Ailing German economy lacks immediate cure

A worker fixes a light-box on the Logo of Germany's Deutsche Telekom, Europe's biggest telecommunications company, at the Cebit fairground in Hanover, yesterday. Experts say Germany needs to scale back unemployment compensation, health care and other government benefits to save the nation's troubled economy. PHOTO: REUTERS

With soaring unemployment, swooning consumer confidence and an economy skirting its second recession in two years, Germany seems to be the undisputed holder of the title "sick man of Europe."

What the country needs, most economists and business leaders say, is a bracing dose of the type of free-market medicine prescribed by Margaret Thatcher in the 1980s, when Britain held the "sick man" title.

Shake loose Germany's calcified labor market, abandon the subsidies that make unemployment almost as lucrative as working, reform its bloated health care system, and Germany could recapture the dynamism that made it Europe's economic engine for much of the post-World War II era, they say.

Chancellor Gerhard Schroeder has initiated such efforts, only to back down under pressure from labor unions and leftist elements in his party. There is a contrary school of thought -- and not just among union bosses and other guardians of the status quo -- that says the best response to Germany's ills would be to do nothing.

"Many investors believe the government is completely adrift, wedded to old policies championed by the unions."

Thomas Mayer, chief European economist at Deutsche Bank

Germany, these people say, is caught in a cycle of stagnation that is, for the most part, out of its control. Its membership in the European Monetary Union has shackled it with interest rates that are too high and fiscal policy that is too austere for a country that needs to revive consumer demand.

Forcing through painful changes now could further depress Germany's consumers, deepening its malaise and hurting its European neighbors, for whom a robust Germany remains indispensable.

"Structural reform is a lot easier to do when your economy is growing rather than stagnating," said David Mackie, the chief European economist at JP Morgan in London. "If Schroeder were to say, 'It's out of my hands, so why should I do these savage reforms now?' I'd be sympathetic."

Mackie said changes were still necessary in the long run to arrest Germany's eroding productivity, chronic unemployment and a limping growth rate. To undertake these today, however, would inflict needless pain without curing those ills. "If I were advising Schroeder," Mackie said, "I'd tell him, `Let's put this stuff on ice for the next 18 months.'"

France, like Germany, has breached the European Union's cap on budget deficits. Unlike Germany, however, it has refused to impose the austerity measures demanded by the commission's bureaucrats in Brussels, Belgium, arguing that its proposed tax cut would better rekindle the economy.

Critics of the no-pain approach warn that it offers an alibi to those who would prefer never to tackle Germany's deep-rooted maladies. The government, they contend, should seize the bad news as a pretext to scale back unemployment compensation, health care and other government benefits.

Confidence game

Such a move would temporarily chill consumers, the experts acknowledge. But it would be offset by a resurgence in confidence in the corporate sector. Foreign investors and local companies would pour money into Germany if they were convinced that it was serious about getting into shape.

"We have a problem of inadequate confidence," said Martin W. Huefner, the chief economist at HypoVereinsbank in Munich.

Although a survey by the Ifo Institute showed a modest rebound in business confidence last month, German companies remain deeply pessimistic.

Much of that gloom stems from a belief that Germany lacks the will to rewrite its restrictive labor laws, which have saddled it with some of the highest costs in Europe. Previous efforts have been strangled by the unions, which form the core of Schroeder's tenuous support.

"Many investors believe the government is completely adrift, wedded to old policies championed by the unions," said Thomas Mayer, chief European economist at Deutsche Bank.

Stifling payroll taxes, which are needed to prop up Germany's health and welfare systems, prompt many people simply to duck out of the official economy, taking black-market jobs that generate no tax revenue.

Schroeder appears determined to try again, with a raft of measures to be announced on March 14.

The European Central Bank gave him a hand last Thursday by lowering interest rates by a quarter of a point. Some economists say rates, while still too high for Germany, are now quite relaxed for other countries. That could spur their demand for German exports.

"People always assume Germany will drag down the rest of Europe," said David Walton, the chief European economist for Goldman Sachs. "It is reasonable to say that Europe could lift up Germany."