Reforms or economic stimulus packages? The right way to revive the economy

A “lost decade” like in Japan? Experts warn: Germany is repeating a fatal mistake

Faced with a stagnant economy and uncertain forecasts, the debate about the right way out of the crisis has reignited in Germany: Should multi-billion-euro stimulus packages boost demand in the short term, or are far-reaching structural reforms the only sustainable solution? While stimulus programs are intended to act as rapid firefighters, reforms aim to strengthen competitiveness in the long term. However, these approaches, often portrayed as opposites, are two sides of the same coin.

The analysis shows that the key to success lies not in choosing one instrument over another, but in their intelligent interplay and, above all, in the right timing. If structural reforms are implemented at the wrong time—in the midst of a deep recession—they can dramatically exacerbate the crisis, as the example of Greece painfully demonstrated. Conversely, if debt-financed stimulus programs fizzle out without a structural foundation, they often leave behind only a short-lived burst of energy and a growing mountain of debt. A proven three-phase strategy of stabilization, investment, and subsequent reform shows how an economy can be sustainably revived—a model from which Germany could currently learn a great deal in order to avoid repeating the mistakes of the past.

The question of the optimal timing and correct sequence of economic policy measures to revive a stagnant or declining economy has occupied economists, politicians, and economic experts for decades. The central debate revolves around the effectiveness and appropriate timing of structural reforms on the one hand and economic stimulus packages on the other. The experiences of recent years, particularly during the financial crisis of 2008/2009 and the ongoing structural weakness of the German economy, show that both approaches are valid, but can only achieve their full effect with proper timing and careful coordination.

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The foundations of economic policy intervention

Economic policy as short-term stabilization

Economic stimulus programs primarily aim to stabilize the economy in the short term and stimulate aggregate demand. They operate through various channels: direct government investment in infrastructure, education, and other public goods; tax relief for businesses and households; and transfer payments such as short-time work allowances. The theoretical basis is Keynesian economics, which assumes that government spending during crises can compensate for declines in private demand and, through multiplier effects, achieve a greater overall economic impact than the funds originally deployed.

Empirical evidence largely confirms this assumption. Studies show that the fiscal multiplier of public investment during recessions is just under 2, meaning that one euro of government investment spending generates approximately two euros of additional gross domestic product. Investment measures prove particularly effective compared to pure consumption stimuli, as they can have both short- and long-term positive effects.

Structural reforms as a long-term growth strategy

Structural reforms, on the other hand, aim at the long-term improvement of an economy's competitiveness and growth potential. They encompass changes in various areas: labor market reforms to increase flexibility and employability, tax reforms to improve incentive structures, education reforms to strengthen human capital, and reforms to social security systems to ensure their long-term financial viability. The main objective is to increase economic efficiency and productivity, thereby laying the foundations for sustainable growth.

Structural reforms typically have a time lag and can even have negative effects in the short term. This is because changes to established structures and institutions can initially create uncertainty, which inhibits private investment and consumer decisions. People tend to reduce their spending during structural changes and wait until the new conditions have stabilized.

The problem of incorrect timing decisions

The flaw in the structural response to cyclical problems

A widespread economic policy mistake is attempting to combat cyclical weaknesses primarily through structural reforms. When an economy is faltering due to a recession or a short-term drop in demand, structural reforms are not the appropriate instrument. In fact, they can even exacerbate the problems, as they lead to additional uncertainty among businesses and households. Experience shows that structural interventions during recessions can further worsen an already strained situation, as they undermine the confidence of economic actors and lead to further reluctance to invest and consume.

This was partly observed in Germany during the early 2000s, when structural labor market reforms were implemented during a period of economic weakness. Although Agenda 2010 was successful in the long term, it exacerbated economic problems in the short term, as the reforms created uncertainty and dampened domestic demand.

The limitations of economic stimulus packages without a structural basis

Conversely, economic stimulus packages without accompanying or subsequent structural reforms can fail to achieve their intended effect or produce only short-term, superficial results. If the fundamental structural problems of an economy are not addressed, the economic stimulus quickly dissipates. This is particularly problematic when an economy suffers not only from cyclical fluctuations but also from fundamental competitive problems.

The current situation in Germany illustrates this problem. Despite the announced multi-billion-euro investment programs, medium-term growth prospects remain subdued because structural problems such as high energy costs, bureaucracy, demographic change, and a lack of digitalization are not being adequately addressed. Economists therefore warn that without fundamental reforms, the debt-financed stimulus package could be only a temporary phenomenon.

The correct sequencing of economic policy measures

The three-phase strategy for crisis management

Successfully managing economic crises requires a carefully coordinated sequence of measures, which can be divided into three phases. The first phase focuses on stabilization. This phase necessitates rapid economic interventions to prevent a further economic downturn and to stabilize confidence. Measures such as bank stabilization, short-time work programs, direct corporate aid, and initial economic stimulus measures are included.

The financial crisis of 2008/2009 provides an example of an initially successful stabilization phase. Germany responded with comprehensive measures: the Financial Market Stabilization Act with a volume of 400 billion euros, two economic stimulus packages totaling over 80 billion euros, and the expansion of short-time work benefits. These measures prevented a complete collapse of the financial system and cushioned the economic downturn.

The second phase: Reconstruction and growth impulses

The second phase focuses on stimulating economic recovery through targeted investments and growth initiatives. Here, stimulus programs should not only have a short-term impact but also create medium-term growth potential. Public investments in infrastructure, education, research and development, as well as in the digital and ecological transformation of the economy, are particularly effective in this regard.

Modern economic policy should increasingly include transformative elements. Green stimulus programs attempt to combine economic stimulus with long-term transformation goals. However, this requires careful consideration, as transformative measures may have different time horizons than pure economic stimulus.

The third phase: Structural consolidation

The third phase focuses on structural reforms to strengthen competitiveness in the long term. This phase should only be initiated once the economic situation has stabilized and initial signs of recovery are visible. Structural reforms implemented during a stable or recovering economic period have a significantly better chance of success, as they do not exacerbate an already strained economic situation.

The Agenda 2010 reforms in Germany demonstrate both the risks and the long-term successes of structural reforms. Although the reforms exacerbated economic weakness in the short term, they laid the foundations for the subsequent “German jobs miracle” and the improved competitiveness of the German economy. Unemployment fell from over five million to under three million, competitiveness increased significantly, and Germany became the growth engine of Europe.

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Success stories and failed approaches

Germany: From successful sequencing to the current reform gridlock

Germany provides both positive and negative examples of economic policy sequencing. The success of Agenda 2010 ultimately rested on the fact that the structural reforms were implemented at a time when the international economy was beginning to recover. The combination of labor market reforms, moderate wage growth, and improved international demand led to a remarkable upswing.

However, it is now becoming clear that Germany enjoyed the benefits of Agenda 2010 for too long and neglected further necessary reforms. The structural problems have accumulated over years: high energy costs, increasing bureaucracy, demographic change, a backlog of infrastructure investment, and a lack of digitalization. At the same time, current policymakers are attempting to solve these structural problems primarily with economic stimulus packages, which limits the effectiveness of these measures.

A mixed reform approach instead of a quick fix: How Germany can save its competitiveness

Greece: The dangers of the wrong order

Greece illustrates the problems of incorrectly sequencing economic policy measures. The structural reforms demanded by the Troika were implemented during a deep recession, which massively exacerbated the economic problems. Austerity programs in an already shrinking economy led to a vicious cycle of declining demand, rising unemployment, and further falling government revenues.

The Greek experience shows that structural reforms without sufficient economic support can be counterproductive. The harsh austerity measures and structural interventions should have been accompanied by economic stimulus measures to limit the social and economic costs. Instead, the one-sided focus on fiscal consolidation and structural reforms led to years of recession and social upheaval.

The integration of both approaches

Complementarity instead of substitution

Modern economic policy increasingly recognizes that stimulus packages and structural reforms should be understood not as substitutes, but as complements. Successful economic policy requires the intelligent combination of both approaches, with timing and sequencing being crucial.

Economic stimulus packages create the necessary economic framework for the successful implementation of structural reforms. They stabilize demand, preserve jobs, and build confidence. At the same time, they can already contain transformative elements that facilitate the transition to structural changes. Structural reforms, in turn, ensure that the impetus generated by economic stimulus measures has a lasting impact and does not merely produce temporary effects.

Political economy of reform sequencing

Political feasibility plays a crucial role in the sequencing of economic policy measures. Stimulus packages are generally easier to implement politically, as they promise positive effects in the short term and enjoy broad support. Structural reforms, on the other hand, are more politically challenging, as they often entail short-term costs for long-term gains and can disproportionately burden certain groups.

Successful reform policies therefore often use times of crisis as "windows of opportunity" for structural change. During crises, the public's willingness to embrace reform increases because the status quo is perceived as no longer tenable. At the same time, economic stimulus packages can mitigate the social costs of structural reforms and thus increase their political acceptance.

Specific challenges facing the German economy

Diagnosis of current problems

The German economy is in a phase of structural weakness that does not primarily manifest itself as a cyclical problem. The problems are multifaceted and deep-seated: declining corporate investment, high energy costs, increasing bureaucracy, demographic change, a lag in digitalization, and waning innovation capacity. At the same time, external factors such as geopolitical tensions, supply chain problems, and changing trade relations are also having an impact.

The German government has responded with multi-billion-euro investment programs, but without adequately addressing the need for structural reforms. Experts warn that these investments could be wasted without accompanying structural reforms and will not sustainably lead Germany out of stagnation.

Necessary areas for reform

Germany needs a comprehensive structural reform approach encompassing various areas. In the labor market, reforms are necessary to increase flexibility and address demographic change. Non-wage labor costs must be stabilized to prevent further increases in labor costs. Job security could be relaxed for highly skilled workers to boost labor market dynamism.

The tax and social security system requires reforms to strengthen investment incentives. The corporate tax burden should be reduced to improve international competitiveness. At the same time, depreciation allowances must be improved and research funding expanded.

Public administration needs fundamental modernization and digitalization. Planning and approval processes must be accelerated, bureaucratic burdens reduced, and administrative efficiency increased. Only in this way can the planned infrastructure investments actually be implemented in a timely manner.

International teachings and best practices

Successful reform models

Several countries have developed successful models of economic policy sequencing. The Nordic countries, particularly Denmark and Sweden, combined structural labor market reforms with a strong social safety net and active labor market policies in the 1990s. These “flexicurity” models made it possible to increase labor market flexibility without jeopardizing social security.

South Korea after the Asian financial crisis of 1997/98 provides another successful example. The country initially combined massive international financial aid for stabilization with subsequent far-reaching structural reforms in the financial sector, labor market, and corporate governance. The correct sequencing and consistent implementation led to a rapid recovery and long-term improved competitiveness.

Failed approaches as a warning

Experiences with failed reform approaches provide important lessons. In the 1990s, Japan tried for years to solve structural problems primarily with economic stimulus packages, without addressing the necessary structural reforms. This led to a “lost decade” with low growth and rising debt.

Similar risks threaten other economies that rely too heavily on debt-financed stimulus programs without addressing structural problems. Experience shows that without accompanying reforms, the effectiveness of stimulus measures diminishes and structural problems can even worsen.

Implementation strategies for optimal sequencing

Phase-appropriate bundles of measures

A successful economic policy strategy requires the development of phase-appropriate packages of measures that include both cyclical and structural elements. During the stabilization phase, cyclical measures should predominate, but should already contain structural elements that pave the way for later reforms.

For example, investment programs can be specifically directed towards areas that simultaneously stimulate the economy and bring about structural improvements. Investments in digital infrastructure, education, research and development, and the ecological transformation can pursue both goals at the same time.

Communication and expectation management

The communication of economic policy strategy plays a crucial role in its success. Businesses and households must understand that current policies are part of a broader strategy that also includes structural changes. Only in this way can positive expectations be generated, which will enhance the effectiveness of the measures.

At the same time, it is crucial to communicate realistically that structural changes take time and can also have negative effects in the short term. Managing expectations is essential to gaining political support for longer-term reform processes.

Monitoring and adaptive adjustment

Successful economic policy requires continuous monitoring of the effects of measures and a willingness to adapt the strategy. If it becomes apparent that cyclical measures are not achieving the expected effect or that structural reforms have unexpectedly negative consequences, policymakers must be able to react flexibly.

This requires the development of appropriate institutional capacities for monitoring and evaluation, as well as the political willingness to make unpopular course corrections when circumstances change.

The right order: Why economic stimulus packages and reforms belong together

The analysis clearly shows that neither stimulus packages nor structural reforms alone are sufficient to sustainably revive a stagnant economy. Success depends crucially on the correct sequencing and intelligent combination of both approaches. Stimulus packages without a structural foundation lead to short-lived effects, while structural reforms in economically strained times can exacerbate problems.

The optimal strategy follows a three-phase approach: first, stabilization through cyclical measures; then, growth impulses through transformative investments; and finally, structural consolidation to strengthen competitiveness in the long term. Crucially, timing is key: structural reforms should only be implemented once the economic situation has stabilized.

For Germany, this means that current investment programs must be complemented by comprehensive structural reforms to achieve a lasting impact. The labor market, tax system, public administration, and education all require fundamental modernization. Without these structural changes, even the billions of euros in investments risk being wasted, and Germany could face years of stagnation.

International experience shows that successful economies are those that have implemented the right reform sequences in a timely manner. Germany has already proven with Agenda 2010 that it is capable of successful structural reforms. Now it is crucial to use this experience and develop a new reform agenda to address the challenges of the 21st century.

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