Risks and benefits of economic interventionism by the German government during the 2007-2009 financial crisis


Term Paper, 2011

28 Pages, Grade: 1,7


Excerpt

TABLE OF CONTENT

1. Introduction
1.1 General explanation of the term “economic interventionism”
1.2 Reasons for economic interventionism during a financial crisis

2. Types of economic interventions during a financial crisis
2.1 Soft protectionism through trade and investment policy measures
2.2 Fiscal policies
2.3 Financial policies

3. Risks and benefits of selected federal interventions in Germany
3.1 Risks and benefits of soft protectionism through trade and investment policy measures
3.2 Risks and benefits of fiscal policies
3.3 Risks and benefits of financial policies

4. Effects of the economic interventionism
4.1 National and international market reactions
4.2 Consequences of interventions for international markets and trade

5. Summary

1. Introduction

The global financial crisis that became obvious in the summer of 2007, led to a severe economic crisis about one year later. It was mainly caused by the bankruptcy of “Lehman Brothers”, one of the largest US investment banks, which was forced to file for liquidation after suffering huge losses in the mortgage market and resulted in millions of additional unemployed all over the world, in both developing as well as highly developed countries. Within weeks the Dow Jones Index fell from over 11,000 to below 7,000 points while the German stock market index, DAX, fell from 7,500 to below 4,000 points.

The apparent helplessness of economists at that time forced the German government to implement strong interventions in the economic market. This paper deals with the risks and benefits of interventionism during the 2007- 2009 financial crisis, using the example of Germany.

1.1 General explanation of the term “economic interventionism”

Economic interventionism is an effort taken by government to influence a country’s own economy. The term “economic intervention” assumes that the state and its economy are inherently separate from each other. Therefore, this term can only be applied to capitalist markets or mixed economies where any government action would be called an intervention.

Laissez-faire economics, or market economy, is a form of social cooperation based on private ownership of the means of production. “One of the guiding principles of capitalism, this doctrine claims that an economic system should be free from government intervention or moderation, and be driven only by the market forces.”1

Socialism, on the contrary, is a form of social cooperation which is based on public ownership of the means of production.

It is frequently asserted that a third form of social cooperation is feasible as a permanent form of economic organization: Mixed economies are defined as “an economic system in which both the private enterprise and a degree of state monopoly (usually in public services, defense, infrastructure, and basic industries) coexist. All modern economies are mixed where the means of production are shared between the private and public sectors.”2

The German economy is essentially a mixed and social market economy. Although the state provides and controls some segments of the economy, the ideas of “free enterprise” and the “rule of the market” are also promoted as a part of governmental policy.

As part of the efforts to combat the recent economic crisis, the state increased influence on the market and returned to the “Keynesian theory”, developed by British economist John Maynard Keynes at the height of the Great Depression of the 1930s. Keynesian economics argue that private sector decisions sometimes lead to inefficiencies in macroeconomic outcomes and therefore advocate active policy responses by the public sector. The main idea of Keynes’ theory is that the total demand, created by businesses, households and the public sector, is the actual driving force in an economy and not the dynamics of free markets. The theory also states that a free-market has no self-balancing mechanisms to achieve full employment. Therefore, government interventions targeting public policies are necessary and justified in order to achieve price stability and full employment. Thereby, economic intervention can target a variety of political or economic objectives, for example managing interest rates and the supply of money, promoting economic growth, or raising (minimum) wages. During the recent financial crisis, the German government intervened by implementing specific stimulus programs to improve the economic situation.

1.2 Reasons for economic interventionism during a financial crisis

A financial crisis is defined as “a situation when the supply of money is outpaced by the demand for money. This means that liquidity is quickly evaporated because available money is withdrawn from banks, forcing banks either to sell other investments to make up for the shortfall or to collapse.”3 The recent economic crisis in 2007- 2009 was mainly caused by the collapse of major US investment banks. Those events also had an effect on economies outside the United States.

Before the financial and economic crisis started in 2007, the German economy was considered relatively immune to crises in individual markets4. Many German companies were leading world markets in their respective industries (e.g. general engineering, medical and environmental engineering sectors). Due to a generally higher demand for goods ‘made in Germany’, German companies felt a sense of security that in case of a drop in demand in other European and US markets possible shortfalls could be offset by increasing sales to new, growing markets in Russia, China, and India.

But this current global financial crisis was different and affected German companies in various ways. Not only was it a sales volume crisis caused by a decrease in product orders from private and commercial consumers, but it was also a financing crisis, as customers still interested in purchasing goods simply lacked the necessary capital to do so. The reason for that was the banks’ curtailed lending behavior. According to the Spiegel article “Berlin sees no limits to economic intervention”, the financial crisis “has taken many banks to the brink of bankruptcy.”5 This finally led to a crisis of confidence, in which those who could afford to buy goods were not interested in doing so.

The economic development, or rather the lack of the same, at that time placed German policymakers under pressure. The number of people out of work was to climb by 500,000 to 3.5 million before the end of the year 2009. Consequently, political turmoil and economic instability occurred. Therefore it was almost inevitable, that Chancellor Angela Merkel’s cabinet approved two stimulus programs, in November 2008 and January 2009, to combat the growing crisis (see graphic 1).

illustration not visible in this excerpt

Graphic 1: German government interventions to combat the economic crisis

According to former German Finance Minister Steinbrueck both stimulus programs totaled 80 billion Euros.6

The key ingredients of these stimulus programs were examples of soft protectionism through trade and investment policy measures. Furthermore the interventions included a number of fiscal and monetary policy measures. The primary goals of the stimulus programs were to secure economic growth and to prevent another sharp increase in unemployment in Germany.

2. Types of economic interventions during a financial crisis

2.1 Soft protectionism through trade and investment policy measures

The international trade has been severely affected by the economic and financial crisis: “As per August 2009, global trade was down 18% from its peak in April 2008, and down 15 % year-on-year.”7 According to the US Census Bureau, German exports to the US fell by 26.9% in 2009. An example: many top German carmakers, like Porsche, BMW, Audi, and Volkswagen, suffered big losses in 2009, due to car sales to the US dropping by almost 40%8.

The German government decided to fight against this development by implementing soft protectionism through trade and investment policy measures. Classical protectionism affects the trade of goods and services, and cross-border investment flows and is defined as “governmental policy aimed at shielding a fragile economy, or a weak or critical sector, from cheaper or better imports through imposition of high duty rates (tariff barriers), quotas, and/or inordinately stringent or time consuming inspection or quality regulations (non-tariff barriers).”9 Key purpose is to keep demand and capital in the country.

In general, the use of protectionism is very debateable and often a country’s last resort to combat a severe economic downturn, as it may disrupt trade worldwide and measures taken may end up being nothing but counterproductive. An example of that would be the effort to preserve and gain jobs in an economy: Instead of saving those jobs, the implementation of protectionism, like import restrictions, may result in the retaliation of trade partners (or other nations). In turn, these partner countries may implement similar protectionist policies for their own nation. Thereby, trade patterns will become disrupted and jobs that were meant to be gained or saved may actually become lost. Due to the World Trade Organization’s (WTO) rules and, for the EU member states, due to the strong position of its Supreme Court, the danger of bold protectionism is limited. However, there is some danger and there are indications of “soft” protectionism being used if, for example, governments start to influence and motivate their citizens to, exclusively “Buy American” or “Buy French”, as has recently been the case. Realizing the potential risks and dangers of the protectionist approach, some countries even prohibit the use of protectionism altogether.

In the wake of the 2007- 2009 economic crisis however, many nations have implemented some form of protectionism - even though their political leaders claim not to seek protectionism as a means to combat this crisis. A 2010 study by the International Chamber of Commerce Germany (ICC Deutschland) ranks the G-20 economies in terms of their use and implementation of protectionist policies as of fall 200910. The study shows that the Russian Federation, the United States, and India are the Top Three in terms of the implementation and consideration of protectionist trade measures between the third quarter of 2008 and the first quarter of 2010. Germany ranked seventh, despite Chancellor Merkel’s criticism towards nations like the US in using protectionist approaches and her claim not to employ protectionism to protect a weakening German economy.

As mentioned above, instead of pursuing a hard and obvious protectionist approach, the German government chose a soft, less obvious path by implementing protectionist measures through the afore mentioned stimulus programs. These programs contained investments in the construction and repairs of roads, the rail network, as well as schools and universities. Some money was also used to enhance internet and communication networks. With that, the German government provided the construction industry directly with work orders in the amount of up to 17.3 billion Euros.

Another example, geared to support and strengthen the German car maker and car dealer industry, is the so-called ’scrap premium‘, a program based on the US government’s ’cash for clunkers‘ initiative: Owners of cars more than nine years old received 2,500 Euros if they replaced them with a new car that met the Euro 4 emissions standards. Officially, the German government declared, this program was meant to protect the environment from harmful emissions of older cars on German roads, but ultimately, this initiative also had a positive effect on car manufacturers, as it stimulated a number of customers to take advantage of this financial offer to purchase a new car. This also helped to offset declines in demand for German cars in the US and other markets.

2.2 Fiscal policies

Fiscal policies provided the German government with important instruments for economic interventionism. The two most important ones are stimulus programs with a view to drive up demand in an otherwise sluggish economy and emergency actions, including outright firm ownership, with a view to supporting firms or bailing out entire industries (e.g. banks, car manufacturers). These expansionary fiscal policies are meant to complement the effects of automatic stabilisers. The latter commonly include unemployment and other social insurances, as well as the cycle-smoothing effects of the tax system. The purpose of fiscal policy measures is to bridge a temporary dip in demand and to prevent healthy firms from closing and staff layoffs from rising.

In terms of the emergency measures taken in the banking sector, their purpose is also to prevent domino effects and the destabilisation of the financial sector in the event of large or interconnected institutions of vital importance to the system failing (e.g. the collapse of the American investment bank Lehmann Brothers).

[...]


1 Business Dictionary, Laissez-faire economics, 2011

2 Business Dictionary, mixed economy, 2011

3 Business Dictionary, financial crisis, 2011

4 Compare Spiegel Online article, Financial Crisis hits German economy,15.October 2008 Spiegel Online article, The State as Über-Entrepreneur: Berlin Sees No Limits to

5 Economic Intervention, 21. January 2009

6 Compare Spiegel Online article, Germany seals 50 Billion Euro Stimulus Plan, 13. January 2009

7 Compare Zimmermann, T. A.: The dangerous rise of economic intervention, 2010, P. 5

8 Compare Suite101/ International Trade, Workman, D., 2010

9 Business Dictionary, protectionism, 2011

10 Compare ICC, Hufbauer, G. et al.: G20 Protection in the Wake of the Great Recession, 2010

Excerpt out of 28 pages

Details

Title
Risks and benefits of economic interventionism by the German government during the 2007-2009 financial crisis
College
University of Applied Sciences Riedlingen
Grade
1,7
Author
Year
2011
Pages
28
Catalog Number
V179509
ISBN (eBook)
9783656018643
ISBN (Book)
9783656018988
File size
516 KB
Language
English
Tags
Economics, interventionism, financial crisis
Quote paper
Nadin Hirsch (Author), 2011, Risks and benefits of economic interventionism by the German government during the 2007-2009 financial crisis, Munich, GRIN Verlag, https://www.grin.com/document/179509

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