EU must allow Germany more time to get over ‘reunification hangover’

By Karen Carstens

Date: 18/12/03

CONTRARY to popular belief, Germany is well on its way to economic recovery, but could get there a lot faster if the EU cut it some serious fiscal slack, according to a top economist.

While the EU's biggest member state is still "nursing a severe hangover from its reunification party in 1990", it no longer deserves its "sick man of Europe" status, Katinka Barysch argues in a policy brief published by the London-based Centre for European Reform (CER).

Despite soaring unemployment and an inability to stick to the EU Stability and Growth Pact rules, the country still scores well on competitiveness, innovation, public services and living standards. And it stands to gain more from the EU's enlargement than most. But Germans must stop saving and start shopping to increase domestic demand, the CER's chief economist suggests.

The trouble began when Germany compounded and prolonged the negative impact of reunification through several big policymaking blunders.

"The shock of absorbing an economy with 16 million people, thousands of outdated smokestack factories and a 50-year legacy of central planning would have brought any economy to its knees," German-born Barysch writes. "But in the case of German reunification, a series of grave policy mistakes made matters worse."

An early deal between western German employers' federations and eastern German trade unions to equalize wages, coupled with the rapid eastward expansion of the generous western German social security system proved crippling.

"Even today, transfers amount to a staggering 4-5% of west German GDP each year (or 50% of east German GDP), making the eastern Länder one of the most aid-dependent regions in the world," Barysch points out.

Borrowing to plug the gaping hole in the federal budget meant the public debt more than doubled from 1989 to 1995.

This was followed by tax hikes which made German labour costs in manufacturing the highest in the world by the late 1990s.

As Hans-Werner Sinn, head of the Institute for Economic Research at the University of Munich (Institut für Wirtschaftsforschung, IFO), puts it: "A fateful mixture of economic policy naivety and selfish abuse of power by the unions and employers' groups has heavily mortgaged Germany's economic future."

But Barysch claims Germany is finally getting over its "hangover". "Fears a rigid labour market and high taxes have undermined Germany's international competitiveness are overblown," she writes.

"Despite the sluggish economic climate of recent years, German exports have grown by 30% since 2000, generating a trade surplus of more than €100 billion in 2003 and making the country once again the world's largest exporter."

Germany can still come out on top in high-tech sectors and investment goods, but "cannot and should not try to compete in labour-intensive industries", particularlywith the new member states.

What really distinguishes Germany from most of its European peers, however, is "the weakness of its domestic demand". Consumption in the UK and France has, for instance, grown by roughly twice as much as in Germany since the mid-1990s.

"Sluggish wage growth and uncertainty about the future have led Germans to save an unusually high share of their income," Barysch writes.

"In 2002 alone, the private sector squirreled away the equivalent of 6% of GDP, or €120 billion." On the bright side, this "also means that Germans have ample cash available for shopping trips and investment projects, once confidence picks up again".

Chancellor Gerhard Schröder's "ambitious reform programmes", backed by a majority of the population, are another plus.

Barysch puts forward four key recommendations for the EU to help Germany get back on track:

• Reinforce the Lisbon agenda
• encourage the European Central Bank to rethink its targets
• reform the Stability and Growth Pact, and
• shake up the EU budget.

Many of the reforms Germany is now pursuing are part of the so-called Lisbon agenda to make the EU the most competitive economy by 2010.

Member states should strive to "improve it to help Germany and other slow-growing countries regain momentum", Barysch stresses.

She also suggests that the ECB questions whether its inflation target of just under 2% is too strict: "If the ECB tries to push average eurozone inflation below 2%, it may well end up with interest rates that are too high for the eurozone's slower-growing core economies, in particular Germany."

As for the beleaguered stability pact, the EU now "needs to come up with fiscal rules that work more symmetrically, forcing governments to save while the economy is strong".

On the EU budget, she suggests that other rich member states pick up some of the slack during the next budget period (2007-2013).

As the largest net contributor (payments minus receipts), Germany shelled out around €10 billion a year in the second half of the 1990s, or €130 for each German.

By comparison, the UK's annual net contribution amounted to €35 per head and France's to €25.

At the same time, and more importantly, Barysch concludes, the EU must stop focusing on "farm subsidies" and "regional projects of dubious economic value" and "should redirect spending toward two major objectives - helping the east European countries catch up, and improving the EU's performance in research, education and innovation. Germany would benefit from both of these."

'Germany - the sick man of Europe?', a Centre for European Reform Policy Brief by Karinka Barysch, argues that Germany no longer deserves its 'sick man of Europe' status, and that the country is well on the way to economic recovery.

http://www.cer.org.uk/pdf/policybrief_germany_man_kb.pdf http://www.cer.org.uk/pdf/policybrief_germany_man_kb.pdf

---