Land of cliques

Corporatism and lack of competition are the enemies of an efficient economy

CITY tours are one of Cologne's strong points. But if you want to get beyond the cathedral, the Romanesque churches and the old city, ask Werner Rugemer, a journalist. He will take you on a tour of the landmarks of the Kolsche Klungel, or Cologne Clique, a particular form of wheeling and dealing for which the city is famous across the country.

Mr Rugemer may soon want to add some new attractions to his tour. A couple of big local property deals--an event forum called Kolnarena and an addition to the city's exhibition centre--have caused a stir recently. The exhibition centre, say critics, was approved without the usual official EU-wide call for bids--though the city treasurer explains that this type of contract does not require a bidding process, and that Ernst & Young, a firm of accountants, was asked to check out the market.

Still, the general impression is that Cologne's politicians have not tried very hard to make their business transparent--and nobody really seems to care. "It is considered folklore--just like the carnival here," says Mr Rugemer.

Cologne provides a striking illustration of the way that in some parts of Germany's economy, rent-seeking seems to be more important than wealth-creation. In a forthcoming book about reform in rich countries, Adam Posen of the Institute for International Economics, a think-tank based in Washington, DC, argues that this keeps prices high and stops the country's economy from becoming more efficient.

"Nothing much has changed. If anything, it has got worse," says Ute Scheuch, a retired journalist. More than a decade ago, she and her husband, Erwin Scheuch, a sociology professor at Cologne University, published a report on the Kolscher Klungel. It contained few new revelations, but for the first time it analysed the rules of the game. What the authors found was both amusing and alarming. Not only were the local organisations of both the Christian Democrats and the Social Democrats controlled by cliques that handed out offices, but in Cologne such deals were actually put in writing.

The way things are done around here

After such publicity, you would expect the participants in these power games to be more careful. But since then it has emerged that fat bribes were paid in the 1990s for the business of building an oversized refuse incineration plant near Cologne. The case is still going through the courts.

Now controversy has arisen over Esch, an investment fund run by Cologne-based Sal. Oppenheim, Europe's largest private bank, over some of the big local property deals the fund has got involved in. Esch has been raising money from wealthy people, of which Cologne has a good number. That seems unsurprising enough. More surprisingly, the fund is run by a former city manager, who took the job after doing a deal with Esch. The fund also bagged, on favourable terms, two of the city's biggest deals, which were rushed through the city council without leaving time for thorough scrutiny by councillors.

One of them is now under investigation by the public prosecutor. It concerns a project that started in 2003 when Cologne decided to add some new halls to its exhibition centre so a big TV broadcaster could move into some of the older ones. The city argued that unless the project went ahead quickly, the TV station would move away from Cologne, causing tax and job losses. The Esch fund bought the land, put up the buildings and rented them out to the city. Neither the city nor the fund will say how much the project cost, arguing that to do so would be unusual business practice.

When a TV programme last summer claimed that the city could have got a much better deal, the public prosecutor's office in Cologne started to look into it; and the local Greens, who were in a coalition with the Christian Democrats when the deal was approved, are having second thoughts. "We didn't know that the Esch fund was involved," says Barbara Moritz, their leader. "We were told that the project was for the good of the city, but it seems it was more for the good of the fund."

The problem, in Cologne and elsewhere, is that local councillors are often unpaid and have no one to help them, so they depend on the information they get from the city administration. The local papers did not take much of an interest in the property deal until the TV programme drew attention to it. The publisher of Cologne's three big dailies is also an acknowledged investor in the Esch fund.

Yet in general, things have improved somewhat, says Hansjorg Elshorst, chairman of the German section of Transparency International, an anti-corruption group. He puts this down to recent legislation to keep civil servants and public officials honest. However, he says, in private firms corruption remains widespread.

At times of rapid growth, lack of accountability did not seem to do much harm; indeed it helped to speed up decision-making. Yet today each euro wasted means a euro less for social services, says Karl Lauterbach, an economist at Cologne University. The city is the most indebted in the state of North Rhine-Westphalia and has long failed to invest enough.

Last September Mr Lauterbach, a Social Democrat, won a seat in the federal parliament. Yet he is an example of a rare species called Quereinsteiger, somebody entering politics after a career in a different field: he originally studied medicine and economics at Harvard. And he has no intention of becoming part of the Klungel.

In any case, Mr Lauterbach would not fit in. His academic speciality is Germany's health-care system, and to him the health-care industry is proof that German-style corporatism can be at least as costly as backroom deals. Just like education, he says, it is a system that protects privileges without adding any value: "It is not only inefficient, but also creates injustice."

Unhealthy influence

Seen from outside, some elements of Germany's health-care system indeed appear counterproductive. For instance, there are the Kassenarztliche Vereinigungen, regional doctors' associations that negotiate fees with the public-health insurers and then distribute the money. They are also meant to ensure that there are enough doctors to go round everywhere, but they seem simply to provide an arena for in-fighting.

Nor does the split in the health-insurance market between public and private firms make obvious sense. Contributions to a public health-insurance scheme are compulsory for everybody below a certain income limit, currently about euro47,000 a year. Above that, people can take out private insurance. Predictably, the public sector is getting stuck with most of the bad risks, whereas private insurers can cherry-pick younger and richer customers.

These arrangements are increasingly creating a wasteful two-class health-care system. Because private insurers pay higher fees, for instance, their clients usually get seen more quickly and receive better treatment. To keep revenues flowing, highly trained hospital doctors often attend to the minor illnesses of these private patients rather than doing research.

To Mr Lauterbach, the solution is to slash bureaucracy and introduce more competition. But even then it would take time for the health-care system to become more efficient, if experience in other sectors is any guide.

Power games

For a demonstration, take a trip to Bonn, Germany's former capital, half an hour's drive south of Cologne. In a sense, it has now become the capital of competition, housing the country's most important regulatory agencies: the Federal Cartel Office and the Federal Network Agency, a body overseeing competition in telecoms, railways and energy. The city is also home to the Max Planck Institute for Research on Collective Goods, a research body, and the Monopolies Commission, a group that advises the government.

In 2004, the Monopolies Commission published a scathing report about the state of Germany's electricity industry. Martin Hellwig, then chairman of the commission (and now executive director of the Max Planck Institute), and his colleagues argued that the industry was a classic case of deregulation gone wrong.

When Germany decided to liberalise its electricity market in 1998, the electricity companies, which until then had been regional monopolies, had to open up their grids to other producers, so consumers and firms could pick their provider. However, constitutional problems made it impossible to separate power generation and distribution. Yielding to German corporatism and efficient lobbying, the government decided to let the industry regulate itself by negotiating the conditions for network access among the competitors.

In the early years, prices did indeed fall, though mainly because there was plenty of spare capacity. At the same time, the electricity industry consolidated, both horizontally and vertically. Now only four companies--E.ON, RWE, Vattenfall Europe and EnBW--control more than 80% of power generation and most of the grid. In recent years they have also bought stakes in local power companies, which makes these unlikely to switch to other providers.

As the Monopolies Commission argues in its report, this market structure, in combination with the regulatory environment, does not make for much competition. In particular, the fees for access to the grid are exceptionally high compared with other countries, discouraging firms from using alternative suppliers. No surprise, then, that electricity prices in Germany are among the highest in Europe.

Equally predictably, power companies argue that the connection is not clear and that their costs and taxes have gone up too. But the pressure on them is mounting. Last summer, the outgoing government passed a law putting the Federal Network Agency in charge of regulating the electricity market from next year. Until then, state governments are supposed to block unjustified rate hikes, which some of them have actually done recently. The tabloid papers have started campaigns against the "power rip-offs", and public prosecutors are looking at junkets for local politicians paid for by the energy giants' gas subsidiaries, which are also accused of overcharging.

It may be tempting to see the protests against high energy prices as a sign that Germany, once a prime example of a producer-driven economy, is turning into one driven by consumers. But so far, the protests seem to be more of a populist uprising against big business rather than a call for more competition. Perhaps Germans have not quite grasped the virtues of freer markets yet. That certainly goes for immigration, the subject of the next article.

Article forms part of a survey of Germany. Corporatism and lack of competition are the enemies of an efficient economy in Germany.