On the record...
Interview with Professor Michael Hüther on the role of the state

October 17, 2011

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Professor Hüther, about three years ago we saw the beginning of the global economic and financial crisis. Currently, there are increasing signs of a renewed noticeable slowdown of the world economy. Against this backdrop, has your personal view on the role assumed by the state changed at all? Will we need more or less state intervention in future, for instance to reduce volatility in the economy?

Our way of looking at the state’s role has been challenged in three ways: by the financial crisis, the economic crisis and the sovereign debt crisis. The financial crisis has highlighted the dangers of some segments of the financial markets being highly regulated while others are left unregulated. We must not leave any geographical or thematic loopholes that make arbitrage look attractive.

This fundamental crisis has shown that in such a global emergency internationally coordinated Keynesian policies are an important tool, in sync with measures to support the labour market such as the prolonged funding of short-time working.

The sovereign debt crisis currently highlights the fact that financial markets have become much more sensitive to government finances. This is not an overreaction but a belated realisation which will result in governments having to monitor their budgets more closely in future. Global financial markets have become debt intolerant.

So there is no single answer to your question of whether we need “more or less state intervention”. We do need a strong state – but to keep it strong we must not call for state action at all times and in all areas. We must take a closer look at where and how government action is needed.

In the course of the economic and financial crisis, industrial policy has become more important in many countries, and it is playing a major role to this day. Do Europe and Germany – also in light of the industry policy measures being implemented worldwide – need more or less industrial policy?

These are highly volatile times. At such times, companies are hesitant to make decisive investments. Even though Germany is currently seeing a small boom in investment, companies are nonetheless very reluctant to make investments whose impact will materialise in the medium or long term. This can certainly have an impact on the geographical loyalty of companies: if a larger package of previously deferred investments is made in the future, then the entrepreneur is more likely to reconsider the location for the investment than in a case where it has made a constant flow of investments at the same location.

That is why it is important to present Germany as an attractive location to companies at the moment when they make their investment decision. In a recent survey we found that the factors which are particularly important to companies besides a well-developed infrastructure are a reliable political environment and legal certainty. This response is undoubtedly related to uncertainties caused by constant changes in policy. The availability of skilled personnel is also extremely important for companies. That is why it is not so much a concrete industry policy that is required as credible and reliable regulatory policy and a strong education and training system. Sound business law and contract compliance by the federal, Länder and municipal levels of government are also in greater demand than ever.

That is how to create the best basis for coping with structural change, but not by pursuing a selective sector-based industrial policy. Nor are there successful examples of this to be found in other countries. In France, which has a long tradition of pursuing such an interventionist industrial policy, the 12% industry share of total value added is just half of that in Germany.

There is currently a great deal of debate about the division of tasks between the EU and the member states. Is this division of tasks between the EU and the member states still appropriate in your opinion? Or to be precise: in which areas should the competencies of Brussels be expanded? And where should there be a strengthening of the role of the member states – and in Germany even of the individual Länder?

Economic theory provides valuable pointers on this topic. It states that the provision of public goods should be centralised as far as possible if the public good has an international character, or if substantial economies of scale can be generated. Defence is one example, while European infrastructure networks are another. The function of economic stabilisation should also be addressed collectively given the close integration of euro-area states. Another area that must be harmonised at the very least at the European level is the regulation of financial markets, since imbalances in one country can trigger problems in other countries. Even better would be their regulation at a global level, with the EU as an influential voice. Moreover, only globally harmonised regulation can prevent sensible rules from being circumvented via “jurisdiction-hopping”. The EU thus has a lot of integration work ahead of it. Nevertheless, most policy areas can undoubtedly be administered in a more personal manner, more in accordance with preferences and presumably more efficiently at the national or regional level. According to the principle of subsidiarity, which is the basis of the European treaties, the respective next higher level is firstly required to be supportive and facilitatory with regard to the lower level. In case of significant regional externalities it can act on its own responsibility This remains a good principle that is fully in keeping with Germany’s federal system.

One concrete example of such a division of tasks between the EU and its member states is “European economic governance”, which is being called for in some quarters as a consequence of the debt crisis in the EU. What is your general opinion of such an institution? Which tasks might be appropriate for the institution and which ones might be inapproriate?

These calls for economic governance mostly remain vague. Such a process should not be based on knee-jerk reactions triggered during a crisis, but it must be formulated prudently and patiently. Sustainable budget consolidation, which is the current motivation behind this, will require some time.

Convergence is in any case being driven by decentralised sources, as we are experiencing a fundamental shift in the way that government action is perceived by the financial markets. Countries are being rated much more strictly than before according to the sustainability of their business model. Many variables are incorporated into this, debt level is of course one of them, but also the investment strength and economic output of the country which ultimately has to generate all government revenues. Many countries will have to reduce their debt ratio. This is possible, as shown by the experience of successful consolidations.

This means that in future all countries will have to link a minimum of budget discipline with investive expenditure. This recognition has come late, but not too late. Coordinating this – more stringent fiscal criteria or the obligation to comply with the debt brake – can help, particularly towards being seen as credible by the financial markets. The French concept of economic governance, however, is far more expansive and bears the hallmarks of its industrial policy tradition. But – as already made clear – it is not a blueprint for Europe.

With the debt brake Germany has introduced a regulation that is meant to prevent policymakers from constantly taking on more public debt. Should more countries follow this example?

An unequivocal “yes“. Politicians don’t like to break recognised regulations, although the current situation might suggest otherwise. A debt brake would anchor the promise of a sustainable budget policy in the national constitutions, which provides an important counterweight to the state’s inherent preference to take on new debt. This is – besides market pressure – a second important step away from uncontrolled debt accumulation, which also harms one’s neighbours in the euro area and was therefore prohibited by the Maastricht criteria with good reason. These criteria were unfortunately watered down, which is why we need more credible measures. And what can be more effective than a national constitutional rule?

From a general point of view: can more rules-based policymaking help in reaching decisions that make more economic sense? Or does this absolve policymakers – especially during periods of crisis – of too much of their responsibility and scope for creative approaches?

Politicians have an innate tendency to focus on short-term desires, which entails the risk of losing sight of the long term. This trend can be counteracted using rules, and I believe that makes sense. Politicians will continue to have enough scope for action; especially during a recession Germany’s federal government certainly has the opportunity to pursue Keynesian debt policy.  Keynes is a good answer to systemic crises, but not to the everyday minutiae of cyclical fluctuations.

 

 

Prof Dr. Michael Hüther, 49, has been head of the Cologne Institute for Economic Research (IW Köln), Germany’s leading private economic research institute, since 2004. He was secretary general of the German Council of Economic Experts (more commonly referred to as the “Five Wise Men”) from 1995 to 1999. He then spent nearly five years as the chief economist of DekaBank in Frankfurt.

 

 

This interview was conducted by Eric Heymann (+49 69 910-31730) and Frank Zipfel (+49 69 910-31890)

 

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