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The state Europe’s in
By
Editorial staff
Simon Wilson
Feb 16, 2006
Isn’t the German economy on the mend? Up to a point. Manufacturing is recovering strongly - output rose 7.6% in the year to July - and exports are racing ahead. Corporate profits are also recovering on the back of extensive restructuring by firms keen to drive costs down.
The trouble is that Germany’s export-driven economy is highly vulnerable to a global downturn and there is little evidence that domestic demand is really going to pick up in a sustainable way. Also, overall growth is still pitifully low (it was down to zero in the second quarter of this year), while unemployment stands at 11%.
What are the key reforms needed?
According to Bundesbank president Axel Weber, the most urgent requirement is labour market reform. “The long-term growth potential of an economy very strongly depends on having flexible labour markets because that’s the key driving force for household incomes, and therefore consumption decisions, and for investment decisions for firms,” he says. In other words, Germany needs to make it easier for firms to survive and prosper by giving them more freedom to employ workers and to make them redundant. Germany’s ageing population and low birth rate (the population actually shrank last year) also mean that fundamental cost-saving reforms are needed in the health, pension and tax systems to protect the long-term viability of the traditionally generous welfare state. Gerhard Schršder made a start with modest reform of state pensions and measures making it harder to qualify for unemployment benefits. Partly as a result of these changes, there are signs of life. Unemployment, which climbed above five million early this year, is starting to fall.
How did the election affect things?
It makes a serious programme of reform less likely. If the CDU’s Angela Merkel had been able to lead a strong majority government, she would have been able to carry out her planned series of labour market reforms - allowing firms and staff to arrange company-level wage deals, giving small firms more flexibility on hiring and firing, and cutting unemployment insurance from 6.5% of salaries to 4.5%, to be paid for by an increase in VAT. Later on, she planned tax cuts and radical changes to healthcare financing aimed at cutting non-wage labour costs. However, now that Merkel is not a majority leader but a member of the new ‘grand coalition’ between the CDU and the SPD agreed this week, she seems unlikely to be able to do any of this. Although she will be Chancellor, the SPD will take eight of the 16 cabinet posts, suggesting political paralysis ahead.
And what about France?
Just like Germany, France has negligible growth in GDP, yawning budget deficits, a cherished ‘social model’ of capitalism based on highly regulated labour markets, and strong public resistance to labour or tax reforms. As in Germany, politicians are struggling to introduce meaningful economic reform in the face of hostility from voters - even in the face of mass unemployment. Dominique de Villepin - prime minister since June and increasingly seen as Jacques Chirac’s chosen successor as president in 2007 - has been busy over the summer on micro-economic reforms aimed at tackling unemployment. Although these have met with some initial success (unemployment has edged back below 10%), they aren’t popular: last week saw protests in France against the tentative reforms (and proposed privatisation of ferry operator SNCM).
What next?
Given the public mood in a country where “economic liberal” and “Anglo-Saxon model” are terms of abuse, and given the political paralysis after Chirac’s humiliation in the EU referendum in May, it is likely that further reform will be next to impossible until after the presidential election in 2007. Then it will depend on the winner. Until Villepin’s sudden rise this summer, the obvious candidate of the right was Nicolas Sarkozy, currently president of Chirac’s ruling UMP party, and still favourite to succeed Chirac. Where Villepin promises “change through continuity”, Sarkozy supports a “rupture” with the failed policies of the past 30 years. Sarkozy promises to shrink the state, cut regulation, and liberalise the labour market.
Will he become President?
It’s just too early to say. But the Germans were not keen enough on the idea of reform to elect Merkel outright, so the signs are not very encouraging. Across Europe, labour and welfare reforms have created a huge backlash. For example, a week ago Belgium held a one-day general strike in protest against pension reforms. The political mood of the continent is now one of retreat from economic reform, which suggests that the eurozone economy is set to disappoint for some time to come.
Published in Economics
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