Jens Weidmann: Not against the laws of economics - Hans-Werner Sinn
as a public intellectual
Speech by Dr Jens Weidmann, President of the Deutsche Bundesbank and Chairman of the
Board of Directors of the Bank for International Settlements, at the International Scientific
Symposium and Official Ceremony to Mark Hans-Werner Sinn's retirement and the
25th anniversary of the Center for Economic Studies (CES), Munich, 22 January 2016.
* * *
1. Introduction
Dear Hans-Werner Sinn,
Ladies and gentlemen,
It is a great honour for me to speak today to such a large audience of distinguished scholars
who have gathered here to honour Hans-Werner Sinn.
Hans-Werner Sinn has been a professor of economics for more than 30 years and President
of the ifo Institute for more than 15 years. Thankfully, I do not have to even attempt to
summarise his copious academic achievements: Kai Konrad has just done that in his excellent
speech. He also pointed out that under Hans-Werner Sinn's stewardship the ifo Institute has
developed into an internationally renowned research institution.
But Hans-Werner Sinn is more than an outstanding academic and an exceptional manager of
science. He is also an influential public intellectual who has shaped every major political debate
over the past few decades by injecting economic arguments into it.
Kurt Tucholsky once said that: "To have an effect on other people, you must first speak to them
in their language".
And Hans-Werner Sinn did exactly that. Like few other German economists, he was able to
make economic arguments accessible to the public. More than a dozen books, hundreds of
opinion pieces and numerous radio and television interviews are proof of this. They provide a
great translation service from the often model-based arguments of the economic profession to
a language that the public is able to understand.
In doing so, he was sometimes polarising, often trenchant and always battlesome - but these
are defining characteristics of a public intellectual. Public intellectuals argue their cases
passionately. They have an attitude and not just an opinion. This is indispensable to ensure
that their public statements encourage others to form their own opinions and to engage in a
discourse.
For Hans-Werner Sinn, interacting with the public was never an end in itself. It is one of his
firmly held convictions that no policy maker can permanently ignore what he calls the laws of
economics. Because doing so would eventually turn out to be extremely costly.
He is convinced that politicians are always tempted to ignore the laws of economics because
taxpayers often discover the true price tag of a policy measure only years later. Hans-Werner
Sinn therefore wanted to alert the public early about when policies were inconsistent with
economic principles.
"It is my duty to speak publicly about economic and fiscal policies and to initiate debates...,"
as he put it in an interview.1 It is this motivation which gave rise to his enormous number of
public interventions.
Even if I wanted to, I couldn't give you the full list of topics he's covered. Today, I will highlight
just three issues that have been milestones over the last 25 years of Germany's economic
history. And they all bear some lessons for today's economic challenges in Europe.
The first stop on our journey through German economic history will be Germany's economic
unification.
2. Germany's economic union: incomplete convergence
When East German companies entered into the Economic, Monetary and Social Union with
West Germany in 1990, their productivity lagged far behind that of their western competitors.
In their book "Jumpstart: The Economic Unification of Germany", Hans-Werner Sinn and his
wife, Gerlinde, pointed out that, to avoid rising unemployment in the eastern part of Germany,
wages there would have to remain below those in the western part until eastern German
companies had increased their capital stock, and thus labour productivity, sufficiently.2
But at that time, policy makers were already confronted with a strong migration movement from
eastern to western Germany. Huge differences in wages between the two parts of Germany
would have further accelerated this movement. So, maintaining large discrepancies in wages
wasn't the preferred option for most policy makers. They accepted that labour unions and
employers' associations agreed to fully adjust wages to those in western Germany in as little
as five years.
The book "Jumpstart" correctly predicted that it would be "completely impossible that
productivity of the East German economy could increase quickly enough to make these wages
compatible with full employment or at least low unemployment."3 And indeed, in the first five
years of economic unification, unemployment in eastern Germany rose from virtually zero to
almost 17%. Unemployment in the western part increased only by 3pp.
But to be fair, other factors may have also contributed to the increase in unemployment. One
was the currency conversion. Some of you will remember the controversial debate about how
to convert the East German Mark into the Deutsche Mark. In the end, wages in eastern
Germany were converted one to one into the Deutsche Mark. The then president of the
Bundesbank Karl-Otto Pöhl had warned - for the same reasons that Hans-Werner Sinn put
forward - that this was to the disadvantage of companies in eastern Germany. However, he
later acknowledged that there was hardly any alternative, as "political realities were stronger
than economic logic".
The high level of unemployment in eastern Germany was cushioned by transfers from the
western part. While the exact amount of these transfers is difficult to calculate, Hans-Werner
Sinn once estimated that transfers paid up to the present day amount to around €1.8 trillion -
roughly the size of the German GDP in 1991,4 but this number certainly comprises more than
just the transfers via the social security system.
A central tenet of "Jumpstart" is that it would have been much cheaper to compensate
employees for accepting lower wages than to compensate the unemployed for their job
losses.5 "Implement distributional objectives through transfers and not by altering factor prices"
was the economic principle that Hans-Werner Sinn saw violated in the formation of the
economic union between the two Germanys. And he feared that this would allow wages to
remain above the market clearing level for too long.
And also the distributional objectives were only partly achieved: Not least because
unemployment in eastern Germany is still higher than in the western part, per capita income
in eastern Germany is still only 71% of that in western Germany.
It is this experience which explains at least partly why many German economists are sceptical
about establishing a transfer union in Europe, as at the European level these problems are
aggravated by the fact that the balance between control and liability would be thrown further
out of kilter. Decisions would mainly be taken at the national level, while the consequences of
those decisions would be spread across the entire euro area. Many proposals in terms of risk
sharing and mutualising liabilities have been put forward over the last years, including
Eurobonds or the establishment of a common deposit guarantee scheme, but little has been
said about the necessary transfer of fiscal sovereignty. Without a transfer of national fiscal
powers to the European level, such a set-up would undermine the incentives for sound and
sustainable policy decisions in the member states. I will come back to this point later on.
3. Germany's welfare system and the forces of globalisation
Hans-Werner Sinn's impetus to explain to the public when policy makers try to defy basic
principles of economics struck again in the early 2000s. In another round of public
interventions, he warned that the German welfare state was ill-equipped to deal with the forces
of globalisation.
Germany's reform of the labour market is the second stop on our journey into the past. The
key economic principle at stake was again the same: distributional objectives should not be
aimed at by changing factor prices.
With regard to the entry of China and India into the global markets, Hans-Werner Sinn was
convinced that this would put downward pressure on the wages of the less skilled workers in
Germany. "Trade in goods and mobility of capital [...] creates a common labour market, and
on such a labour market there can no longer be substantial differences in wages,"6 as he put
it.
He was rightly concerned that Germany's approach of using wage substitutes to compensate
the losers of globalisation would define an implicit minimum wage that would prevent wages
from adjusting. This was another attempt to defy economic forces. And "[...] as a result,
globalisation produces unemployment rather than gains from trade,"7 he wrote in an influential
article in 2004.
So a way had to be found to compensate the losers of globalisation without preventing the
market from adequately determining factor prices. Together with other economists, the
German Council of Economic Experts and also the Bundesbank he therefore called for a
change in the welfare state paradigm: to rely more on wage subsidies and less on wage
substitutes.
This made Hans-Werner Sinn one of the trailblazers of the so-called Agenda 2010 reforms that
were enacted between 2003 and 2005. A central element of the reforms was to shorten the
period of eligibility for unemployment assistance and to tighten work availability requirements.
In return, the government began topping up low wages. Germany's welfare system now paid,
as Hans-Werner Sinn put it, "more for taking part and less for staying away".
And the recipe worked as predicted: unemployment began to trend downwards and
employment began to rise. The full truth is, however, that this was also supported by a
changing behaviour on the part of trade unions and employers' associations, resulting in more
moderate wage policy and the strengthening of establishment-level agreements as trade
unions reacted to the further increase in the already high level of unemployment.
These changes allowed Germany to rise to the multiple challenges stemming from German
unification, the competitive pressures from EU enlargement to the east, and globalisation.
By the way, even today and against the background of almost full capacity utilisation the wage
settlements are still mindful of their employment effects. The Bundesbank's focus with regard
to wages is purely analytical. The crucial question is here, whether their development is in line
with our main objective: price stability. And in this regard we have in particular to check for
second-round effects. According to our analysis such second-round effects can currently be
denied for Germany.
This perspective on wages is not a policy recommendation. Not only because we do respect
the autonomy in wage bargaining but also because we agree with Hans-Werner Sinn that wage
negotiations should not be overburdened by aiming other policy goals - for example by
targeting the current account.
Recent economic policy decisions, however, such as the introduction of the minimum wage
and the option to draw a full pension at 63 offered to long-term contribution payers can be seen
as a roll-back of the Agenda 2010 reforms.
And again, these decisions illustrate the key challenge related to policy advice I mentioned
earlier: In the short run, where the economic situation and employment is relatively stable, the
minimum wage, for example, might even have positive economic effects, as it leads to an
increase in the income of the workforce. And consequently, the Bundesbank assumed in its
macroeconomic forecasts for last year that the minimum wage would have a slight, stimulating
growth effect. In the medium term, the consequences of the minimum wage are certainly less
benign and will first of all depend on whether a politicisation of the work of the Low Pay
Commission can be avoided.
4. Reforms for a more stable monetary union
Ladies and gentlemen, the last stop on our time travel expedition is the euro-area crisis, which
is also one of Hans-Werner Sinn's central points of focus in his academic and political work.
In his book "Der Euro" (The Euro) he writes: "The tension in Europe stems from a fundamental
conflict between wish and reality - or what has been dubbed the primacy of policy over the
laws of economics. For years, policy makers have been able to get their own way and pretend
that fiscal constraints, laws of economics, and mathematics simply do not exist."
In his description of the euro area's current state he is rather negative: "Today the Eurozone
is a shambles, staggering from one crisis to the next."
As Hans-Werner Sinn knows, I am not as pessimistic as he is with regard to the state of the
euro area. This is not only because of the difference in age and the fact that as life advances,
recollection takes the place of hope - to quote the German writer Wilhelm Raabe. After all,
there has been some progress in the euro-area countries and institutions.
But I agree with him that one important reason for the euro-area crisis was the limited success
of capital markets in constraining public and private indebtedness in the euro-area member
states, which found its expression in an exaggerated convergence of risk premiums for lending
to governments and households in the euro area after the introduction of the euro.
This convergence could be partly explained by the elimination of the exchange rate risk
because of the introduction of the euro. But the convergence in risk premiums went even
further as investors mispriced the risks associated with the increase in public and private debt
levels.
While the rescue mechanisms that were put in place prevented the crisis in the euro area from
escalating, they did so by a bailout of creditors to banks and sovereigns. The principle of
creditor liability was further undermined.
This is another of the economic laws, violation of which Hans-Werner Sinn warned would turn
out to be very costly. "Creditor liability is the core tenet underpinning the market economy," he
wrote. "Investors only act with caution when making their investments if they reckon with being
held liable in case their investment fails." Hans-Werner Sinn devoted at least three books to
this issue, all of which contain impassioned calls to realign control and liability.
An important step in this direction with regard to investments in banks was made at the
beginning of this year, when the Bank Recovery and Resolution Directive, (BRRD) became
effective. It helps to ensure that, in the future, the shareholders and creditors of a bank will be
first in line to absorb any risks and losses.
And in this context it is important to note that because of the new Basel III regulation, banks
are now obliged to maintain higher capital buffers. This helps to increase bank shareholders'
liability if the bank has to be restructured or even resolved.
To ensure that the principle of liability - or as Walter Eucken put it: "Those who reap the
benefits must also bear the costs." - is also respected with regard to sovereign debt, the
founding fathers of the euro had incorporated the no-bailout clause into the Maastricht Treaty.
It was the "linchpin of the construction of the euro", as Hans-Werner Sinn wrote in one of his
books.
But with the institutions and rules in place before the crisis, simply letting a sovereign default
happen proved to be risky for the financial stability in the euro area. Because government
bonds were treated, wrongly, as risk-free in the capital regime for banks, they held a significant
stock of government bonds - the sovereign-bank nexus is strong in the euro area.
Hans-Werner Sinn suggested a number of measures that would bring more market back to the
sovereign debt market. Here, I would like to mention only two that strike me as being
particularly important - and which are similar to points that I also make frequently:
The first is to do away with the regulatory privileges afforded to public debt.
The second proposal is to limit assistance from the rescue mechanisms to what is
absolutely necessary to assess whether the situation at hand is one of illiquidity or
insolvency.
While Hans-Werner Sinn tries to achieve this by limiting the time for assistance up to two years
the Bundesbank has suggested to introduce an automatic three-year maturity extension for all
government bonds - which would be activated the moment a government applies for an ESM
programme - designed not to let private bondholders off the hook until it is clear that the
problem is one of illiquidity and not insolvency.
Addressing both issues is crucial to enhance the functioning of the Maastricht framework,
which is - as it has to be recalled from time to time - still the legal foundation of the monetary
union.
Last but not least, Hans-Werner Sinn unquestionably deserves special acclaim for pointing the
public's attention on the impact of central banks' crisis measures. He anchored his criticism in
the discussion at one specific keyword: The balances of the "Trans-European Automated
Realtime Gross settlement Express Transfer system", known as TARGET for short. He even dared
to write a book about that topic, which was previously known to only a handful of experts. I am
sure that no one else than Hans-Werner Sinn could have taken such an unwieldy subject and
propelled it to the top of the German bestseller list for business books.
I don't wish to rehash the whole Target debate here. The Bundesbank shares many of the
observations made and conclusions reached by Hans-Werner Sinn. However, our opinions do
differ in several points of analysis. For instance, we don't see the Target system as the problem
per se, but rather as a system that reflects existing problems in the euro area. Above all, the
underlying risks stem from the provision of liquidity and the liquidity provisioning framework,
as well as in the subsequent cross-border distribution of liquidity. Similarly, in banking, it is the
non-performing loan that is a potential risk, not the payment system through which the
payments were routed. Consequently, our critical appraisal focuses on aspects of such liquidity
provision where the boundary between monetary policy and fiscal policy is in danger of
becoming blurred. For example, when emergency liquidity assistance is granted on a very
large scale, the collateral framework is severely watered down, or when government bonds
are purchased. This is doubtless in keeping with Hans-Werner Sinn's views. But our views
probably differ in our assessment of the risks that the Target system presents for Germany,
say.
Despite some differences of opinion it is without any doubt one of Hans-Werner Sinn's
outstanding achievements that he has fostered intense broad public debate - even though the
sometimes sharply propounded arguments did not always make life easier for us in the
Eurosystem.
5. Conclusion
Dear Hans-Werner Sinn, Arthur Schopenhauer once wrote: "There is no greater consolation
in age than the feeling of having put the whole force of one's youth into works which still remain
young."
Well, I am not sure your age necessarily warrants the need for consolation. Looking at your
latest publications, you seem to have maintained a lot of this force. And you have obviously
saved some of your youth for a host of other achievements above and beyond those which I
have discussed today.
But I hope that the short time journey I have undertaken today through your public interventions
over the past decades demonstrates at least one thing clearly: that your achievements will not
age. They contain lessons that are still relevant today and will remain relevant tomorrow.
And there is no doubt that your publication list will become even longer. You already said in an
interview that you were planning to write more books. I wish you the strength and energy for
many more public interventions.
And ladies and gentlemen, I hope you will find the discussions here at today's symposium
inspiring.
This is the right time to hand over to the first panel of today's symposium. The title of the first
panel is "The European Monetary Union: Deficits and Cures". Harold James, the floor is yours.