TCS Daily


Germany's Cup Runneth Under

By Jens F. Laurson & George A. Pieler - July 5, 2006 12:00 AM

Even after its heart-stopping overtime loss to Italy in the semi-finals, Germany is riding the waves of World Cup Mania. The IFO business confidence index hit a 15-year high, the young German team showed top form and defied criticism in advancing to the semi-finals, and Angela Merkel's unity government has been a good host to soccer—sorry, football—fans from the world over.

Psychology is not a trivial factor in economic success, but this rosy picture for Chancellor Merkel is hard to square with realities on the ground. The realities are these: German growth at best may hit 2 percent this year (yes, that's an improvement over recent years but a modest one at best), Merkel's Grand Coalition has not yet begun to tackle serious labor market reforms and welfare state costs, and her only decisive policy changes are tax increases. Merkel refused to back off her planned VAT increase for next year, even as Germany's fiscal condition improved. She has agreed to yet another revenue-raising, instead of savings elsewhere, to feed the unbounded appetites of Germany's near-universal health care system.

The health "reforms", which include increased benefits for mothers and children, repeat the Merkel pattern of restraining labor costs by shifting some of them to the general public (central budget subsidies), while leaving generous welfare state benefits untouched that Germany simply can't continue to fund -- not unless it boosts the economy to a permanently higher growth-path. German growth is still led by exports (nothing wrong with that), a very modest rise in domestic consumer demand notwithstanding. For that matter, inquiring minds wonder how much World Cup excitement has contributed to consumer and business enthusiasm, and what will happen after the last match has been played.

In short, an era of good feeling can do a lot for a nation's economy, but unless those high spirits are used to leverage serious reform, they will have no lasting impact on Germany. Merkel has had quite a run in everything but domestic economic reform, supposedly the reason she was elected in the first place. She has reasserted her nation's traditional role in foreign affairs, providing a useful and largely non-judgmental point of balance between East and West in Europe, and between America and Russia on the broader world stage. The Chancellor doesn't need to prove her seriousness or her political skills at this point, but she does need to bring those skills to bear in a credible way on the German welfare state.

Three crucial tests await. Implementing the health care reform is one: will tax hikes be linked to any modest steps towards market discipline on health care costs? Labor reform poses a near-identical issue: will there be constraints, however minor, on unemployment benefits and job-training, or just a shift from employer-paid fees to general tax revenues? Will the haywire, counterproductive Hartz IV "reform" be overhauled? Tax reform is the third crucial element: phased-in rate reductions for corporations are agreed on, but so is tightening taxes on non-wage earnings. Some simplification to boost German competitiveness may occur, but will the tax burden go up, go down, or stay the same? If Merkel's VAT hike is so sacrosanct, it must be "earned" with pro-growth rate cuts elsewhere in the tax system. With modest growth even before scheduled tax increases, a no-growth strategy is unlikely to keep Mr. Ifo happy for long.

Success, including economic success, is of course relative. Germany is not France and has a brighter future in many respects, even with all the traps Merkel needs to run. Even so, and taking into account the much-vaunted (deservedly so) ability of the German business community—like its World Cup team— to prevail against long odds, the illusion of economic reform never leads to actual reform. When the last celebratory beer is poured in Berlin and the stadium crowds disperse, reality will set in once more. Better to be ready for the next (political) round than just hope things turn out all right.

George A. Pieler is Senior Fellow with the Institute for Policy Innovation. Jens F. Laurson is Editor-in-Chief of the International Affairs Forum.

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