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September 2013

Paper Series
The Power of Ideas: Why Germany is so Different and What it Means for the World
by Mark Schieritz

Summary: Neoconservative thinking may have gone out of fashion in recent years, yet it provides important tools to understand what drives German foreign economic policy and thus helps to understand why Germany is so different when it comes to economic issues. This paper starts with a brief discussion of neoconservative thinking and a description of where Germany stands in the international debate and then moves on to the analysis of the causes and consequences of the countrys policy choices.

Three years before the start of the 2003 Iraq war, Robert Kagan and William Kristol published a book that neatly summarized their view on U.S. foreign policy. In the words of these eminent neoconservative thinkers, the United States does not pursue a narrow, selfish definition of national interest, but generally finds its interests in a benevolent international order.1 U.S. foreign policy, they claim, is infused with an unusually high degree of morality.2 Neoconservative thinking may have gone out of fashion in recent years, yet it provides important tools to understand what drives German foreign economic policy and thus helps to understand why Germany is so different when it comes to economic issues. I will start with a brief discussion of neoconservative thinking and a description of where Germany stands in the international debate and then move on to the analysis of the causes and consequences of the countrys policy choices.

The Neoconservative Heritage As Jacob Heilbrunn3 famously argued, no one has ever succeeded in rigorously defining neoconservatism. There are, however, some common features of the various strands of neoconservative thinking. Neoconservatism draws on several intellectual traditions including the views of a group of Jewish intellectuals at City College of New York in the 1930s and 1940s, students of German political science professor Leo Strauss, and followers of Rand Corporation strategist Albert Wohlstetter. Heilbrunn has suggested that neoconservatism is about a mindset that has been decisively shaped by the Jewish immigrant experience, by the Holocaust, and by the 20th-century struggle against totalitarianism.4 Initially influenced by Judaism, Marxism, and liberalism, neocons, as they soon were branded, eventually embraced conservatism. While the movement remained confined to academic circles for many years, the decline of the Soviet Union and the collapse of communism in Eastern Europe suddenly opened the corridors of power. Under the administration of President George W. Bush, neocons such as Paul Wolfowitz
3 Heilbrunn, J. (2009). They Knew They Were Right: The Rise of Neocons. New York: Anchor Books. 4 Ibid.

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1 Kagan, R. and Kristol, W. (2000). Introduction: National Interest and Global Responsibility. In R. Kagan and W. Kristol (Ed.), Present Dangers: Crisis and Opportunities in American Foreign and Defense Policy. New York: Encounter Books, 2000. 2 Ibid.

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and Richard Perle became leading members of the Bush White House and pushed for interventionist policies to promote regime change and to spread democracy. They were united by a distaste for cultural relativism and a belief in the universality and cultural supremacy of Western values. Irving Kristol has argued that neoconservatism is a persuasion. It defines national interests in terms of power and not in terms of narrowly defined self-interest. Following Francis Fukuyama, neoconservatism in its most general form stands for a foreign policy orientation that has a strong idealistic or moral component.5 George W. Bush touched the essence of neoconservatism in a speech in London in 2003: The United States and Great Britain share a mission in the world beyond the balance of power and the simple pursuit of interest.6 And this is where parallels to Germanys economic policy emerge. The World Against Us In the run up to important international meetings, officials in national capitals exchange many phone calls and emails in order to prepare the agenda. A few days before the 2013 spring meeting of the International Monetary Fund in Washington, DC, a high-ranking official in the German finance ministry received an email from his U.S. counterpart. Attached to the email was a picture of Jesus with the slogan, No More Debt written below it, a reference to the perception of many U.S. experts that debt is considered akin to evil in Germany. The episode shows how close personal ties between the two countries are, but its main message of course is that Germanys approach to fiscal policy is considered dogmatic in the United States. In addition, in instances involving issues of fiscal and monetary policy, German officials were isolated in most international and European meetings in recent years. For Germany, the focus of the global policy agenda should be on the reduction of public sector debt and the unwinding of aggressive monetary easing measures. For everyone else, the main priority should be to get the economy going. The agreement at the G20 summit in Toronto in June 2010, when heads of state and government committed to at least halve deficits by 2013 and stabilize or reduce government
5 Francis Fukuyama. (2006, February 19). After Conservativism. The New York Times Magazine. http://www.nytimes.com/2006/02/19/magazine/neo.html 6 Remarks by the President at Whitehall Palace (2003, November 19). http://yaleglobal. yale.edu/content/remarks-president-whitehall-palace

debt-to-GDP ratios by 2016, was a rare exception to this rule. It is telling, however, that barely anyone mentions the Toronto commitments these days except for the Germans. Germany has sought to establish a quantitative global debt ceiling but did not manage to win enough supporters in the G20.

Germany has sought to establish a quantitative global debt ceiling but did not manage to win enough supporters in the G20.
The German insistence on fiscal austerity is even more pronounced in the context of the eurozone. When the troika of the IMF, the European Central Bank, and the European Commission negotiated the first financial support package for Greece in 2010, the German side pushed through deficit targets that were considered far too ambitious by the economists of the IMF and, according to these economists, contributed to the economic disaster in Greece. German officials have since blocked any attempt to mutualize government or bank debt in the currency zone, a move that is considered a necessary condition to end the crisis by most international economists. Thus Germany has gone out of its way to water down the proposal to set up a European banking union including a common fund to restructure ailing banks and a common deposit insurance scheme. When EU heads of state and government, amidst extreme market pressure and after hours of negotiations, decided to use the European Stability Mechanism (ESM) the currency blocs main crisis fighting tool to directly recapitalize banks in order to break the vicious circle between weak banks and indebted governments, Germany made it clear quickly that the decision would only apply to banks that have their balance sheets inspected, any holes filled with national funds and that no legacy assets shall be covered. This all but invalidated the ESM as a tool to fight the current banking crisis, which is precisely about too many bad legacy assets on the books of the banks.

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Interests and Ideas As every student of international relations knows, there are many variables that shape national preferences, and there is not one single factor that explains why states take certain positions and reject others. In the case of Germany, there are perfectly rational reasons to advocate fiscal and monetary restraint in Europe. As the last remaining large member state with a top credit rating, Germany has a lot to lose if its debt were to be pooled with that of weaker nations. In addition, Germany is a net creditor country and its households rely heavily on fixed income instruments for their retirement savings, while the share of people owning stock or property is low by international standards. This means that low interest rates which tend to boost stock and property markets but negatively affect bond returns are less beneficial from an individual perspective than they are in countries with different investment patterns. Yet precisely because it is a net creditor country that has built up foreign claims as a result of years of massive current account surpluses, Germany has an interest in keeping its debtors afloat. According to calculations by the German Council of Economic Experts, total foreign claims (excluding claims by the Bundesbank) against other member states of the eurozone stood at 2790 billion by the end of 2011, of which 777 billion were against peripheral countries.7 It is reasonable to assume that a large chunk of this money would be gone if the eurozone were to fall apart

and national currencies were to be reintroduced. Why, then, is the German government and the population not more accommodating towards an ambitious solution to the crisis, such as the debt redemption fund proposed by the Council of Economic Experts? The German stance is even more peculiar on an international level. With most of continental Europe in recession, the United States has become increasingly important as a market for German companies. Exports and imports from and to the United States grew by 12.3 percent in 2012 to 137.4 billion, whereas trade with Italy, for example, declined by 4.3 percent. The numbers for exports are even more impressive, with an increase of 17.7 percent in the case of the United States and a decrease of 9.8 percent in the case of Italy. One would assume that German government officials would have an interest in a healthy demand for German goods and services from the other side of the Atlantic in order to compensate for the decline in orders from the rest of Europe. It seems logical that Germans would demand their U.S. counterparts do everything to support the economy. However, this is not the case. The German government and most German economists are extremely critical of the asset purchases by the U.S. Federal Reserve, which are regarded in Germany as an artificial means to stimulate demand. And while the IMF has repeatedly criticized the U.S. government for what the Fund sees as overly ambitious fiscal consolidation measures, the Germans want the Americans to cut their deficit even quicker. If that were to happen, German companies would lose business in the United States and most likely would have to cut employment. In fact, German officials have discussed a plan to tackle global economic imbalances by forcing the United States to decrease domestic demand and thus its current account deficit. Given the size of the U.S. economy, that would have meant risking a global recession, which would have affected Germany heavily, as the large decline in German output during the international financial crisis has shown. Importantly, while this was an idea of the current government, it is broadly supported throughout the German political establishment. Regarding international macroeconomic issues, all of the parties represented in the Bundestag with the exception of the radical left party Die Linke have similar views. This is why a victory for the

Precisely because it is a net creditor country that has built up foreign claims as a result of years of massive current account surpluses, Germany has an interest in keeping its debtors afloat.
7 German Council of Economic Experts. (2012, July 30). After the Euro Area Summit: Time to Implement Long-term Solutions (p. 9). http://www.sachverstaendigenratwirtschaft.de/fileadmin/dateiablage/download/publikationen/special_report_2012.pdf

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center-left Social-Democratic Party (SPD) at the September general elections and a replacement of the centre-right coalition of the Christian Democratic Union (CDU) and the Free Democratic Party (FDP) would not dramatically alter the countrys international stance. The environmentalist Greens just agreed on a platform that relies heavily on tax increases that, according to polls, may even give them a boost at the election. Germany is probably the only industrialized country where cutting spending and raising taxes may win votes. History Matters To understand why Germany apparently is ready to act against its national interest, one has to understand the German economic tradition that dates back to the Freiburg School formed in the early 1930s around the economist Walter Eucken, who taught at the University of Freiburg in Southern Germany at the time. The group shared many similarities with classical liberalism, such as the belief in the forces of the market and rejected central economic planning. However, Eucken and his collaborators observing the rise of communism and fascism in Europe asserted that the market would destroy the social fabric and collapse if left on its own. They concluded that in order to achieve political and economic stability, markets need a robust set of rules or framework within which they can operate; consequently, much of their research was dedicated to developing this framework. According to the Freiburg School, these rules should be insulated from popular pressures in order to prevent special interest groups or politicians seeking a boost at the ballot box to hijack the economic order. It demonstrates the groups deeply rooted distrust in the rationality of political processes under the conditions of mass democracy. After the Latin word for order, Ordo, the members of the school became known as ordoliberals and the policies they advocated as Ordnungpolitik (a term for which there is no literal English translation). As the German political scientist Thomas Biebricher has demonstrated impressively, their teachings have dominated Germanys post-war economic thinking and are still extremely influential in institutions such as the fiercely independent and hawkish Bundesbank and the finance ministry. In addition, the tradition is still alive in many German universities. It is common in Germany to evaluate new legislation not only by looking at its efficacy or the costs for the budget,

but also by checking whether it contributes to a better economic order. The ordoliberal heritage also has a number of important consequences for policy. First, it has promoted a clear focus on the long-term and on getting economic incentives right which is probably the most important reason for the German obsession with moral hazard. Jens Weidmann, the president of Bundesbank, for instance, is well aware that aggressive monetary easing might ease the plight of Europes peripheral nations. However, he strongly believes that central bank action will reduce the pressure on national policymakers to get their house in order. His main concern is not the effect of lower interest rates or asset purchases on the structure of incentives. Suffering now, in this view, paves the way for a better future and fiscal or monetary intervention prevents necessary adjustments. The German economic tradition also helps to explain the insistence by German officials on the EUs fiscal compact with its strict rules for government debt.

Suffering now, in this view, paves the way for a better future and fiscal or monetary intervention prevents necessary adjustments.
Second, it explains why Germany never had a strong macro-economic tradition in the U.S. sense of managing aggregate demand. As in most countries in the Western hemisphere, German economists flirted with Keynesianism after World War II and subscribed to supply-side views when the period of stagflation following the oil shocks of the 1970s seemed to have revealed the shortcomings of demand management. But while the conservative backlash was quickly followed by a consensus approach, German academics stuck to a strictly supply-side view, which shaped the mindset of policymakers in the government and the central bank. With those advocating countercyclical monetary and fiscal policy, ordoliberals claim government interventionism is necessary for the economy to function properly. Yet the role it assigns to the state is fundamentally different. Whereas most U.S. macro-economists believe in

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discretionary intervention, the focus in the German tradition is on the development of a set of rules. The very idea of stimulating the economy and smoothing out swings in the business cycle sounds strange to many German economists, who would argue that policy should concentrate on improving the framework governing economic activity through structural reforms and avoid engaging in finetuning. Third, ordoliberalism has led to a somewhat selective reading of German history by most German economists. While the experience of mass unemployment during the Great Depression has strongly influenced U.S. economic thinking, the brief episode of hyperinflation in the early 1920s was crucial for the German tradition. While soaring prices did harm many German families, the political order of the Weimar Republic collapsed ten years later amidst high unemployment. In fact, when Adolf Hitler came to power in 1933, Germany was mired in a severe deflation with prices falling by around 10 percent year-on-year. The ordoliberals, however, focused on the hyperinflation years, which fit into their narrative as it could be presented as collapse of the monetary order, while a large decline in output would have been much more difficult to explain for them. Finally, it makes German economic policy very difficult to categorize ideologically: The countrys relatively high taxes and generous welfare state are typical characteristics of a center-left approach to economic policymaking. However, the emphasis on the longer-term outlook and the refusal to accept monetary and fiscal policy as a tool to stabilize the economy put it firmly into the conservative camp and explain why many on the U.S. right sympathize with the German approach. The Limits of Principles As neoconservative foreign policy, German economic policy hence has a clear moral dimension in the sense that it promotes rules and regulations that are not necessarily always in the narrow self-interest of Germany. For most German economists, this is the lesson to be drawn from the horrors the country has inflicted upon its neighbors in the first half of the 20th century. In fact, Germanys economic situation was remarkably stable in the post-war era. While inflation rates shot up in the Western world after central banks accommodated the dramatic increase in oil prices in

the 1970s, they remained comparatively low in Germany, where an independent central bank prevented excessive wage increases (essentially, the Bundesbank managed to communicated credibly to trade unions and employers that it would hike interest rates if wages rose too much). German inflation peaked at 7.2 percent in 1973, while it reached double-digit rates in the United States and the United Kingdom. The success of the German economic model became an important element of the countrys postwar national identity. The ordoliberal tradition is so powerful in Germany that even lobby organizations tend to argue against discretionary macro-economic intervention, even if it benefits their members. Thus German industry bodies have repeatedly criticized interest rate reductions by the European Central Bank, despite the fact that these would lower the cost of capital for firms. Moral in this context does not mean altruistic, but rather stands for a focus on rules and incentives that supersede national interests and an acceptance of short term pain, which the Germans believe ultimately will be positive for everyone, including Germany. This is, of course, another parallel to neoconservatism, which held that the Wests long-term interests would be served by the benevolent international order it sought to establish. However, the financial crisis also revealed the weaknesses of the German approach. Fighting a financial crisis is very much about discretionary intervention, as a framework designed to govern economic interactions in normal times, by definition, reaches its limits when times are not normal. If nervous private investors start to withdraw their funds,

The ordoliberal tradition is so powerful in Germany that even lobby organizations tend to argue against discretionary macroeconomic intervention, even if it benefits their members.

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for instance, financial markets would collapse without a central bank that provides in huge quantities the liquidity that is needed to keep the economy going. On many occasions during the most recent crisis, German officials had to choose between sacrificing their principles or the economy. And while they do not like to talk about it in public, the German government has shown a degree of flexibility that is remarkable by German standards. Thus, while preaching the merits of orthodoxy after the collapse of Lehman Brothers, Germany implemented an economic stimulus package that dwarfed those of many other countries in the Western hemisphere. Similarly, while the Germans are telling their partners in Europe to consolidate their budgets, the German fiscal stance this year is expansionary according to IMF calculations, and Bundesbank officials are telling trade unions that wage increases are legitimate in the current environment. At the same time, Chancellor Angela Merkel and Finance Minister Wolfgang Schuble tacitly backed the decision by the European Central Bank to buy sovereign debt of the crisis countries in order to prevent spreads on sovereign debt from exploding. Pragmatism is not a core value of German economic thinking, but the Germans surely have discovered its merits. It remains to be seen, how far they are ready to go.

About the Author

Mark Schieritz is the economics correspondent for DIE ZEIT. He started his career at the Financial Times Deutschland and has been covering German and international economic issues for more than ten years. He holds a degree from the London School of Economics.

About The EuroFuture Project

The German Marshall Fund of the United States understands the twin crises in Europe and the United States to be a defining moment that will shape the transatlantic partnership and its interactions with the wider world for the long term. GMFs EuroFuture Project therefore aims to understand and explore the economic, governance, and geostrategic dimensions of the EuroCrisis from a transatlantic perspective. The Project addresses the impact, implications, and ripple effects of the crisis in Europe, for the United States, and the world. GMF does this through a combination of initiatives on both sides of the Atlantic, including large and small convening, regional seminars, study tours, paper series, polling, briefings, and media interviews. The Project also integrates its work on the EuroCrisis into several of GMFs existing programs. The group of GMF experts involved in the project consists of several Transatlantic Fellows as well as program staff on both sides of the Atlantic.