Fri, Mar 01, 2002 page19

• Social, global pressures putting a squeeze on German economy

  Once Europe's industrial locomotive, the country's economy has gone from boom to bust in just 10 years -- and there seems to be no solution in sight

  • By Edmund L. Andrews / NY TIMES NEWS SERVICE
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  Ten years ago, in the euphoric economic boom after German re-unification, nothing seemed capable of stopping this country.

  Now nothing seems capable of restarting it. Like the US, Germany is struggling to climb out of a recession. But unlike the US, Germany has become a perpetual laggard with problems that started long before the current slowdown and seem likely to continue long after.

  Once Europe's industrial locomotive -- home to Mercedes and Porsche, Siemens and Bosch -- Germany has had either the slowest growth or second slowest growth in Europe for the past six years.

  "It doesn't matter whether we are in a boom or a recession, we are always the last in economic growth," said Hans-Werner Sinn, director of the Munich-based IFO Institute for Economic Research. "I do not think the trend will change soon."

  Wednesday, the German government confirmed that the economy shrank for the past two quarters -- the informal definition of a recession in the US and the worst performance of any European country. Many economists say that German growth will revive later this year, but there is widespread doubt about the pace.

  Germany's central bank, the Bundesbank, said that it believes the country's long-term "potential" growth rate has slowed to less than 2 percent a year. That is far slower than the US, as well as the rest of the European Union.

  Germany's long-term pattern resembles a much milder version of the stagnation plaguing Japan -- anemia at home, unhealthy dependence on exports, a paralyzing culture of consensus decision-making and an inability to carry out much-needed economic reforms.

  That is bad news for almost everyone. Germany's economy is the world's third largest, after the US and Japan, and it accounts for one-third of the euro zone's economic output. When Germany slumps, it drags the rest of Europe with it. And when the US falls into a recession, Germany's weakness makes it impossible for Europe to step in as the engine of world recovery.

  The conventional wisdom is that Germany's problems merely stem from the global downturn. Exports make up a third of the economy, so Germany is sensitive to slumps elsewhere.

  The real problems, however, are at home. Even last year, a terrible year for global demand, German exports were slightly higher than the year before.

  Carmakers like BMW, Mercedes and Volkswagen all booked big increases in foreign sales, particularly in the US. Puma, the sport shoe manufacturer, said its sales in the US rose 28 percent.

  By contrast, the mood at home is anxious, pessimistic and risk-wary.

  "Everyone is looking for security, security, security," said Manfred Wittenstein, owner of a Wittenstein Gmbh, which makes servo motors for automated machinery.

  Germany's much-criticized job-protection rules remain rigid, discouraging companies from hiring full-time employees. Many stores close at 2pm on Saturdays, and most do not open at all on Sundays. Ordinary discounts are illegal, because they might confuse consumers.

  Evidence of domestic insecurity is everywhere. Adjusted for inflation, retail sales have been stagnant in Germany for six years. Consumers were so rattled that store owners say last Christmas was the worst in 10 years. Car sales within Germany dropped 5 percent last year and were stagnant in 2000, when the economy was relatively strong.

  Investment in factories and equipment has lagged behind the rest of Europe and far behind the US. Manufacturers, fearful about every whiff of trouble in export markets, abruptly canceled plans for new investment last year when the US stopped growing.

  "Germany reacts very sensitively to swings in the world economy," said Hermann Remsperger, chief economist for the Bundesbank.

  Such caution would have been hard to foresee a decade ago. Driven by boundless optimism and huge tax subsidies, West Germans pumped hundreds of billions of dollars into East Germany's re-construction. East German consumers, who had been allowed to convert their nearly worthless East German marks into West German marks, streamed west to buy Volkswagens, television sets, kitchen appliances and clothes.

  "It was unbelievable, like a wild fire," recalled Guenter Sander, owner of Horstmann & Sander, a retailer of luxury leather goods in Hanover. But after two delirious years, the party ended and never resumed.

  Today, Sander's sales have yet to reach their former peak. Brinkmann's, a chain of appliance superstores, went bankrupt two months ago. Unemployment in Hanover is 11 percent and rising. For western Germany as a whole it is about 8 percent and for eastern Germany it is above 15 percent.

  Germany's problems have produced acute embarrassment for Chancellor Gerhard Schroeder, who campaigned for office on the issue of reducing unemployment and who is up for re-election in September.

  Not only is unemployment climbing, but the German government's finances are coming unglued. Last month, the EU nearly issued a warning that Germany's ballooning budget deficit threatened to violate fiscal rules that Germany had itself insisted upon before most of the union adopted the euro.

  Germany avoided a reprimand, but only after Schroeder lobbied other European leaders and not before he endured scathing criticism for trying to wriggle out of the rules.

  "I ask myself all the time, how can it be that exports do so well and consumers spend so little of their money at home?" said Sander, whose modern store sells leather shoes, handbags and luggage from Prada, DKNY and Mandarina Duck.

  "The answer is that every consumer is like a small businessman. A businessman only invests when he sees something positive in the future, and consumes are the same way. Right now, the consumer is saying things don't look that good."

  The gloominess has been evident for years. Even when the economy finally accelerated, in 2000, unemployment never fell lower than 8.6 percent and has now climbed back to 9.6 percent. In eastern Germany, it is nearly twice that high.

  Germany remains a manufacturing country, particularly of industrial equipment and components. The problem is that its export exuberance masks its internal anemia, which means Germany has become more dependent on exports.

  Remsperger, the Bundesbank economist, said the share of the economy attributed to exports has climbed to 35 percent from 24.5 percent since 1995. So now business confidence, investment and the economy has a whole is more vulnerable to swings in the global economy.

  Economists say some of the problems are not of Germany's making. The adoption of the euro as a common currency created virtually identical interest rates in all 12 member countries. Germany, which has consistently had low inflation and low interest rates, lost an important competitive advantage.

  The collapse of communism and the re-unification of Germany created other burdens. Companies shifted manufacturing to Poland and the Czech Republic, where wages are one-fifth to one-tenth of those here. Eastern Germany became a drain on the country, swelling its debt burden.

  But the more enduring problems have to do with economic reform. Taxes and employer-paid contributions to social security account for about half of a workers' gross wages. Job-protection rules have been relaxed, but they still make it extremely difficult and expensive to lay off workers. Germany's post-war "consensus culture," which pervades everything from labor relations to corporate decision-making, has made change tortuous.

  An unemployed person with a family of four is entitled to receive, indefinitely, an income of 74 percent of the average wage. That works out to about US$1,500 a month. Any company with more than three employees can be required to form a "works council," a group of workers who must be consulted on issues ranging from hiring and firing. Larger companies need to follow rules laid down in a 500-page book governing employee issues.

  "The sum of these labor laws results in a very strict environment," said Hans-Werner Sinn, director of the IFO institute. Because of high wages and rigid work rules, he said, German companies have over-invested in automation and hired a minimum number of skilled workers at high wages.

  "That only makes sense when you are not trying to eliminate jobs," he said. "German firms cut back on their labor force by not employing people. It sounds strange, but Germany needs to create a new sector of low-wage, low-skilled jobs."

  With national elections in September, big reforms are unlikely this year.

  "In the German psyche, the state is the protector," said Fred Irwin, president of the American Chamber of Commerce in Germany, who has worked here for nearly 30 years. "On the surface, people talk about reforms and lower taxes. But the bottom line is that people don't really want reforms. Regardless of whether it's the Christian Democrats or the Social Democrats in power, there is a consensus around the way things are."
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