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16 January 2023

A German cautionary tale for Britain

Otto von Bismarck, the 19th century German chancellor has been quoted as saying: “Only a fool learns from his own mistakes. The wise man learns from the mistakes of others.” Rishi Sunak has not been in office for long enough to qualify as a fool in Bismarck’s definition. But he could have learned from the mistakes Bismarck’s modern-day successors. The UK and Germany have vastly different economic problems. Germany had become reliant on old industries and old technology. Brexit has exacerbated pre-existing economic ailments like low productivity and the dependence of its financial industry on the eurozone. What both countries have in common is that their economic models are unsustainable, and that their political leaders have dropped the ball.

Angela Merkel’s politics of the last decade is a cautionary tale, one that holds lessons for Rishi Sunak. For all her analytic rigour, Merkel was chronically uninterested in solving problems. She agreed to global emissions benchmarks or Nato military spending targets she had no intention, and no means, of meeting. Austerity policies of successive Merkel-led coalitions led to a half-trillion pounds shortfall of public investment.

The dire consequences have only become apparent recently. The mobile network is dysfunctional in many places, so much so that visitors to Germany think their phones are broken. A motorway that links the north and the south of Germany has been permanently closed because there was no money to repair a bridge that had become unsafe. A Bundeswehr general warned that the army is so underfunded that they are not in a position to fight a war over several weeks There is a clear pattern here.

Nothing quite compares in terms of short-termism to Merkel’s decision to speed up the exit from nuclear power. Germany was outwardly a successful economy during her period in office. Growth rates were good, and public finances were rock solid. Some naive foreign observers were so impressed that they gave her the accolade of leader of the western world. They didn’t see what was brewing under the hood.

Germany has missed out on the digital revolution in many sector. It was still clinging on to 20th century industries that relied on cheap Russian gas to stay competitive. To this day, German politicians, whether conservative or Green, have not questioned Germany’s industrial model.

To her credit, Merkel was never as quite cynical as Sunak, whose five-point to-do list last week constituted mostly of self-fulfilling promises. The Bank of England is already predicting that inflation will fall sharply from the middle of this year. Economic growth will, of course, return at one point. Has there ever been a recession that does not end?

The UK’s overriding economic problem that needs to be addressed is low productivity growth. Stagnant productivity has many knock-on effects: lower profits for companies, lower wages for employees, less tax revenue for the government and less spending on public services. The National Institute for Economic and Social Research contrasted average productivity growth of the UK economy of 2.3% in the period from 1974 until 2008, with a productivity growth rate of only 0.5% between 2008 and 2020.

Brexit is not the cause of the UK’s productivity growth decline. As the data cited above show, the decline set in around the time of the global financial crisis. This is when the UK’s trickle-down economic model ceased to trickle.

One way to raise productivity growth is through higher public investment. President Joe Biden’s somewhat misleadingly named inflation reduction act shows how this can be done. The US bill aims to attract foreign companies with subsidies in qualifying sectors like clean energy and low-cost pharmaceuticals. Freed from the strings of European competition policy, the UK could have offered European manufacturers similar incentives. It could have even constituted the beginning of a post-Brexit economic strategy.

You could finance infrastructure investments and subsidies through an off-budget instrument. Such investments, unlike Liz Truss' tax cuts, would stand a chance to raise productivity growth. Even a small increase in productivity would have a disproportionately large effect on the government’s ability to borrow. It is not the debt that is the problem. It was what you do with it.

Unfortunately, none of the three prime ministers since Brexit seemed interested. Boris Johnson’s wish to make Brexit work never matched his desire to get Brexit done. Truss tragically front-loaded her agenda with tax cuts. Sunak does not have any plan whatsoever. The Labour Party is also not focused on productivity. Sir Keir Starmer’s big idea is a combination of fiscal discipline and devolution. This is all fine and well, but not the answer to an investment and productivity crisis. When you subject the UK economy in its current state to devolution all that will happen is that underfunded state services become underfunded local services.

Problem avoidance can work politically. It worked for Merkel, who served four consecutive terms. But it is a logical fallacy to think that the converse is true in general. Failing to solve problems does not win you an election, especially if that failure blows up in your face while you are still in office.

I don’t think that Sunak will be as lucky as Merkel. The UK’s productivity crisis has already been going on for 15 years. The combination of Brexit and the serial economic shocks of this decade would suggest that the best time to address the productivity crisis is right now. What we have learned from the speeches by Sunak and Sir Keir last week, is that this is not going to happen. As the German philosopher Georg Wilhelm Friedrich Hegel once wrote: “What we learn from history is that nobody learns from history.”

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