments priority over additional welfare spending, in particular at times of low interest rates and rising tax revenues. Another lesson is to pick investments that actually pay back, and only those. That would be the way to turn a once-in-a-lifetime opportunity in the capital markets into prosperity for another lifetime to come.
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