Friday, August 15, 2003
Will a dose of Thatcherism rescue Germany?
Posted by David Smith at 03:50 PM
Category: David Smith' s magazine articles

Germany, as anybody in industry knows, is a formidable competitor. Legend has it that the first time British manufacturers knew they had a fight on their hands was when they saw the products German firms put on show at the Great Exhibition of 1851.

More recently, Germany has shown that modern economies do not need to turn their back on manufacturing. The German economic miracle was built on industrial exports. Manufacturing remains the backbone of the economy.

Lately, though, Germany has ceased to be a strong competitor in one important sense. In terms of economic performance, Europe’s biggest economy has become its laggard. For the past three years it has suffered from economic stagnation and rising unemployment. The jobless total has already risen above 4.5 million and is tipped to break five million in the coming winter.

This was not how it was supposed to be. Many predicted that the advent of the euro, with other European countries no longer able to devalue their currencies vis--vis Germany, would play directly into the hands of German exporters. As it is, for most of the euro’s life the economy has been in and out of recession.

Looking a little further back, the unification of West Germany with the communist German Democratic Republic in 1990 was predicted to foreshadow a time of enormous economic and political strength for Germany. Margaret Thatcher feared it for that reason. Instead, unification is now seen as a huge burden on German taxpayers, and the former GDP, with its relatively high costs, is under pressure from cheaper locations in eastern Europe, in countries like Poland, Hungary and the Czech Republic, which are about to join the EU.

Germany’s troubles go deep. Britain’s long-run, or trend growth rate is reckoned by the Treasury to be 2.75% a year. America is slightly higher. In Germany, however, trend growth is thought to be only 1% annually. That is not only weak growth; it is also insufficient to reduce unemployment. The risk is of a vicious circle, in which higher unemployment interacts with a slow-growing economy. One obvious impact of this is that the country’s budget deficit is more than 3% of gross domestic product, and set to continue that way. The irony of this is that it puts Germany in breach of a euro stability and growth pact that it insisted on. If it goes on much longer Germany could face hefty fines.

In Britain, this combination of circumstances, and in particular the loss of control of interest rates implied by euro membership, would be political dynamite. In Germany they take rather a different approach. Few people speak out against the decision to join the euro. Membership has become an accepted fact.

Instead, the focus has switched to so-called structural reforms and they involve, perhaps surprisingly, a large dose of Thatcherism. From the beginning of next year, for example, income tax rates are to be cut, with the top rate cut from 48.5% to 42%and the starting rate from 19.9% to 15%. Not long ago Germany’s top rate was close to 60%. From January it will be close to that of Britain. These cuts will be paid for, in part, by a scaling back of subsidies, notably those for homeowners.

Cutting taxes is not the only “Thatcherite” move. As part of the so-called Agenda 2010 reform package, the maximum length of time people will be allowed to draw unemployment benefits is to be cut from nearly three years to 12 months. That is not the only labour market change. “Hire and fire” rules are to be made less stringent for smaller firms and for newly-established businesses. The idea is that if it is easier for these firms to get rid of staff they will be keener to hire them. In order to encourage small business creation, Germany’s tight “craft” restrictions, which limit certain trades only to master craftsmen, are to be relaxed.

There are other proposals, some far-reaching. In order to wean people off expensive state provision – Germany has a pressing ageing population problem – a new funded system is being established, and the retirement age will gradually be raised to 67 from 2011. Other proposals aim to cut the taxpayer costs of public services, such as by charging for certain consultations and treatments.

It adds up to quite an impressive first reform step. Will it work? The history of labour market and other reforms is that they take time. Cutting back the power of the unions in Britain, which began in the early 1980s, did not really pay dividends until well into the 1990s. There is a danger, as happened here, that things will get worse before they get better.

The hope in Berlin is that the tax cuts in January will give an immediate boost to the economy, giving it a momentum that will carry it through the reform process. If it doesn’t - and the jury is out - Germany’s woes will be far from over.

From Industry magazine, August 2003