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January 14, 2011

A Tale of Two Recoveries

By

Can a nation spend its way to prosperity? We don't have to guess. The experience of two countries over the last year - Germany and the United States - provides an answer.

Prior to last summer's summit of the G-20 group of nations, German Chancellor Angela Merkel spurned President Obama's call to boost spending. For Merkel, control of government debt was the "urgently necessary" priority. Ultimately, the two agreed to disagree.

This unusually visible policy spat between the leaders of two of the world's leading economies underscored fundamentally different approaches to the financial crisis and recession. Germany, at least in Merkel's view, had reached the limits of its government's ability to promote growth through spending.

The chancellor saw reckless spending as the main threat to future prosperity. Obama, by contrast, had been on a spending spree. He continued to see, in radically increased fiscal deficits, the promise of greater growth and employment.

Now, with the release of the 2011 Index of Economic Freedom by The Heritage Foundation and The Wall Street Journal, we see the results of these diverse approaches. Over the last two years, Germany, despite the financial crisis and recession, has increased its level of overall economic freedom by 1.3 points on the Index's 0-to-100 scale, improving its world ranking from 25th to 23rd. The United States, which ranked sixth in the world two years ago, has dropped to ninth place and shed almost 3 points on the index's freedom scale.

A major factor in Germany's economic freedom rise was its government's commitment to holding the line on government spending. At the beginning of the crisis, Germany's government budget was essentially in balance.

By the end of 2009, it had a small deficit equivalent to about 3 percent of GDP. By contrast, the United States was already running a deficit of almost 3 percent of GDP when the crisis started. By 2009, more than $1 trillion of stimulus and bailout spending had pushed the U.S. deficit to 11.3 percent of GDP.

It's rare to get a good test case of competing economic policies in real time, but in Merkel's and Obama's responses to the crisis, we can see a sharp divergence, with Merkel practicing fiscal discipline while Obama championed, and continues to champion, Keynesian spending stimulus. The numbers tell the story: Germany emerged from recession a full quarter before the United States, and has had positive growth in GDP since the second quarter of 2009. The United States, by contrast, emerged from the recession only in the third quarter of that year. In the first three quarters of 2010 (the latest data available), Germany's quarterly growth rate for GDP averaged 1.2 percent. The U.S. average for the period? Only 0.6 percent.

So despite the massive government spending undertaken by the Obama administration, the U.S. economy is growing only about half as fast as Germany's, where spending growth was kept under much tighter control.

How about unemployment? Before the recession, in 2007, Germany was suffering from unemployment almost twice as high as in the United States: 8.4 percent compared with 4.6 percent in the United States. Three years later, following massive U.S. government spending and regulatory interventions, the U.S. rate has more than doubled, to 9.6 percent. Germany's unemployment, by contrast, has dropped to 6.7 percent as of October 2010.

Seen in the context of the Index of Economic Freedom, the results are dramatic and instructive. Before the recession, the U.S. economy, with its significantly higher traditional levels of economic freedom, was performing better than Germany's. Since the onset of the recession, Germany has increased its citizens' economic freedom, while in the United States, economic freedom has been curtailed. German economic performance now outpaces that of the United States.

Charles Dickens began his epic novel "A Tale of Two Cities" with the following: "It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness ..." No one would claim we have just passed through the best of times, but the tale of two recoveries - in Germany and the United States - shows the contrast between wisdom and foolishness. Government policies do matter, and as Germany has shown, those that increase economic freedom produce better results.

Terry Miller is director of the Center for International Trade and Economics at The Heritage Foundation.

First appeared in The Bellingham Herald

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