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Sunday, Sept. 3, 2006

Merkel's reforms drift toward dead end


MUNICH -- A year ago, Angela Merkel, Germany's charming new chancellor, was in the final phase of her election campaign. The incumbent, Gerhard Schroeder, lagged so far behind her Christian Democrats (CDU) in public opinion polls that she thought she would win a landslide victory and could therefore afford to expound on the cruelties of the liberal austerity program delineated in her electoral campaign. She even announced a value-added tax increase (which her new government has, indeed, decided to implement in 2007).

But German voters did not appreciate her honesty. When she named law professor Paul Kirchhoff, who advocated a flat tax, as her candidate for finance minister, Merkel's electoral cakewalk turned into a nightmare. She lost nearly her entire lead, and in the end won by only a tiny margin -- a margin too small to form her preferred coalition with the liberal Free Democrats.

Instead, she had to form a coalition with Schroeder's Social Democrats (SPD), though without Schroeder himself.

Merkel's first year of government will soon be over. It has been successful in terms of international relations. She won the respect of her European Union partners and managed to salve Germany's damaged relationship with the United States. Her unpretentious manner and intellectual capacity (she holds a doctorate in physics) quickly won her the respect of many, even of Russian President Vladimir Putin, whose language she speaks fluently.

However, Merkel has disappointed everyone who hoped that she would continue and even expand Schroeder's domestic economic reform agenda. While her party program speaks of opening union contracts, relaxing job protection and, in particular, overhauling the incentive structure of the welfare system, her government has been mostly silent about these issues. The cautious steps toward wage subsidies that her government has taken are mere window dressing and cannot be taken seriously.

Thus Merkel has so far dampened any hope that the important and hard reforms that she announced during her campaign and that Germany urgently needs will be carried out under the CDU-SPD "grand coalition" government. To be sure, she has put health-care reform and a reform of company taxation on the agenda, but the plans presented so far give no indication of a major breakthrough.

This stagnation in policymaking has been heavily criticized by the media and the influential Wirtschaftsrat (Economic Council), an association of entrepreneurs who sympathize with the CDU. Even Germany's Christian Democratic president, Horst Koehler, has continually reminded the government of the need to press ahead with economic reforms to pave the way for sustainable growth.

So why does Merkel not dare more? Why is she not sticking to the announcements she made during her campaign?

The superficial answer is that her coalition partner, the SPD, is not willing to go further. But if this is the explanation, the next question is why the SPD is unwilling to continue Schroeder's reform course. Such questions lead to the real explanation of Germany's political stagnation: There is simply no popular majority in favor of liberal reforms, because in the near term such reforms would create too many losers. Germany's extensive welfare system spends 31 percent of the country's GDP for entitlement programs operated by the government sector.

No less than 41 percent of the voting-age adult population lives primarily on government transfers such as state pensions, full-scale public stipends, unemployment benefits, disability benefits, and social assistance. (In East Germany, the figure is a whopping 47 percent.)

Among those adults who actually vote, recipients of public transfers form a clear majority. Indeed, the upper 10 percent of income recipients pay more than 50 percent of aggregate income tax revenue, and the upper 20 percent pays about 80 percent, while 40 percent of income recipients pay no income taxes whatsoever. Small wonder that a huge majority of the population -- and even a slight majority of CDU voters -- prefer a strengthening of the welfare state to a more market-oriented system.

The SPD learned about these preferences the hard way, when Schroeder's liberal reforms, as cautious as they were, prompted an internal revolt and induced his predecessor as party chairman and temporary former Minister of Finance Oskar Lafontaine to desert the SPD and found a new party. Lafontaine now plays directly on the preferences of public transfer recipients and firmly occupies the left margin of German politics, dreaming the dream of the everlasting welfare state that can draw on unlimited resources.

Indeed, after Lafontaine's "The Left" party merged with eastern Germany's ex-communists, it secured a firm base among voters, changing the political equilibrium in the country. Faced with the prospect of losing members and voters to the new party, the SPD simply cannot afford to continue Schroeder's reform agenda.

Many Christian Democrats may be dreaming of the next election, and a new coalition with the Free Democrats -- and perhaps the Greens -- that would carry out the necessary welfare and labor market reforms. But the reality is that the CDU leadership is re-orienting the party toward more socialist attitudes in order to attract a larger share of the electorate, making postponement of the necessary reforms all but inevitable. In the midst of such political machinations, Germany is gradually losing its future.

Hans-Werner Sinn is the director of the Ifo Institute for Economic Research in Munich.

Copyright 2006 Project Syndicate (www.project-syndicate.org)


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