TCS Daily

TCS EU Summit Coverage: German Economic Quicksand

By Nico Wirtz - March 21, 2005 12:00 AM

This month, Germany's largest industry association, the Association of German Chambers of Industry and Commerce (DIHK) published its latest survey of German industries. The results were remarkable, but should not have come as a shock to anybody who has been following Germany's economic development over the past decade.

While domestic investment by German companies continues its downward spiral, their foreign investment has reached an all-time high. At the same time, 27 percent of all companies surveyed plan on cutting their German workforce in 2005.The export of capital combined with negative growth rates of domestic investments over the last four years paints a bleak picture for the country's economic recovery. Germany is not only faced with profound investment imbalances affecting its economic competitiveness, but also with an under-utilized population. With unemployment (12.6 percent) at its highest level since the end of World War II and no improvement in sight, it is time for meaningful reforms in a country that was once Europe's economic powerhouse and role model.

A lot remains to be done in Germany, which in 2000 was at the forefront of pushing the so-called "Lisbon Agenda", Europe's ambitious economic makeover. Ultimately, the Lisbon Agenda seeks to turn the European Union into the world's most competitive and most dynamic economic region by 2010. To reach this goal, the agenda calls for an EU-wide overhauling of tax, social, education, research/technology and labor policy in order to achieve its objectives within the set time frame.

In at least at some, if not all, of these areas, European enthusiasm and ambition is likely to collapse in very short order. Take technology for example. While the EU is willing to invest $680 million in nanotechnology over the next four years, the United States alone has committed $3.7 billion over the same period. Combined with its dwindling pool of top-notch researchers, it is highly unlikely that the EU will be able to overcome this funding gap.

Other obstacles stand in the way of the EU reaching its Lisbon goals or of Germany stemming the economic downturn in the foreseeable future. While some of the reforms Germany implemented under Chancellor Gerhard Schröder's Agenda 2010 and his willingness to cut Germany's capital gains tax from currently 25 percent to 19 percent, were helpful, far more needs to be done. The Lisbon Agenda's insistence on fostering social justice will likely hamper meaningful reform.

German and European investment, economic growth and job creation can only be achieved if Germany finally parts with its policy of ideologically-driven income redistribution. It is surely encouraging to see all parties in Germany favoring cutting taxes one way or the other, but growth and employment creation does not happen solely because of low taxes. Additionally, Germany has to seriously consider tackling the rigidities of its labor laws. Companies and employees should be able to negotiate pay and fringe benefits according to local conditions and not based on national standards set by either the government or labor unions, enabling companies to hire and pay people at levels they can actually afford.

It is for exactly these reasons that Central and Eastern Europe has seen steady increases in investment and employment numbers vis-à-vis the EU: the adoption of low or flat tax systems and highly flexible labor markets have spurred economic growth and development in these young democracies.

In Germany, exorbitant tax rates and government-imposed workforce protection have all had the opposite effect: Less employment, less job security, less investment, slower income growth and skyrocketing budget deficits. It is indicative that a liberalization of Germany's restrictive labor laws was not even discussed during last Thursday's high profile "Job Summit" between Schröder, and opposition leaders Edmund Stoiber and Angela Merkel.

Since true liberalization of Germany's economy remains unlikely for as long as politicians do not have the guts to tackle the inevitable, a look into the future paints a dim picture: At the European level, the German government will continue to lobby for further "harmonization" (read: centralization/socialization) of the European market, under the guise of creating "equal" and "fair" conditions inside the EU's borders.

It is no secret that Germany, and to some degree France, have already been trying hard for a long time to harmonize tax and labor policy in the EU. The reasoning behind these harmonization efforts is as follows: By narrowing the tax and labor policy gap between EU member countries compared to Germany, the need to reform is assumed to become less pressing.

At this weeks EU summit Schröder will lobby hard for a redefinition of the strict budget deficit rules set in the 1990s. The main argument brought about is that Germany funds 20 percent of the EU's entire budget and is therefore somehow entitled to a redefinition of "what constitutes a deficit".

Schröder is hard-pressed at home to protect the employment that still exists in Germany and keep the economic house from total collapse. It should not come as a surprise to see Germany trying to modify the EU-directive for services. In its current form it would allow a Polish plumber to offer his services to a German company subject to Polish law regarding safety standards, for instance.

Citing "safety concerns" for German consumers due to "lower standards" outside Germany, the Schröder government would love to see this changed to where services performed in Germany are subject to all German rules and regulations. At first glance, this might make sense from a liability standpoint. At closer inspection, however, it becomes apparent that this is nothing but a protectionist measure, raising the compliance costs for outsiders, so that they cannot compete with their German counterparts.

Unless Germany and the other old members of the European Union fundamentally transform their economic policies and part with their tradition and philosophy of state interventionism, the economic goals of the Lisbon Agenda will remain unfulfilled. For the sake of all of Europe, one can only hope that the newly admitted members to the European Union stand firm in their vision of a freer economic order and the benefits such an order provides.


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