Is economic adjustment driven by business interests? German state capacity and the changing nature of industrial policy

Inga Rademacher - DAAD Fachlektor in German and Transnational Politics, Department of European and International Studies, King’s College London

World Bank data show that capital investment and total government spending in subsidies and tax concessions as a share of GDP have fallen gradually since the 1970s. Since this decline accelerated in 2000, we can contrast the period of gradual decline in tax and subsidies since the 1980s with the more radical reforms in the 2000s. Most crucially, we can trace the institutional development of the degressive AfA – a declining balance depreciation schedule with a maximum rate of 30 percent for movable assets and an allowable 4 percent rate for buildings. Since the 1970s, policy makers had attempted but failed to cut this instrument due to the resistance of large manufacturing businesses. At the same time, attempts to open the German bank-based system of finance towards a greater market-based structure were obstructed by the resistance of credit co-operatives and the savings bank sector. Despite considerable pressures to reform the banking system through EU Directives in the 1990s, it was only in 2000 that the Tax Reduction Act of 2000 eliminated tax incentives for company networks.

My research explores the following question: ‘How did state actors transform the German Model despite the resistance of powerful economic interests?'

State-society approaches, most notably those associated with John Zysman, have argued that industrial adjustment (i.e. the adaptation of the organisation of production to new requirements in international markets) is both an economic and a political phenomenon. Because change will shift resources from one economic group to another, adjustment will cause conflict between businesses over the direction of economic policy. Entrenched interests will resist change to preserve positions of power. This is why state capacity to manage conflicts is an integral part of the adjustment to market pressures.

Change depends on policymakers’ ability to resolve conflicts of business groups and their respective representatives in parliament. German proportional representation produces coalition governments which often comprise several parties; each representing different interest groups. Since coalitions have to find consensus, Helmut Kohl’s conservative-liberal government (1982-1998) struggled to reform the German tax system because too many business sectors were represented. The catch-all Christian Democratic Party, the CDU, represented manufacturing businesses, the small Christian Democratic sister party, the CSU, supported farmers’ interests and the crafts sector and the Free Democrats, FDP, supported small and medium sized businesses.

Small business groups, like the BDS which represents the self-employed and the ZDH which represents the crafts sector, objected to corporate income tax cuts which mostly benefited big manufacturing firms and proposed to abolish the degressive AfA to generate the fiscal room for income tax cuts, often paid by small firms. But the BDI, the largest German business association which represents large manufacturing businesses, rejected the plan to cut the AfA. In order to get the bill passed in parliament, the government had to strike deals with several economic actors leading to an expansion and not a reduction of subsidies and tax concessions.

To get beyond  the deadlock, the Red-Green Schröder administration (1998-2005) developed three strategies to resolve the conflict. First, it selected key sectors for the future of the German export economy: large multinational manufacturing firms and internationally operating medium-sized businesses. The BDI, the Bayer AG and the DIHT – which represents chambers of commerce – were consulted in a reform commission. Finally, , export interests were aligned with interests of the public finance sector. The DIHT received the desired adoption of the half-income system in dividend taxation which allowed for mergers of medium-sized firms. Additionally, public savings banks and the Landesbanken were brought into the tax coalition by offering a private pillar to German pensions – which was believed to enhance the wealth creation in the German economy and generate credit resources available to exporting firms.

To evaluate the relevance of these reforms for the overall functioning of the German Model one needs to bring in the third pillar, state intervention through the developmental banks. The fact that the credit allocation of KfW additionally increased resources for German exporting firms (aside from the considerable resources they accumulated from the tax reforms) might explain part of the accelerated export-orientation of the German economy since the 2000s. Profits of German exporting firms have increased since the 1980s, however they are increasingly not fully re-invested. At the same time financial investments of non-financial firms have increased. Taken together, these developments indicate that the elimination of tax incentives for company networks and capital investment have contributed to a hyper-export-accumulation regime, which no longer incentivises capital investment in the German economy.