Dear Lee... Thanks for the link.
The Economist in its June 5 issue deals with German Economy, IDEA on June 4 dealt this issue, I have highlighted the Economist article and my post, the link to this article was provided by you, I am thankful to you. For me what is more important that issues we discuss here have relevance with the most authrotative weekly like The Economist. I am since very long time proponent of this failing 'hire and fire problem in Europe' and if you remeber this cradle to grave social security system, nice to read my observations and THE ECONOMIST side by side.
SPECIAL
The sick man of the
euro
F R A N K F U R T
The biggest economy in the euro area,
Germany's, is in a bad way. And its ills are a
main cause of the euro's own weakness
THE social-market economy devised in Germany
after the second world war, with its careful blend
of market capitalism, strong labour protection and
a generous welfare state, served the country well
for several decades. But it is now coming under
pressure as never before. As economic growth
stalls yet again, the country is being branded the
sick man (or even the Japan) of Europe. This is
inevitably casting a cloud over Europe's single
currency, the euro, for Germany accounts for a full
third of the euro countries' output. When Germany
sneezes, its neighbours feel a chill-and nervous
markets are likely to sell the euro. Thus the biggest
economic problem for Europe today is how to
revive the German economy.
The numbers certainly tell a bleak story. German
GDP shrank by 0.2% in the fourth quarter of 1998,
against growth of 0.5% for the rest of the euro
area. The figures for the first quarter of this year,
which will be published next week, are not
expected to provide much cheer. A few
forecasters-albeit in the minority-think that the
economy may have shrunk for a second quarter in
a row, which would put Germany technically in
recession. Any growth that is recorded is sure to
be small. The government has scaled down its
forecast of GDP growth for this year to 1.5%. Even
that may be optimistic; several private-sector
economists' forecasts go as low as 1%.
Next year may bring better news, as exports at last
pick up again, helped by the weaker euro. But few
expect a stellar performance. Rather, Germany
seems likely to persist with more of the sub-par
growth that has characterised its economy in recent
years. On average, indeed, German growth has
lagged that of the rest of the euro-11 countries by
almost one percentage point a year since 1995.
German consumers
have remained
surprisingly resilient
amid this overall
gloom. Not so its
companies. They are
still reeling from a
showdown over tax
with the pugnacious
former finance
minister, Oskar
Lafontaine. The latest
survey of business
conditions shows that
businessmen are at their gloomiest since mid-1996
about the current business climate, although there
are signs that they expect things to improve slightly
later this year. The red-green coalition government
led by Gerhard Schröder since last October has
"encouraged the suspicions of a corporate sector
predisposed to fear the worst," says Alison
Cottrell, chief international economist at
PaineWebber in London. The dark picture painted
by Hans Eichel, Mr Lafontaine's replacement, to
justify fiscal belt-tightening has further unsettled
industrial bosses. And a lack of corporate
confidence has been one of the main factors that
has kept unemployment so high.
Mr Schröder came to power with job creation at
the top of his agenda, but the new government has
so far noticeably failed to get people back to work.
Unemployment remains stubbornly high at 4m, or
10.7% of the workforce, seasonally adjusted. This
may be lower than in, say, France, but it is
nevertheless embarrassing in a country that still
likes to think of itself as an economic powerhouse.
So is the fact that new jobs are not being created
anywhere near as fast as in other, comparable
countries.
Germany can hardly claim that its malaise is a
rich-world commonplace. The American economy
is still booming, for now. Closer to home, Italy may
be in a pretty bad state, but France and several
smaller European countries are growing quite
comfortably. In the early 1990s, France struggled
while the Germans enjoyed a short-lived
post-unification boom. Since 1997 the opposite
has been true.
Some of the blame for this can be laid at the door
of a tight macroeconomic policy. For much of the
1990s, the Bundesbank kept interest rates high in
response to pressures from German unification and
from an expansion in the budget deficit. In the
run-up to the euro's launch, German monetary
policy was constrained by the need for most
European countries to converge on a single
euro-wide interest rate; and fiscal policy has been
kept in check by the need to comply with the
single-currency countries' "growth and stability
pact". These constraints still bind: left to itself,
Germany might respond to its latest bout of
weakness with lower interest rates and a bigger
budget deficit, but it no longer has these options.
Germany's weakness has, indeed, come at an
especially awkward time for the euro. The new
currency's almost uninterrupted slide against the
dollar since its introduction in January owes much
to gloom over the German economy. The country's
exporters may be breathing a sigh of relief after
repeated bouts of D-mark appreciation in the
1990s, but central bankers are not amused. This
week, Otmar Issing, the European Central Bank's
chief economist, who was formerly in the same
position at the German Bundesbank, pinned much
of the blame for the sagging euro on German
policymakers, who have failed to tackle their
overly generous welfare net. The ECB's president,
Wim Duisenberg, has said that Germany's
problems are not cyclical but the result of too little
basic reform to social security, the labour market
and so on. Mr Duisenberg also said this week that
he was inclined to "play down" the short-term fall
in the euro.
Shocks and spanners
Some argue that Germany's ugly recent statistics
can be blamed as much on a series of one-off
shocks as on the economy's structural faults. Once
these have passed, the optimists go on to argue,
growth should start to take off again.
The first and biggest shock was the unification of
East and West Germany in 1990. This was always
going to hit the much bigger and richer western part
of the country hard, especially after the less
productive easterners won over-generous wage
rises. Much of the early, tax-driven investment in
the east went, in effect, down a black hole. The
pain continues. The level of subsidy to the east,
which accounts for roughly 5% of overall German
GDP, has barely fallen since 1990. The rejoining of
Germany led to a series of mini-booms and busts,
exacerbated by further wage rises at the first hint of
recovery and a sharp appreciation of the D-mark,
which stung exporters.
A second spanner in the works was the economic
crisis in emerging markets. Germany sends more of
its GDP abroad than any other big European
country (around 30%), with roughly a quarter of
that going to emerging economies-and so has
suffered more than most. The collapse of Asian
markets hit basic producer goods especially hard;
along with capital goods, these make up as much
as four-fifths of Germany's exports. Many German
exports, such as chemicals and aluminium, were
already suffering from global overcapacity before
the crisis hit Thailand in mid-1997. The meltdown
in Russia, formerly another big export market, has
not helped either. It is striking how far Germany's
share of world exports has fallen since the early
1990s.
Nor did last year's interest-rate convergence in the
run-up to monetary union do much to bolster
Germany. As interest rates in other euro-area
countries fell towards German levels, their
economies received a boost that has increased the
gap between their performance and Germany's.
The slowdown in Britain, which is one of
Germany's biggest export markets, has made
matters worse as well.
IQBAL LATIF on Jun 4 1999 12:06AM EST << We talk of new paradigm in economy it is not
only IT but globally the decisions of government even the socialists to avoid tax and
spend policies. The macro changes in approach the conversion of Tony Blair and
British Labour part to ideals of Thatcherism! >>
Yet much as these temporary problems may have
hurt the German economy, they are not the root
cause of its ills. Nor would it be fair to lay the
blame entirely on macroeconomic mistakes in the
1990s. In the longer run, the main factors tugging
down German (and indeed European) economic
performance do indeed remain structural and
microeconomic: a byzantine and inefficient tax
system, a bloated welfare system and excessive
labour costs.
The tax issue has already come to the fore in
Germany in the recent showdown between
business and government. Mr Lafontaine infuriated
company bosses by threatening to close some
DM7 billion-worth ($3.7 billion) of tax loopholes,
without shaving much off corporate tax rates,
which run as high as 60%. Some of the biggest
insurers and utilities even threatened to move their
headquarters abroad unless the government made
firm promises to lower their tax bills.
Businessmen have been equally incensed by the
government's treatment of fringe workers.
Low-paid, part-time jobs (so-called "DM630
jobs") have long been exempt from tax and
social-security contributions. Many economists
think that the government's plans to end this
exemption, drawn up by the labour minister,
Walter Riester, will destroy many of the 6m such
jobs, just when the government should be
encouraging workplace flexibility. The German
Chamber of Commerce reckons that over 500,000
jobs may be at risk. Some service industries, such
as cleaning and catering, fear losing up to a fifth of
their workers.
Yet another planned
reform, to raise the
levy on small
consultancies and their
clients, is equally
controversial.
Businessmen complain
that it will discourage
the formation of
innovative new
companies. Such is
the opposition to these
measures-from
employers, workers
and some regional governments-that they may yet
have to be scrapped or amended.
The appointment of the business-friendly Mr Eichel
has calmed some corporate nerves, not least
because he has pledged to cut corporate taxes. But
the fear lingers that the ruling Social Democrats
remain bent on redistributing income at the expense
of big business, which explains the continued sag in
corporate confidence. This fear is hitting
investment. "What we have is uncertainty. We are
investing less in our German sites until we are sure
which way things are going," says Franz Nawratil,
chairman of Hewlett-Packard's European
operations.
From IQBAL LATIF on Jun 4 1999 12:06AM EST<<I can give many other examples but the fact remains that change of 'politicians' heart
the new found love for financial discipline and 'convergence criterion' heart is not fully recognized or understood by the economic pundits. The lack of beneficial impact of lower long term rates at 3% in Europe compared with big boast to employment as the yields dropping to 4.5% on 30 year bond in US can only be appreciated if you see the difference between European and Anglo-Saxon economic model. The former imposes labor rigidity the later releases the firms from rigid structural codes. US policies of hiring and firing of Labor and wage structure provides jobs to everyone but at a low cost. This has resulted in buoyant labor market, strong domestic demand. The lower unemployment with low salaries and robust GDP growth is better than high unemployment with low GDP growth. In Germany the labor market is rigid and you find the 'unemployment at 11% and GDP growth nearing recession with low inflation. US have employment for every one with far lower size of the government intervention, the entitlements have seen a significant drop. Lost of lust for gold, lost of commodity price pressures, peace dividend, end of cold war, integration of China in global trade, new emerging economies like India where demand is robust are other factors one need to know well if this new paradigm of economy has to be fully understood.
This thread engages in kind of debate highlighted above, simple and straight. It is
result of such posts that we trade and find bottoms and tops.>>
Hire and fire
Another big reason not to invest is the cost of hiring
and firing workers. Holger Schmieding, senior
European economist at Merrill Lynch, thinks that
Germany has got itself caught in a vicious circle.
The welfare state is largely financed by payroll
taxes, half of which are paid by employers and half
by individual workers. As welfare costs have
swollen, non-wage labour costs have shot up too,
from 36% of gross wages in 1990 to a painful 42%
last year. This encourages companies to shed
workers, reducing payments into the welfare
system while ratcheting up the benefits that must
flow out.
Mr Schmieding thinks that Germany's high costs
relative to what it produces help to explain why
unemployment has risen from cycle to cycle since
the 1960s. German workers may be productive,
but not enough to justify costs that are running at
50% above levels in any other G7 country. Getting
rid of workers is costly too. Severance pay is
typically a month's salary per year worked, plus
generous retirement pay-offs for older workers.
"The jobs market doesn't really deserve to be
called a market," says one disgruntled company
manager.
This has not, however, stopped many German
companies from shedding workers by the
thousand, at home and abroad, as they restructure
in response to globalisation. This has created an
irony: corporate Germany has gone from strength
to strength even as the economy, beleaguered by
high costs and rigidities, has faltered. Companies
such as DaimlerChrysler and Hoechst have set the
pace of change in their industries. Even sleeping
giants such as Siemens are shaking themselves up.
Why has such industrial success not fed through to
the economy at large? One answer is the way in
which German firms have learnt to deal with their
country's rigidities: by shifting operations abroad.
Last year they invested some DM150 billion in
other countries (by contrast, Germany attracted a
mere DM35 billion in foreign direct investment).
Many big companies now make more than half
their profits abroad. But smaller firms that make up
the backbone of Germany's famous Mittelstand
have also been packing up and moving abroad,
especially into lower-cost and more flexible
countries to Germany's east. Some 20,000 such
firms have invested in Central and Eastern Europe,
largely to escape steep wage bills at home.
Thomas Mayer, an economist with Goldman
Sachs, thinks that euro-area countries, and
Germany in particular, are now stuck in what he
calls a "restructuring trap". Since Germany's last
recession, in 1993, its companies have greatly
increased their return on capital as they have shed
unproductive workers and subsidiaries or moved
to low-cost locations. The same thing happened a
few years ago in America (and before that, in
Britain). In both these countries, slimmed-down
companies soon started to create new jobs. In
Germany, however, firms have been reluctant to
rehire because of the soaring non-wage costs of
labour. "The framework is not there to encourage
the replacement of jobs lost in restructuring," Mr
Mayer says. "It is only the enduring strength of the
export sector that has stopped things getting really
bad."
Mr Mayer thinks that the eastern part of Germany,
where economic growth is even lower than in the
west, is in a different kind of trap. Political
compromises have prevented the kind of creative
destruction that might have led to robust growth.
Instead, the east has become a "colony of
pensioners", consuming with the help of subsidies
but not producing enough that others want. Large
parts of the eastern economy have become so
addicted to subsidies that he fears they may
become a German version of Italy's poor south,
the Mezzogiorno, whose economy depends on
handouts from Rome and Brussels, and has been
plagued by low growth.
In search of flexibility
To be sure, there are some rays of hope. The
strength of opposition to the DM630-job changes
shows how important part-time work has become
to many Germans, often supplementing full-time
work. "It has shown that there was more flexibility
than many people realised," says Ulrich Beckmann,
an economist with Deutsche Bank.
Red tape is slowly being unravelled too. Yet
Germany is still smothered in regulations that crimp
markets. Many prices are still regulated, and
consumers remain "protected" in bizarre ways:
shops can be fined for discounting or making
three-for-the-price-of-two offers if these are
deemed to send confusing signals to consumers.
But other constraints are being lifted. Shopping
hours are getting longer. In the eastern state of
Saxony, for instance, high-street stores will soon
be allowed to open on Sunday afternoons. Banks
may soon be able to open on Saturdays. Progress
will come only gradually, however. "We got 90
minutes extra shopping after a decade's debate, or
nine minutes a year. Call it the German way," sighs
Ulrich Ramm, chief economist at Commerzbank.
There are also signs of new flexibility in the
one-size-fits-all system of collective bargaining.
The concept of Mitbestimmung-or seeking
consensus between managers and
workers-remains a powerful force, and worker
representatives still have half the seats on firms'
supervisory boards. But the number of wage deals
being negotiated at company level, rather than
regionally or nationally, has doubled since the early
1990s. Around 10% of the western workforce has
wriggled out of old-style collective-bargaining
arrangements; in the east the figure is over 50%.
This has allowed many companies to adjust to their
own market conditions.
Mr Beckmann argues that Germany's unions
became more accommodating after seeing how
hefty pay increases cut short economic recovery in
1995. They accepted three years of scant pay rises
that have helped to reverse a previous rise in unit
labour costs. The question now is whether they can
maintain the restraint that economists reckon
Germany needs to stay competitive.
The omens are bad. IG Metall, the largest union,
recently won its 3m members a pay rise of roughly
3.5%, way above inflation, after its boss had called
for "an end to modesty". Commerzbank forecasts
a 2.5% rise in unit labour costs this year and a
smaller rise in 2000. The only silver lining is that the
wage deals will boost flagging demand in the short
term: real consumer spending should grow by 3%
this year. Retailers are starting to emerge from the
hole in which they have spent most of the past few
years.
In any case, none of this cheer will last long unless
Mr Schröder's government enacts some radical
structural reforms. Slashing the top rates for
corporate and income tax could bring substantial
benefits at little cost. Germans would spend less
time seeking tax shelters or ploughing money into
tax-driven investments that make little
sense-whether east German property or Asian
shipping.
Many economists also argue that the state could
actually make money out of a cut in capital-gains
tax, as the current high rates discourage banks
from selling industrial stakes they want to unload.
The main barrier is politics: this government, like
the last one, worries that such reforms will be
unpopular if they are widely perceived as a
handout for the rich at the expense of the average
citizen.
The other big challenge for the government is to
defuse Germany's welfare timebomb. That will
necessitate cutting benefits and encouraging private
provision for pensions and healthcare, as the
workforce declines and the number of pensioners
grows. This is the only way to bring down payroll
taxes for good-and thus to reduce the tax on
jobs-without running an ever widening budget
deficit.
The government could also do the economy a
favour by speeding up privatisation and further
deregulating the underdeveloped services sector.
The federal government has been slow to fulfil its
sell-off pledges, while most of the regional states
have clung to their banks and utilities-one reason
that more than half of all German spending is done
by the public sector. Putting state-owned
companies on the block would bring extra money
to cash-strapped budgets as well as improving
efficiency. Deregulating services would have a
similar effect. Professional services, such as legal
and tax advice, are still highly cartelised: for
instance, tax advisers agree a common price list
through their guild, and may not undercut one
another.
Unfortunately, progress in most of these areas is
likely to be agonisingly slow-indeed, it could even
go into reverse. The Schröder government has
already backtracked on the efforts to cut pension
entitlements that were made by its predecessor. Its
Alliance for Jobs, a roundtable involving ministers,
employers and unionists, has achieved little. Its
health-care reforms have become bogged down by
battles with various interest groups.
It is, perhaps, not surprising that market-friendly
politicians, including one or two in the government,
now complain of Germany being a blockierte
Gesellschaft (blocked society). Unblocking it will
take determination. Without that, Germany is
unlikely soon to shed its title as the sick man of
Europe. Germans must find it more galling since it
was coined in the last century by the Russian tsar,
Nicholas I, to describe Ottoman Turkey-a once
dynamic polity that failed.
|
