The German Economy since 1998

By Jan Pieter Schutz

[This article published in: Forum Wissenschaft, 9/6/2005 is translated from the German on the World Wide Web,]

[The German government has dismantled its economic-, tax- and social-policy more than other governments. Jan Pieter Schutz reviews the developments.].

The analysis of whether aggregate economic problems are more on the supply- or demand-side and whether they are short-term or long-term precedes all state economic policy. (1) At the beginning of the 1980s, two important macro-economic indicators already pointed to demand-side problems. The production potential of processing industries was only four-fifths utilized. Unemployment rose drastically (from 0.889 million registered unemployed in 1980 to 2.586 million in 1984). (2) Nevertheless the Kohl government pursued supply-oriented economic policy. (3) Corresponding to this paradigm, the German Central Bank gained independence in relation to politics in 1998 and later the European Central Bank. Monetary policy was no longer an element of economic policy. (4) In addition, the Kohl government took the first steps in deregulating labor markets by loosening protection against unlawful termination, promoting limited labor contracts, expanding possibilities of unions and management in fixing working hours, weakening union fighting strength, limiting continued wage payment in case of sickness and intensifying pressure on the unemployed to accept low earnings and poor working conditions. Social benefits were restricted to lower taxes on corporate profits above all.

At the same time private households were confronted with three increases of the sales tax. (5) In the election year 1998, successes of supply policy were still awaited. The degree of utilized production capacity in processing industries increased (86.2% in West Germany and 81.9% in East Germany) but the total German unemployment was still high at 4.279 million registered unemployed. Whoever had hoped for a change to demand-oriented economic policy by the new red-green German government was soon disappointed. According to Keynesian theory, a short-term oriented policy could have been expected to stimulate the demand components of private consumption and investments as well as increased state demand. (6)

This policy was only focused on the short-term. In 1999, private consumption grew 3.7%, in 2000 2%, 2001 1.7% and since then has declined absolutely. The growth rates of state consumption fluctuated between 1.9% (2002) and 0.1% (2004) while the growth in investments since 2001 was only negative. In September 2004, the degree of utilized production capacity in processing industry amounted to 84.2% in West Germany and 81.9% in East Germany. In 2004, 4.381 million were registered unemployed while there were 4.844 million in 2005. (7)


In the first 134 days with Lafontaine as finance minister, the red-green government fulfilled part of the people’s expectations. Pressure was applied to the German Central Bank that had quenched hopes for an economic recovery with its high interest policy. Regulations for part-time work were intensified. The new government turned against pseudo-independence, removed a demographic component in calculating pensions introduced under Kohl, began an active labor market policy, reintroduced continued wage payments in case of sickness and resolved a large-scale tax reform. An ecological tax reform was introduced. (8) Its goal was to raise the price of primary energy consumption by marking up the tax on oil and with the revenues lowering the contributions to legal pensions. (9) This project failed in two respects. While the contribution rate was reduced from 20.3% in 1998 to 19.1% in 2001, it has been at 19.5% since 2003. (10) A demographic component was incorporated in the pension formula. The large number of exemptions for energy-intensive productive businesses made the ecological tax reform problematic. Not surprisingly the CO2 emissions remained largely constant in this time period. (11)

The judgment on the great tax reform originally planned in three stages 1999, 2000 and 2002 is hardly any better. Massive resistance on the part of capital frustrated the goals of relieving private households in terms of effective demand and compensating lower state revenues by reducing subsidies. Thus massive tax rate reductions occurred with considerable revenue shortfalls. In a supply-oriented way, the focus was again directed at the higher income recipients. Serious losses were incurred with the corporation tax whose rates were lowered from 45% to 25% to remove alleged weaknesses in the international comparison. (12)

On top of this, the income tax was lowered up to 2005. Relief amounting to 93 billion Euros is expected in the period 2001 to 2005. (13) Thus red-green went further than the Kohl government. Since the tax cuts did not revive the economy, high unemployment remained along with high costs in the social budgets. In 2002, the Institute for Labor Market Research estimated these cuts at 75.1 billion. (14) Together with inconsistent spending, this led to uncontrolled increased state indebtedness. Observing the indebtedness limits of the German constitution (15) and the European Stability Pact is increasingly difficult for the German government. Heavy debts no longer occur only to finance long-term investments but result from dubious financing of budgets. This increasingly chaotic policy was described as “finance policy by shouting.” (16)


The judgment on social policy is not better. Social policy is supply-oriented and anti-social. Stability in contribution rates to the legal social security seems to be the highest goal. Expenses are increasingly shifted to individuals – with negative consequences for aggregate economic demand. The Riester pensions give private households additional training in savings. Several benefits are eliminated from the legal health insurance and the insured are burdened with higher co-payments and added costs in practice fees. The time limits for insurance benefits and unemployment benefits were cut. (17) Unemployment assistance and income support were combined. This was said to improve the efficiency of the system but improvement is hard to see. Since the payments are according to household situations, this is an impoverishment program for the affected that reduces private demand in the total economy.

The labor market policy of the red-green German government is the final evidence of their departure from Keynesian demand policy. Although the employment offices list several hundred thousand jobs, the reasonability rules of the Kohl government were tightened again. A reversal of the burden of proof was introduced and dubious instruments reminiscent of forced labor like 1-Euro jobs were made. Despite a lack of jobs and the poor economic situation, the unemployed are now responsible for their fate. (18) All in all, the Kohl government and the red-green government are only different in their professionalism. From an economic perspective, parties like the CDU, SPD, CSU, Greens and the FDP damage people living in Germany and the economy.


1) The supply and demand categories are central within free enterprise economic thinking. Short-and long-term perspectives are usually distinguished in economics. In the long-term, the amount of the gross domestic product (GDP) is determined by the potential production of goods and services. In the short-term, the amount of the GDP also depends on the aggregate economic demand for goods and services.
2) Cf. Council of Experts on aggregate economic development (2004)
3) Within the supply doctrine, economic life appears as a purely private affair. Instabilities observed in reality are stylized as state interventions in the market process. Supply-oriented economic policy is limited to law=-and-order policy. It is long-term oriented; micro-economic conditions of supply conduct of economic subjects are put in the limelight. Supply-side economics trusts the coordinating power of the neo-classical market system with undistorted competition to mould the future expectations of economic subjects. Advocates of this policy hope for innovation incentives and adjustment to aggregate economic structural change. Fees, regulations, administrative approval procedures should not impair these incentives, protection in foreign trade or inflationary tendencies in monetary policy.