Reforms or economic stimulus packages? The right path to reviving the economy

"Lost decade" like in Japan? Experts warn: Germany repeats a fatal mistake

In light of a stagnating economy and uncertain forecasts, the debate in Germany about the right path out of the crisis is flaring up again: Should economic stimulus packages worth billions boost demand in the short term, or are far-reaching structural reforms the only sustainable way out? While economic stimulus programs are intended to act as quick firefighters, reforms aim to strengthen competitiveness in the long term. But these approaches, often presented as contradictory, are two sides of the same coin.

The analysis shows that the key to success lies not in the choice of one instrument or another, but in their intelligent interaction 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 has painfully demonstrated. If, on the other hand, debt-financed economic stimulus programs fizzle out without a structural foundation, they often leave behind only a short-lived flash in the pan and a growing mountain of debt. A proven three-phase strategy of stabilization, investment, and subsequent reform demonstrates how an economy can be sustainably revitalized – a model from which Germany could currently learn a lot to avoid repeating the mistakes of the past.

The question of the optimal timing and the correct sequence of economic policy measures to revive a stagnating 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 2008/2009 financial market crisis and the ongoing structural weakness of the German economy, show that both approaches have their merits, but can only achieve their full effect with the right 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 work through various channels: through direct government investments in infrastructure, education, and other public goods; through tax relief for businesses and households; and through transfer payments such as short-time work benefits. The theoretical basis is Keynesian economics, which assumes that government spending in times of crisis can offset the decline in private demand and, through multiplier effects, achieve a greater macroeconomic impact than the original resources.

Empirical evidence largely confirms this assumption. Studies show that the fiscal multiplier of public investment in recessionary times 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 to improve an economy's competitiveness and growth potential in the long term. 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 of social systems to ensure their long-term financial viability. The main goal is to increase economic efficiency and productivity and thus lay the foundations for sustainable growth.

Structural reforms typically take effect with 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 consumption decisions. People tend to reduce their spending when structural changes occur and wait until the new conditions have stabilized.

The problem of wrong timing decisions

The mistake of the structural response to economic problems

A widespread economic policy mistake is to primarily combat economic weaknesses with structural reforms. When an economy is weakening due to a recession or a short-term slump in demand, structural reforms are not the appropriate tool. In fact, they can even exacerbate the problems by creating additional uncertainty among businesses and households. Experience shows that structural interventions during recessions can further worsen an already tense situation by undermining the confidence of economic actors and leading 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 because the reforms created uncertainty and dampened domestic demand.

The limits of economic stimulus packages without a structural basis

Conversely, economic stimulus packages without accompanying or subsequent structural reforms may fail to achieve their full effect or only have short-term, flash-in-the-pan effects. If an economy's fundamental structural problems are not addressed, the economic stimulus quickly fizzles out. 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 economic stimulus package could only be 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 that can be divided into three phases. The first phase focuses on stabilization. Rapid economic interventions are required to prevent a further economic downturn and stabilize confidence. This phase includes measures such as bank stabilization, short-time work programs, direct business aid, and initial economic stimulus.

The 2008/2009 financial market crisis 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, two economic stimulus packages totaling over €80 billion, 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 stimuli. Here, economic 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, and in the digital and ecological transformation of the economy are particularly effective.

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

The third phase: structural consolidation

The third phase focuses on structural reforms to strengthen long-term competitiveness. This phase should only be initiated once the economic situation has stabilized and the first signs of recovery are apparent. Structural reforms in a stable or recovering economic situation have significantly better prospects of success, as they do not contribute to an already strained economic situation.

The Agenda 2010 in Germany demonstrates both the risks and the long-term successes of structural reforms. Although the reforms exacerbated economic weakness in the short term, they laid the foundation for the later "German job 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 Europe's growth engine.

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Successful models and failed approaches

Germany: From successful sequencing to the current reform backlog

Germany provides both positive and negative examples of economic policy sequencing. The success of Agenda 2010 was ultimately due to 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 clear that Germany has enjoyed the fruits of Agenda 2010 for too long and has delayed further necessary reforms. The structural problems have been building up over the years: high energy costs, increasing bureaucracy, demographic change, investment backlogs in infrastructure, 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 the measures.

Reform mix instead of hasty measures: How Germany is saving its competitiveness

Greece: The dangers of the wrong order

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

The Greek experience shows that structural reforms without adequate economic protection 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 dislocation.

The integration of both approaches

Complementarity instead of substitution

Modern economic policy is increasingly recognizing that economic stimulus packages and structural reforms should be seen 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 in which structural reforms can be successfully implemented. They stabilize demand, preserve jobs, and build confidence. At the same time, they can already contain transformative elements that facilitate the transition to structural change. Structural reforms, in turn, ensure that the stimulus created by economic stimulus measures has a lasting impact and not merely a temporary effect.

Political Economy of Reform Sequencing

Political feasibility plays a crucial role in the sequencing of economic policy measures. Economic stimulus packages are usually easier to implement politically because they promise positive short-term effects and enjoy broad support. Structural reforms, on the other hand, are politically more difficult because they often impose short-term costs on long-term gains and can burden certain groups.

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

Specific challenges of the German economy

Diagnosis of current problems

The German economy is in a phase of structural weakness that is not primarily manifested as a cyclical problem. The problems are diverse and deep-rooted: declining corporate investment, high energy costs, increasing bureaucracy, demographic change, a lag in digitalization, and declining innovation. At the same time, external factors such as geopolitical tensions, supply chain problems, and changing trade relations are at play.

The German government has responded with investment programs worth billions, but without adequately addressing the need for structural reforms. Experts warn that these investments could fizzle out without accompanying structural reforms and will not sustainably lead Germany out of stagnation.

Necessary reform areas

Germany needs a comprehensive structural reform approach that encompasses various areas. Reforms in the labor market are necessary to increase flexibility and address demographic change. Non-wage labor costs must be stabilized to prevent further increases in labor costs. Employment protection could be relaxed for highly qualified workers to increase labor market dynamism.

Reforms to the tax and levy system are needed to strengthen investment incentives. The corporate tax burden should be reduced to improve international competitiveness. At the same time, depreciation options must be improved and research funding expanded.

Public administration requires fundamental modernization and digitalization. Planning and approval procedures must be accelerated, bureaucratic burdens reduced, and administrative efficiency increased. Only then can planned infrastructure investments actually be implemented in a timely manner.

International lessons and best practices

Successful reform models

Several countries have developed successful models of economic policy sequencing. The Nordic countries, especially 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 compromising social security.

South Korea, after the 1997/98 Asian financial crisis, 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 improvements in competitiveness.

Failed approaches as a warning

Experiences with failed reform approaches provide important lessons. In the 1990s, Japan attempted for years to solve structural problems primarily with economic stimulus packages, without addressing the necessary structural reforms. This led to a "lost decade" of 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 packages of measures

A successful economic policy strategy requires the development of phase-appropriate packages of measures that incorporate both cyclical and structural elements. During the stabilization phase, cyclical measures should dominate, but should already include structural elements that prepare the ground for subsequent reforms.

For example, investment programs can be targeted at areas that simultaneously provide economic stimulus and bring about structural improvements. Investments in digital infrastructure, education, research and development, and ecological transformation can pursue both goals simultaneously.

Communication and expectation management

Communicating the economic policy strategy plays a crucial role in its success. Businesses and households must understand that the current policy is part of a broader strategy that also encompasses structural changes. Only in this way can positive expectation effects be created that reinforce the effectiveness of the measures.

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

Monitoring and adaptive adjustment

Successful economic policy requires continuous monitoring of the impact of measures and a willingness to adapt the strategy accordingly. If it becomes apparent that economic stimulus measures are not achieving the expected effect or that structural reforms have unexpectedly negative effects, policymakers must be able to respond 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 economic 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. Economic stimulus packages without a structural foundation lead to flash-in-the-pan effects, while structural reforms can exacerbate problems in economically strained times.

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

For Germany, this means that current investment programs must be supplemented by comprehensive structural reforms to achieve lasting effects. The labor market, tax system, public administration, and education require fundamental modernization. Without these structural changes, the billions of euros in investments risk fizzled out, and Germany could fall into years of stagnation.

International experience teaches that successful economies are those that implement the right reform sequences in a timely manner. With Agenda 2010, Germany has already proven its capability for successful structural reforms. Now it's important to leverage these experiences and develop a new reform agenda for the challenges of the 21st century.

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