Path Dependent Economics: Explaining Differences in German & US Reactions to Financial Crisis

1. Path Dependent Economics: Explaining Differences in German & US Reactions to Financial Crisis Prof. Stephen J. Silvia School of International Service, American University Indiana University, 8 April 2011

2. Introduction • Paper compares elite conceptualizations in three recent episodes of economic crisis: • 2008-2009 Financial Crisis • Contents of the stimulus packages • Euro crisis • It finds that constructions and pre-understandings affect both the preferences perceived as serious and the ordering of those preferences Silvia-Indiana U-8 April 2011

3. Financial Crisis: Domestic Consensus, Transnational Divergence • Elite reaction to recent financial crises do not align transnationally along ideological lines. • Instead (esp., among economists), broad consensuses formed nationally that spanned ideologies, but sharp divides arose between countries: • Not only Paul Krugman and Joseph Stiglitz, but also Martin Feldstein and Ben Bernanke called for accommodating fiscal and monetary policy. • Not only Wilhelm Noelling and Joachim Starbatty, but also Michael Burda and Jürgen von Hagen voted in favor of a statement against creating a European Stability Mechanism. • No significant difference between the policies of the Bush and Obama administrations. • The German Grand Coalition (i.e., Christian Democrats and Social Democrats) also saw eye to eye, but their choices did not align with the United States. • Why? Silvia-Indiana U-8 April 2011

4. Financial Crisis: Domestic Consensus, Transnational Divergence • It is NOT differences in the severity of the crisis. • Crisis and bounce-back slightly bigger in Germany Silvia-Indiana U-8 April 2011

5. Financial Crisis: Domestic Consensus, Transnational Divergence • Germany and the United States have very different understandings of the “decade of extremes” (i.e., the 1920s). Silvia-Indiana U-8 April 2011

6. Constructed Understandings in Germany and the United States • USA: Great Depression was the biggest crisis; unemployment and deflation were the biggest problems: • Unemployment hit 25 percent. • Prices fell by 30 percent. Silvia-Indiana U-8 April 2011

7. Constructed Understandings in Germany and the United States • Germany: The Great Inflation of 1923 is seen as the biggest crisis. Silvia-Indiana U-8 April 2011

8. Constructed Understandings in Germany and the United States • The United States has never had a great inflation. • Germany DID have high unemployment in the 1930s, BUT the phrase in German for the Great Depression is the “World Economic Crisis,” which externalizes its causes. Silvia-Indiana U-8 April 2011

9. Constructed Understandings in Germany and the United States: Economists • USA: “Americans are from Keynes.” • “Saltwater” Economists: • (Neo) Keynesians on the East and West coasts. • Freshwater Economists” • Chicago School neo-monetarists. • BUT, both schools accept a common objective of demand management. Keynes Silvia-Indiana U-8 April 2011

10. Constructed Understandings in Germany and the United States: Economists • Germany: “Germans are from Hayek.” • Government should maintain “framework conditions” for market competition, and have a very minimal safety net for the “losers” (“ordo-liberal” Freiburg School). • Governments only exacerbate misallocation (e.g., create bubbles) and prolong economic crises when they attempt to manage demand, so they should not try it (Hayek). • The predominant German position is very much like the argument in favor of “shock therapy” for Central and Eastern Europe immediately after the end of the Cold War. W. Eucken F. v. Hayek Silvia-Indiana U-8 April 2011

11. Financial Crisis: Domestic Consensus, Transnational Divergence • The transatlantic divergence among economists is all the more striking given the widespread public skepticism regarding stimulus and transfers in both countries. Silvia-Indiana U-8 April 2011

12. Policy Responses to the Financial Crisis • Politicians in both countries endeavored to strike a balance between their publics and experts. • US Stimulus Package: • Content: Infrastructure programs, tax cuts, aid to states, cash for clunkers • Debate over size of stimulus package. • German Stimulus Package: • Some infrastructure, tax cuts, cash for clunkers and short-time work (i.e., government subsidies allow people to work half-time but be paid 70-80% of their full-time wage). • Both stimulus packages are consistent with the depictions of the economies in the “varieties of capitalism” literature: • USA: Liberal Market Economy. • Germany: Coordinated Market Economy. Silvia-Indiana U-8 April 2011

13. Germany’s Response to the Euro Crisis • The euro crisis has proved far more intractable for German policy-makers. • The German government has three objectives: • Maintain the euro as a stable currency. • Maintain the stability of the European private-sector financial system (esp., German banks). • Keep fiscal decentralization (i.e., no sovereign or cross-national bailouts). • Germany’s problem is that under current circumstances (i.e., sovereign debt crisis and exposed domestic banks), these three objectives are incompatible. Silvia-Indiana U-8 April 2011

14. Germany’s Response to the Euro Crisis • Transatlantic Divide among Economists: • US economists argue that Germany benefits from large euro area (e.g., Barry Eichengreen and Adam Posen). • Most German economists denounce EFSF and ESM. • German government reluctantly approves bailout mechanisms, but adds conditions to appease public and professional critics. Silvia-Indiana U-8 April 2011

15. Conclusion • Economics, like the natural sciences, often appears to be completely objective and transnational. • The financial and euro crises demonstrate that understandings within epistemic communities (in this case the community of academic economists) still have a tremendous impact on shaping preferences. Silvia-Indiana U-8 April 2011