Economics and Herd Instinct

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By Matthias Mersch

Beijing Rundschau, November 26, 2009 [original version published online in German]

Professor Dr. Klaus F. Zimmermann is President of the German Institute for Economic Research (DIW). The Institute, which is located in Berlin, was founded in 1925, and with 185 permanent employees it is the largest German institute for economics. In addition Klaus F. Zimmermann is Director of the Institute for the Study of Labor (IZA) in Bonn, which is the second largest network of economists in the world. IZA pioneers international research in all areas of labor economics and transforms scientific findings into concepts, which are made available and often help politicians and business in making decisions. IZA is currently conducting research on urban and rural migration in China. The project is in cooperation with Beijing Normal University and the Australian National University and is set to last several years. The occasion of his latest visit to Beijing gave the Beijing Rundschau the chance to interview him.
The market for policy advice is growing. Experts are having more say in the decisions made by politicians and business. How do you avoid the temptation of playing politics with your forecasts and commentaries?
It is extremely tempting for a scientist to say, I know better and I will tell you how it is, I am like God. On the other hand I belong to the generation of think tank leaders who come from academic research. We were all scientists, who first attained international acclaim and then took on the task as political advisors. We are all in agreement not to take a political position. I have also pressed this home at my institute, despite resistance from both within and beyond. We are not opinion-makers in the sense of helping a certain goal to be reached. Of course we have research findings, but these results serve as a way of developing recommendations and revealing alternatives. Politicians then have to decide themselves and carry the responsibility. Only the media undermines this from time to time by exaggerating our statements and acting as if these were concrete instructions addressed to politicians. We try to give some transparency to where the problems are and leave the decision naturally to the politicians.
You believe it makes little sense to rely on permanent subsidies when promoting a green economy. Even with evidence of climate change, you prefer a market-based approach. But haven’t the subsidies from the red-green coalition government at the end of the 90s contributed substantially to the fact that German companies are nowadays market leaders in many areas of green economics?
I believe so, although it has not been conclusively proven. But it is true that the relative advantage which Germany enjoys is also to do with the fact that these initiatives were created out of political reasons which were not rational in an economic sense. To what extent do you deem the regulatory measures as sensible? Take Japan as an example: the high environmental standards owe themselves entirely to government specifications. Industry sometimes appears to require a push in the right direction. How do you see it? It is very difficult to identify the factors which will play a role for the economy of a country in the long-term. A subsidy policy should serve to strengthen certain aspects, so that they work in the first place. This happens for example in the pursuit of industrial policy. In this sense the promotion of green technology is active industrial policy. In doing so, we try to reach dimensions in one area of the economy which allows the companies to be able to perform in the market. You have to however step back as soon as the products have proved themselves in the market. The question is when is this the case. And who decides what is viable for the future? The majority of the German population now believes that something must be done to stop climate change. When the population says we want to have this, then it is justified investing money, and perhaps also wasting some, to pursue this wish. It may in retrospect be more than mere amusement, perhaps it turns out to be even essential for survival. We had an enormous increase in energy prices last year. This also has to do with speculation on dwindling energy supplies. Here the positive function of speculation can be seen: it does not wait until the last day supplies are completely depleted. The prices have to rise first before awareness of the problem increases. When the markets function in this manner, companies follow in line because they then invest in new forms of energy production in good time. Then also other, renewable, energy is viable. However it is seldom that the market reacts in advance. Also because we are at times too quick to demonize the speculators. Politicians can anticipate, when they know where the problems are. But the problem is that politicians generally do not know where the greatest problems are! And when they do know, they are often unwilling to approach the problem purposefully. Take the demographic challenges facing Germany, whose effects will first become apparent in the next 5 to 10 years. This question has so far been ignored, although we analyzed it at our institute 20 years ago.
As an economist do you not rather have the role as a brake? Although you have instruments to make prognoses, these are based on data you have collected in the past. Does that not automatically lead to a conservative observation?
Scientists, including climatologists, do what they can to illustrate the potential problems. My position as an economist is more in the middle. I say, we have to accept that it behaves so and so. Therefore we should construct our systems in such a manner that they react adaptively through market mechanisms to the respective problems. It may well not be true that fossil fuels will run out entirely in the coming years. We just don’t know. It would be good to design systems which made sure that prices rose as early as possible, so that we could adjust in good time. The same is also true with climate change. That is why you should not throw the baby out with the bath water. I personally do not really believe that the climate targets can be easily reached politically. There are still climatologists who distance themselves from the worst-case scenario.
Every form of energy is subsidized in some way, including nuclear energy. If there is going to be a subsidy, which is useful?
Good subsidies are always those which you receive yourself! If the market can take care of it, it should be left to do so. In many cases however the market uncovers a worthwhile future venture too late. We then have to intervene. A market-based system needs to be devised which is best able to ensure that the mechanism works.
To what extent is government intervention the cause of the persistent economic crisis in Japan, which has lasted for 20 years?
If an economy is to be led out of the Stone Age with a defined program, it requires intervention. Possibly then the Japanese or Chinese model is required. But the program should be abandoned once the Stone Age period is over. The Japanese might have thought that they could carry on in this manner for ever. When I know that I have to go in this direction to develop the economy, then it can be enforced from above. But the wish to replace market processes in every detail is very dangerous. I believe that this also lies at part of the root of the crisis. The model for Japan had outlived its purpose 20 years ago, and this will one day be the case for China. Not the economic focus on export, but the model of state subsidies and intervention. This type of planned economy is good when it is a question of catch up, and it has advanced Japan and China. Tremendous progress has been made in individual regions of China, but simultaneously it has created huge problems. Things will have to change.
The economy still seems to be fixated on economic growth. Do you believe that everlasting growth is still an essential prerequisite for well-being?
We have also had an increase in productivity. We want to make things better. And that is why we need the possibility to pay more and that is why we need growth. At the same time it is becoming ever more difficult to measure what growth is. If we are talking about machines, then I can easily calculate; the same goes for bananas or the whole area of trade and production. With the service industry it begins to get harder, especially when the market share is increasing. We have determined that Berlin’s economy always falls behind compared to the rest of Germany. But the employment situation there is relatively advantageous, which can’t really be true. This probably is to do with the fact that output for the service industry can not be measured correctly and the value of the generated services can not be estimated properly. There are of course more complicated services, which are often generated on the internet. We can not measure these with our current conventional instruments. We need to be aware of the fact that we can only continue to aim for full employment if we regard growth as fundament. Growth is something neutral. Growth can also be qualitative: it can contribute to the conservation of the environment. The service industry is also normally more environmentally friendly.
In the recent general election in Germany the economy played an incredibly minor role. Is the economy losing its central importance for voters in elections?
Although the economic situation is bad, the population does not experience it as such. The whole crisis has cut deep this year; the economy has clearly contracted. But this is reflected in the capital accounts, where the profits of companies and asset holders are. Wages have remained rather stable, together with an inflation rate which is practically zero. No one has lost their job, unemployment is falling. As long as this is the case, who should worry? The companies? Some are active in the consumer goods industry. Companies in the export sector, which have been affected, know that it is not the government which has caused the difficulties. It was external. That we, in my opinion, have actually put together too many stimulus packages to be on the safe-side gives the impression that something has been done. We have for example ruined cars. CDU and FDP say, we are going to lower taxes; the voters say, we don’t believe you, but we’ll vote for you anyway! The current mood in Germany is rather interesting.
Why has it come to cash hand-outs for those who trade in their old car for a new one?
There are several reasons: it was not exactly known on what the money could be quickly spent. The money had to go somewhere, although consumption in Germany was not a problem. The money flow was able to be tied with the attempt to face a structural crisis. The automobile industry is in a world-wide crisis of its own doing, not in a financial market crisis. This industry is a very important sector for Germany, and so the cash hand-outs were created to give the sector some breathing space and to avoid, among other things, giving money directly to Opel. Which company has profited the most from all this? Volkswagen, since they have the largest turnover in the domestic market and have not had any problems with sales. What was good about the cash hand-outs was that they were not limited to German products. Closing borders and only consuming home-grown products, now that will lead us to misfortune.
Translation by Ross McRae