Germany Economic Policies in the 1990’s

Germany Economic Policies

During the initial stages of reunification, the orientation of the federal government regarding the policies necessary to address the enormous financial commitment was to avoid resorting to an increase in the tax burden. Electoral interests certainly affected this choice, which was not shared by the Bundesbank, which feared a rise in the rate of inflation, but also the conviction that the positive economic conditions of the BRD would have allowed the financing of the expenses for reunification without causing excessive tension on the money market. Already for some years, in fact, the western Germany was experiencing a strong economic expansion, associated with a high surplus of current portion (4, 5 % of GDP in 1989) And a fiscal surplus equal to 0, 2 %. The unification process, more than an obstacle, was seen as a formidable opportunity for development. In fact, immediately after the start of the integration process, the Länder Westerners have recorded outstanding economic growth (5, 7 % in 1990 and 5 % in 1991). Soon, however, the gigantic financial transfers required by the economic reconversion process of the former GDR (250 billion marks in the two-year period 1990 – 92 alone) Fueled a large public finance deficits (2, 6 % of GDP in 1992). Furthermore, the strong growth in demand from the Eastern Länder exceeded the production capacity of West German companies, spilling over into imports and the current account balance, which between 1990 and 1992 began to show a deficit of the order of 40 – 50 billion dollars. The rapid deterioration of the internal financial situation and the worsening of the external accounts prompted the government to review its initial strategies and to introduce between 1991and 1992 corrective measures with increases in direct and indirect taxation. However, these measures did not affect the progressive growth of the financial needs of the public sector which, at the end of 1992, came to absorb more than half of domestic savings. Judging from the economic policies of the government inadequate to counter rising inflation, the Bundesbank in August 1992 decided to increase the discount rate to ‘ 8, 7 %, a level never reached before.

The Bundesbank’s decision was taken just at a time when the economic recession and rising unemployment hit a large part of the European economies. The rise in the discount rate has fueled massive capital inflows in Germany causing a severe currency crisis within the European Monetary System and forcing higher inflationary countries, such as Great Britain and Italy, out of exchange agreements. The Bundesbank’s policy has aroused criticism from many quarters, as the high German interest rates have been interpreted as the consequence of a decision aimed at shifting the burden of reunification to the other countries of the European Union. Even if this accusation does not appear fully founded (G. had already proposed in 1990to France and Italy an appreciation of the mark, but these had refused in order not to compromise the credibility of the exchange rate defense policies), the fact remains that the high German interest rates have transformed Germany from a capital exporter to importing country. Between 1991 and 1995, in fact, Germany borrowed over 200 billion dollars from abroad which made it possible to finance the enormous current deficit associated with the reunification process.

Between the end of 1992 and the first half of 1993, the Germany has entered the most acute phase of recession since the war, which has caused the end of 1993 a contraction of GDP equal to ‘ 1, 2 %. The most serious consequence of the recession was the explosion of unemployment which also involved the Western Länder. During 1993in fact, the large industrial groups of western Germany have reacted to the loss of competitiveness, caused by the strengthening of the mark and the low growth of productivity, with the launch of restructuring plans that have led to massive cuts in employment and the relocation of most of the production plants abroad. During the same year, the industrial sector recorded a contraction of the places of work of one million units, and helped to raise the national unemployment rate to ‘ 8, 8 %.

The economic recession has also had a negative impact on the public financial balance, exerting a negative effect through two channels. On the one hand, the rise in unemployment has led to a rise in expenses for the financing of unemployment support plans (the so-called Arbeitbeschaffungsmassnahme, or ABM), on the other hand the economic recession has caused a reduction in tax revenues: the net effect on the public financial balance was a growth in the deficit, which in 1993 reached 3, 2 % of GDP.

To cope with the effects produced by the economic crisis and the financial difficulties of the unification process, the government has tried the path of consultation, in order to define a framework of interventions on which to bring together the maximum political and institutional consensus. Moving in this direction, in March 1993 government, opposition, trade unions, business associations and Länder they signed a ‘solidarity pact’ through which the intervention strategy for the economic restructuring of the eastern regions was redefined. As a result of this agreement, the trade unions have undertaken to accept reductions in real wages, while the government has defined a plan to reduce the public deficit based on the redistribution of revenues between the Länder and the introduction of a ‘solidarity tax’ (revenue into force in 1995), which led to an increase in the tax burden on income of 7, 5 %.

A new phase of growth began in 1994 for the German economy, but it turned out to be weaker than expected. The GDP increased by 2, 7 % in 1994 and ‘ 1, 2 % in 1995. Both the weakness of domestic consumption, held back by the stationary purchasing power of wages and salaries, and the overvaluation of the mark, which penalized German exports on the European and US markets, contributed to the slowdown in the economic recovery. Furthermore, despite the cautious easing of interest rates decided by the Bundesbank in response to the decrease in the rate of inflation (which has fallen since 4, 1 % in 1993 to 3 % in 1994 and 1.8 % in 1995), the activity of internal investment remained very weak and did not allow to absorb the continuous growth of the unemployment rate, which in 1996 exceeded for the first time the two digits (10, 3 %). In fact, companies have accelerated the processes of productive displacement, making direct investments in the United States, in the more dynamic Asian markets and in Eastern European countries, where labor costs are up to nine times lower than in Germany.

The context in which the government had to decide the lines of economic policy was therefore conditioned by two orders of factors: on the one hand, pressure from industrialists, who continued to ask for restrictive wage policies, tax relief and deregulation of the labor market, envisaging a further growth in unemployment and productive delocalization in the event of non-acceptance of their requests, and on the other the need to counteract the now unsustainable pressure on the federal budget for social expenditure and transfers to the Eastern regions. The economic policy problem, in particular, was to reconcile the easing of the tax burden with the objectives of financial consolidation and the fight against unemployment.1994 (tax relief for businesses, increase in the unemployment contribution, reduction in health care costs and pension benefits) did not produce any significant effects. The public deficit, in fact, grew further, exceeding between 1995 and 1996 the threshold of 3 % of GDP required by the Maastricht Treaty for joining the European Economic and Monetary Union. In an attempt to correct financial imbalances and reduce unemployment, in January 1996the government attempted a new consultation with the social partners, presenting an ‘action plan for investment and employment’, followed a few months later by a ‘program to promote growth and employment’ (Sparpack).

The plan set the objectives of reducing the stock of public debt to 46 % (i.e. the pre-unification level) and halving the unemployment rate by 2000. The plan included, among other things, raising the retirement age, reducing wages in the event of illness, freezing family allowances, freedom to dismiss companies with fewer than 10 employees, and reducing the solidarity in favor of the Länder oriental. In essence, it was a question of calling into question the principles of social security guarantees and the protection of the fundamental rights of workers which represented the cornerstones of that ‘Rhenish model’ which had characterized Germany’s economic growth since the post-war period.

However, the program met with strong opposition, which resulted in the largest trade union demonstration since the postwar period in June 1996. After having heavily downsized the content of the plan, the government proposed a new reform of the tax system, but met with strong resistance from the opposition and the trade unions.

In 1997 the German economy showed slightly more sustained growth than in previous years (2, 2 %). Faced with a stagnant trend in domestic consumption, crushed by the strong increase in taxation and the regression of the purchasing power of wages, economic growth was fueled almost exclusively by exports which, benefiting from the appreciation of the dollar over the mark since 1996, they have reached around 30 % of GDP. The unemployment rate has instead reached historic levels (11, 4 %, corresponding to more than 4, 5 millions of unemployed), also due to the low propensity for internal investment on the part of businesses. The latter, in fact, have further accentuated the processes of productive dislocation abroad and accelerated the plans for the internationalization of their activities (the acquisition and merger operations of foreign companies carried out by the large German industrial groups reached, between 1997 and 1998, the 75 billion dollars). Despite the difficulties in proceeding with tax reforms, the government managed (thanks also to some accounting tricks) to bring the budget deficit below 3%, and at the same time to satisfy the constraints imposed by the Maastricht Treaty. The external accounts also showed significant improvements and, in 1998, the current balance was back in surplus, for the first time since unification. The positive macroeconomic picture of Germany has reappeared again in 1998 with good GDP growth and a further reduction in inflation. However, uncertainties due to the financial crises in the markets of Southeast Asia and Russia weigh on Germany’s economic prospects (which, in addition to being recipients of a significant share of Germany’s direct investments, also represent increasingly important outlet markets for German exports) and above all the high unemployment than in 1998 it has shown some improvement only thanks to the intensification of public funding.

Germany Economic Policies