Question

• Brief explanation of the theory of economic perspective of a country.
• Identify the cause of the problem covered by the article.
• Effect analysis: analyze the effects and prospect of the German economy by:
• • drawing a standard PPF graph for Germany and representing the current economic decline the country is suffering (draw the graph by hand, copy and paste it into the Word document);
  • identifying the structural weakness of the German economy
  • identifying the choices the German economy is facing;
  • identifying the opportunity cost (sacrifices) the German economy was facing before the COVID-19 pandemic hit the country.
• Describing the German's government response to their current economic crisis.

Answer 1

• economic perspective of a country

We have seen how the economies of some capitalist countries such as the United States have features that are very similar to socialism. Some industries, particularly utilities, are either owned by the government or controlled through regulations. Public programs such as welfare, Medicare, and Social Security exist to provide public funds for private needs. We have also seen how several large communist (or formerly communist) countries such as Russia, China, and Vietnam have moved from state-controlled socialism with central planning to market socialism, which allows market forces to dictate prices and wages and for some business to be privately owned. In many formerly communist countries, these changes have led to economic growth compared to the stagnation they experienced under communism (Fidrmuc 2002).
In studying the economies of developing countries to see if they go through the same stages as previously developed nations did, sociologists have observed a pattern they call convergence. This describes the theory that societies move toward similarity over time as their economies develop.

Convergence theory explains that as a country’s economy grows, its societal organization changes to become more like that of an industrialized society. Rather than staying in one job for a lifetime, people begin to move from job to job as conditions improve and opportunities arise. This means the workforce needs continual training and retraining. Workers move from rural areas to cities as they become centers of economic activity, and the government takes a larger role in providing expanded public services (Kerr et al. 1960).

Supporters of the theory point to Germany, France, and Japan—countries that rapidly rebuilt their economies after World War II. They point out how, in the 1960s and 1970s, East Asian countries like Singapore, South Korea, and Taiwan converged with countries with developed economies. They are now considered developed countries themselves.
To experience this rapid growth, the economies of developing countries must to be able to attract inexpensive capital to invest in new businesses and to improve traditionally low productivity. They need access to new, international markets for buying the goods. If these characteristics are not in place, then their economies cannot catch up. This is why the economies of some countries are diverging rather than converging (Abramovitz 1986).

Another key characteristic of economic growth regards the implementation of technology. A developing country can bypass some steps of implementing technology that other nations faced earlier. Television and telephone systems are a good example. While developed countries spent significant time and money establishing elaborate system infrastructures based on metal wires or fiber-optic cables, developing countries today can go directly to cell phone and satellite transmission with much less investment.

Another factor affects convergence concerning social structure. Early in their development, countries such as Brazil and Cuba had economies based on cash crops (coffee or sugarcane, for instance) grown on large plantations by unskilled workers. The elite ran the plantations and the government, with little interest in training and educating the populace for other endeavors. This restricted economic growth until the power of the wealthy plantation owners was challenged (Sokoloff and Engerman 2000). Improved economies generally lead to wider social improvement. Society benefits from improved educational systems and allowed people more time to devote to learning and leisure.

• structural weakness of the German economy

Germany Strong recovery, but structural weaknesses . The economy is booming and even showing signs of overheating. Wage costs have been rising, in particular in sectors which have been confronted with severe labour shortages. Nevertheless, in the framework of negotiations to form a new coalition government, the CDU/CSU and SPD agreed on delivering a substantial fiscal boost. The coalition could be in place by mid-March. After strong growth in 2018, the economy is expected to slow substantially next year, because of shortages of production capacity and skilled labour and of monetary tightening in the US and in Europe.

The current upswing is hiding some structural weaknesses. Since the crisis, productivity growth has slowed down substantially. In the period 2014-2016, multi-factor productivity only increased by 0.7% on average, whereas in the period 1995-2002, the three-year moving average was 1% or higher. This slowdown is not only observed in Germany, but in many other OECD countries. In fact, Germany did slightly better in this area.
Several factors might have contributed to the productivity slowdown. First, investment has been very sluggish since the financial crisis. Projects are hampered because of lack of skilled workers. Moreover, political uncertainty is weighing on investment decisions. In the absence of a government, enterprises are reluctant to embark on projects.
Productivity is also undermined by the wrong allocation of capital. Following years of very low interest rates, much investment has gone to low productivity sectors, such as real estate, and also to zombies firms. These are firms that do not make enough profits to cover their interest payments for a number of years. According to OECD research, around 12% of the German capital stock was sunk in zombies in 2013, compared with around 6% in France. These companies do not only reduce overall productivity, but also retain capital and human resources that could have been used in more productive ways in other industries.

In particular in services, productivity has only slowly increased. The OECD reports that the productivity gap between business sector services and manufacturing is relatively large in Germany. In the period 2015-2017, labour productivity in business sector services excluding real estate increased on average by only 0.9%, whereas it grew by 2.1% in manufacturing. Restrictive business regulation is an important factor that is harming productivity growth. According to the OECD, Germany is among the countries with the most restrictive regulation for professional services.

Despite being symmetric in its very nature, the Covid-19 shock is affecting European economies in a very asymmetric way, threatening to deepen the divide between core and peripheral countries even more. It is not Covid-19 itself, however, but the contradictions within the EU’s growth model and institutional architecture that would be to blame for such an outcome. The dramatic impact of the economic crisis brought on by the pandemic and the threat that it poses to Eurozone survival seem to have forced a reluctant Germany into action: a minor step, but an important signal. This note analyses the crossroads currently facing Europe—the risk of disintegration vis-a-vis the opportunity for a ‘Hamiltonian moment’—discussing possible future scenarios in the light of past developments.

Like viruses, crises too can rapidly change their DNA: the financial crisis of 2008 changed from international to regional, from financial to real, eventually turning into an existential threat to the whole European integration project. In the institutional context of the Eurozone (EZ), the financial crisis soon developed into a sovereign debt crisis, dragging the banks along with it. In the austerity environment that followed, the southern periphery (SP) never completely recovered the losses in output, employment, and fiscal sustainability. Thus, the “symmetric” coronavirus shock hit countries that were in highly asymmetric conditions. In fact, not all the countries of the Union have the resources needed to intervene in support of their economy, prompting concern that countries with the deepest pockets might be getting an unfair advantage in the EU’s single market. Far from triggering mutual protection, the Covid-19 crisis seems to be paving the way for the same mistakes that followed the 2008 financial crisis. The centrifugal forces threatening disintegration of the European Monetary Union (EMU) seem to have been defused, albeit only in part and only in extremis, at least for the time being. However, the survival of the Union depends not only on responding to the severe financial problems caused by the epidemic, but also means addressing the long-term, structural problems that led to the increasing divergences among her members. As Chancellor Merkel herself acknowledged, “It is in nobody’s interest for Germany alone to be strong after the crisis”.Footnote1 Convergence is essential to put the Union on a more solid basis so as to guarantee its long-term sustainability.

What policies and what reforms should be implemented to pursue this objective? And are they economically and politically feasible? Trying to answer these questions, we shall briefly review the institutional and structural causes of the increasing divergence between core and SP, shedding light on three momentous events: the creation of the monetary union, the 2008 financial crisis and the Covid-19 shock.

• Enters the Covid-19

The pandemic arrived in Europe from the south: Italy was the first country to suffer the contagion. Its abrupt, dramatic effects exposed the fragility of the periphery and the crippling effects of austerity policies. Since 2010, across the board cuts in social spending had hit the entire range, from health to education, from social assistance to social investment.Footnote6 Figures 2, 3 and 4 show the evolution of the share of public expenditure on education and health (divided between general expenditure and hospitals) relative to GDP in the EMU, Germany and the SP between 2008 and 2018. Many hospitals had been closed, the number of beds reduced, medical and nursing staff cut back (for a detailed analysis of the impact that austerity policies had on the Italian health care system, see Prante et al. 2020). It is not surprising that the death toll was higher where intensive care facilities were scarcer. On the eve of the Covid crisis, public health accounted for 6.5 percent of the social product in Italy and Spain, and almost 10% in Germany, where per capita healthcare spending did not suffer cuts due to austerity (though it was not completely spared self-imposed restrictions). The Covid-19 exposed another aspect of the ‘divisive’ Union (Celi et al. 2020): different capacities to respond to the pandemic crisis.

The German legislature has enacted a package of measures to enable businesses to face the impact of COVID-19.
FINANCE
The German government will protect businesses with new measures to provide liquidity, the volume of which is unlimited. Due to the high degree of uncertainty in the current situation, the government has very deliberately decided to not set any limits on the volume of these measures. This is a very significant decision which is supported by the entire federal government.

Economic Stabilisation Fund Act

In addition to the KfW liquidity assistance programmes the Federal Ministry of Finance has prepared a legislative initiative that has been adopted by the German parliament and enacted on 28 March 2020, the Economic Stabilisation Fund Act.

The German government is making use of measures that were successfully applied in the financial crisis in Germany. Those measures are now being made available to companies meeting at least two of the following criteria (for at least two consecutive financial years prior to 1 January 2020):

• German Economic Crisis Response Could Have Sting in the Tail

Germany extended another crisis tool to prevent corporate bankruptcies, a move that critics say will store up bigger problems later for Europe’s largest economy. The longer suspension on insolvency filings has raised alarm bells that it’s masking a growing credit risk that could explode into a wave of bankruptcies when the moratorium ends. It may also be creating a cohort of zombie companies that hold back investment and innovation and act as a drain on the economy.
“It was an appropriate measure during the acute phase of the coronavirus crisis,” said Ulrich Keil, founder of insolvency register Insolvex. “But the risk is big that an extension will create zombie firms.” The insolvency waiver will now stay in place until the of the year, while Germany’s enhanced Kurzarbeit job scheme will run through 2021.

Across Europe, such support has saved companies and jobs -- Germany’s Ifo institute predicts an imminent pickup in the labor market. But now countries are grappling with how to balance that protection against allowing economies to restructure. Aid is making it easier for unviable businesses to survive, delaying much-needed change to keep the economy globally competitive. It may also erode the chances for currently insolvent firms that still have a place in today’s corporate world. While the Association of German Chambers of Industry and Commerce, or DIHK, welcomed the insolvency decision, it also said “concerns are building that protracted insolvencies are triggering dangerous chain reactions.” In Germany’s case, some problems go beyond the cyclical. Even before the pandemic, many companies were struggling with more profound shifts, particularly in the crucial car industry.

“Governments now have to strike a difficult balance,” said Paul Donovan, global chief economist at UBS Wealth Management. “In the long term, it is economically efficient to preserve jobs in companies with a future. It is economically inefficient to preserve jobs in companies that are unlikely to survive the structural changes of the fourth industrial revolution.”

Along with loan and credit guarantees, tax-payment delays and wage support, Germany’s insolvency waiver helped cash-strapped firms get through the past few months. One in five companies sees itself at risk of failure due to the pandemic, according to a recent Ifo survey.

Debtor registration firm Creditreform predicted in mid-August that insolvencies would increase about 20% this year, more than during the 2008 financial crisis, though an extension of the waiver could lower that estimate.

Prolonging the life of weakened firms can also have repercussions on payments across the business chain. Suppliers, particularly in the chemical and basic-goods industries, saw longer delays in settling bills in the first half of the year. In response to questions by Bloomberg, Germany’s justice ministry brushed off concerns about payment delays, saying the moratorium differentiates between insolvent and over-indebted companies.

There’s a political element to any decision, with an election due in 2021. The health of the economy, businesses and employment will all play large in the campaign.

“Insolvencies can quickly trigger crises of confidence,” said Christoph Niering, who heads Germany’s Registered Association of Insolvency Administrators, or VID. “If a big number accumulates and is released all at once, it can erode sentiment, particularly if bigger companies are involved and suppliers become affected as well.”