Angie after 100 days: The party hasn't even started yet

Michael Burda 01 March 2006

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Around the world, a glass is always either half-empty or half-full, depending on how you look at it - and how thirsty you are. In depressed Germany, people have a habit of seeing things more empty than they are, and the economic outlook is no exception. Yet things have begun to look better in the last few months: the stock market, a tried-and-true predictor of a recovery, is booming; the DAX index is up by about 30% relative to a year ago. Investment is picking up, and foreign hedge funds have become increasingly sanguine about Germany. According to the Ifo Institute survey, managers are more optimistic now than any time since reunification fifteen years ago. Industrial production in the former East is up by 30% since 2000 (compared with only 4% in the West!) Even German analysts are talking about a "Merkel-Boom." Are good times right around the corner?

I hate to rain on the parade, but we are far from a new golden age in Germany, which will certainly be sobering news for the rest of the EU. Real growth, forecast by the optimists at 2% for 2006, is modest even for EU standards. The boomlet of 2006 will be fed by consumers trying to beat a 3%-point VAT increase planned for 2007, and is thus all the more likely to peter out in the aftermath. Judged from the longer-term perspective, much more that needs to be done. In the period 1995-2005, the German economy grew in real terms by only 14.5%, compared with 23% in Denmark, 25% in the Netherlands, and 32% in the UK (25% in the EU25). Despite record unemployment, Germany is in the throes of the first public sector strike since 1992 -- over a workday increase of 18 minutes. On the heels of this dispute looms another: the powerful metalworkers union IG Metall is demanding a 5% pay increase, justifying it as their contribution to aggregate demand management: if you pay workers more, they'll buy more, they argue. "Cars don't buy cars," to quote Jürgen Peters, head of the powerful IG-Metall. No, with discussions at this level, Germany is definitely not out of the woods yet.

Yet there is hope. Germany has a golden opportunity to implement serious reforms not seen since the 1960s. In this country, grand coalitions are a rare chance to make progress on "third rail" issues that no single party would touch alone. Traditionally, opposition parties tend to reject even reasonable and necessary reforms proposed by government as a matter of principle (and opportunism). In a country obsessed with consensus, it is important to get everyone on board - if anything to ensure that future governments do not reverse policies. Remarkably, in the past 100 days noticeable discussion has taken place on a number of pressing third-rail issues that have accumulated over the past decades:

Pension reform: After years of dogmatic opposition to any form of demographic adjustment of retirement benefits the SPD has recently proposed raising the retirement age to 67, to some internal grumbling but to applause from analysts around the world. (It was Schröder who rescinded a modest Kohl (CDU) reform in the mid-1990s).

Minimum wage. Germany is one of the few OECD countries that doesn't have one, relying on powerful unions and employers associations to enforce wage agreements. Now that membership is plummeting and eastern Germany is a union-free zone, wages are tumbling, especially in the new states. Long opposed by the CDU, the minimum wage is rapidly gaining support in both coalition parties. The urgency is compounded by job subsidies planned for low paid work a la européenne (subsidies to employers and not to employees), which will likely shift the wage structure south, increasing the program's cost to the government. In principle, a minimum wage should prevent employers from exploiting increasingly desperate and immobile unemployed.

Labour market policies. Gerhard Schröder started the reform ball rolling in 2003 when he announced the Agenda 2010. He created the now-infamous Hartz commission which proposed among other things, tightening up eligibility and cutting duration of unemployment benefit, and more disciplined use of active market labour policies. While Schrörder appealed for the full implementation of the Hartz measures, he was prevented by his own party and the CDU opposition from doing so. Now there is hardly a word about rolling back these reforms, if anything there has been remarkable progress in cutting waste in active market labour policies in the meantime. As for passive costs, the government now spends more on unemployment benefits than it did before the Hartz IV reforms, making it difficult to credibly criticise them as cold-hearted. In fact, they increasingly stress both the carrot (increased benefits, job offers, wage subsidies) as well the stick (sanctions for job refusal or unavailability).

Reform of the federal system The "federalism reform" package which was already approved some time ago as a compromise of a bipartisan commission may actually be implemented. The Bundesländer (federal states) would get more freedom in budgetary and economic policy making as well as education policy, and the second chamber (Bundesrat) would lose some of its ability to block legislation, as has been the case increasingly in recent  years.

If the goal is a lasting recovery, more supply-side reform is clearly needed. The success stories of the UK, the Netherlands and Denmark  were all backed by solid, credible and lasting supply side reforms. Curiously, economic good times - or expectations of them - are likely to be counterproductive, as politicians tend to lose their concentration when the economy picks up and unemployment starts to decline. The situation is made more complicated by the fact that the SPD controls the labour ministry and makes itself less popular with every mention of reform, while the Chancellor is able to shine on the international stage. Merkel owes much of her fledgling success to supply-side reforms that her predecessor implemented -- notoriously slow to take root, but when they are believed permanent they will have lasting effects on growth and employment. Naturally, supply side measures are only one side of the coin. But demand won't come until consumers are convinced that the recovery is here. Until now, they have been proven right – real consumption expenditure has been flat since 2000.

One has to admit that, overall, the first 100 days of Angela Merkel has been something of a sensation. Yet, with her unheard-of approval rating of 80%, the party hasn’t even started. And it’s a race against time: grand coalitions tend to self-destruct as soon as the low-hanging fruit is gone. Most guess that despite all the teamwork (and both CDU and SPD are currently run by Easterners!) the coalition won't survive past the end of 2007. Product market, tax and especially labour market reforms are likely to force open conflict in the coming months. Yet both parties are acutely aware of the pressure to succeed. If they can't solve Germany's problems, who can?

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Topics:  Macroeconomic policy

Tags:  Germany, Merkel

Professor of Economics at Humboldt University Berlin and CEPR Research Fellow

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