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Innovation and Growth: The Missing Dimension in Germany’s Election Campaigns

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Germany faced an election yesterday because Chancellor Gerhard Schroeder’s reform efforts have failed so far to produce a reduction in the country’s high unemployment levels. Although every party vowed to lower unemployment if elected, the economic policy discussion during this election ignored the crucial fact that a consistent reduction in Germany’s unemployment levels, without a loss of wage growth, will require more innovation.

Currently, productivity growth – innovation – is expected to hover between 1 and 1.5 percent for the near future – far below the levels of other industrialized countries, such as the United States. At the same time, Germany needs to put policies in place that ensure that faster innovation will quickly translate into higher wages – and not just larger profits – to strengthen and stabilize economic growth.

Achieving higher employment levels without reducing wages requires that productivity grow faster and that the gains of higher productivity be distributed to workers in the form of higher wages and more employment. Without faster productivity, Germany would continue to see slow growth. Its labor market policies would amount to nothing more than a redistribution of misery by raising employment at the expense of wage growth, since the economic pie would not grow fast enough to accomplish both.

Despite the inevitable economic necessity to seriously consider policies that could enhance Germany’s innovative capacity, global competitiveness, and ability to grow, this discussion did not receive the attention it deserves in Germany’s current election debate. Admittedly, economists are often unclear on what exactly constitutes the ingredients for successful innovation in the future. However, it is clear that both a skilled labor force and a strong capital base are a necessary, if not sufficient, condition for more innovation in the future. While Germany’s politicians lamented the fact that the quality of Germany’s education system has fallen behind that of other industrialized countries, they offered few specific proposals on how to address this shortcoming.

In comparison, building a capital base by giving Germany’s entrepreneurs more incentives to invest in productive capital did gather some traction in sloganeering, especially through the argument that lower taxes and fewer regulations would ultimately entice business to invest more. While lower corporate taxes can have a small effect on investment, other factors that loom especially large in Germany overshadow this argument.

For one, businesses invest only if they are confident that new customers will exist in the future, a doubtful premise in a climate of slow income growth, high savings rate, and likely tax increases after the election. Moreover, Germany’s entrepreneurs, especially among small businesses, have had a harder time than in the past securing adequate financing for their investment projects, which often raises the costs of capital to a point where projects are no longer viable. In such a situation, lower taxes will only fuel growing budget deficits without achieving more investment and innovation.

There are paths to innovation in Germany. For instance, in recent years, Germany has made large strides in promoting renewable energy sources. A new report this week showed that for the first time, Germany received more energy from renewable sources than from nuclear power. Given rising oil prices and the strains they pose for families and households, more investment in renewable energy sources and in more energy efficiency appears especially pertinent.

So far, the governing coalition of Social Democrats and Greens has relied on more environmental regulations and higher taxes on non-renewable energy sources to coax businesses into investing in this direction. Instead of using the “stick” approach, a “carrot” approach, such as easier access to financing for small businesses that want to invest in the production of new technologies, could produce better results. This could be done through subsidized loans or loan guarantees, among other financing vehicles, sponsored, for instance, by the country’s development bank, the KfW. Lower costs of capital for investments in renewable energy sources and in more energy efficiency would entice more businesses to invest in this direction, laying the foundation for more innovation in the future. Yet, the governing coalition as well as the opposition parties have remained largely silent on the issue of innovation in this area.

At the same time, innovation alone is not enough to produce more and better paying jobs, a fact that many in Germany are mindful of. Without strong labor market institutions that will help to translate faster innovation and stronger growth into more employment and higher wages, profits will rise, but growth will inevitably slow down. This is particularly true in a country where consumers do not have the ready access to massive amounts of consumer credit that, for example, U.S. families do.

The governing coalition has a track record of weakening crucial labor market institutions, particularly by creating a low-wage labor market and pressuring unions into concessions. The opposition parties, if elected, would continue this path, likely at an accelerated pace. Consequently, if innovation increases, it is unclear that Germany’s labor market situation will allow German workers to share in the fruits of their labor. However, if the total sum of wages in the economy continues to grow slowly, demand for Germany’s products will falter, ultimately maintaining the obstacles to durable growth and more and better employment.

As long as innovation does not become a central theme of Germany’s economic policies, future governments will be relegated to rearranging the pieces of a pie that does not grow. Without more innovation, Germany can reduce unemployment only by reducing wages at the same time, especially if German labor market institutions are continuously weakened. For the time being, there are no new visions or policy proposals that could ultimately help to significantly improve Germany’s chances for faster innovation and for letting Germany’s workers share in those gains. Thus, Germany could face a prolongation of the economic pains of the past few years.

Christian E. Weller is senior economist at the Center for American Progress.

 

 

 

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