Much will be desirable but little affordable

Date: 29/10/1998

By Alison Cottrell

THE real practical importance of the German election lies less in the arrival of a new government per se than in the removal of the upper/lower house parliamentary stand-off which has blocked significant policy initiatives for the past four years.

Both houses are now controlled by the SPD, although it should be noted that upper house party allegiances have a tendency to be less than solid, with regional loyalties occasionally speaking louder than party ones.

With the upper house roadblock removed, the economy will finally get its tax cuts. Clearly, a red-green government will give demand-side policies a greater emphasis than did its CDU-led predecessor, and Finance Minister Oskar Lafontaine will give the markets more than a few sleepless nights with references to the need to relate monetary policy to growth, wages to productivity and both, preferably, at an EMU-wide level.

But the markets should not overlook the fact that Lafontaine has been much and openly impressed by the recent performance of the US economy, and looks for lessons there for Germany.

Nor should they forget that the main parties have spent four years discussing tax reform and come close to a blueprint with the 'Petersberg declaration', and that , at least initially, Chancellor Gerhard Schröder will be keen to stress his pro-business sympathies and the fact that he learned his lessons from Volkswagen rather than from Marx.

Among the many promises in the SPD manifesto drafted by Lafontaine, one Schröder-inspired phrase stands out: “Not everything that is desirable is affordable.”

Following the rite of passage now practised by any incoming centre-left leader, Schröder can be expected to commission an immediate audit of the government's books, through which he will discover that his predecessor has left the public finances in a far worse state than he had ever dreamed possible.

As he will hasten to reassure the markets, however, his party's main priority will now be consolidation and its main virtue patience. Much, in other words, will be desirable and surprisingly little affordable.

Changes in social policy, in citizenship laws, in gay rights, in immigration and asylum: all of these should come relatively quickly. Child benefits are certain to be raised in January and the first income tax cuts put into effect after July, but much of what is left and costs money will take longer.

The expectation of corporate and income tax cuts after almost a decade of consistent increases has, however, already begun to boost the confidence of German consumers and even, finally, retailers. After all, it was quite clear to every voter that, whoever they voted for, they would get tax cuts.

True, the SPD has promised to reverse some legislation, such as cuts in companies' sick pay obligations.

Equally true, however, is the fact that the impact of this legislation has been minimal, with wage contracts continuing to incorporate the full sick pay entitlement irrespective of the letter of the law.

Plans to reverse pensions legislation cutting payments from 70&percent; of previous net pay to 64&percent; are more significant, and send out entirely the wrong message. But this move would have been far more important and retrograde had the legislation actually taken effect.

Of greater long-term importance will be steps to encourage the growth of personal and supplementary pensions and on this the jury is still out.

As the parliament progresses, and even if growth does not slow, the budget arithmetic will get tougher.

The privatisation revenues and Bundesbank revaluation transfers to which former Finance Minister Theo Waigel owed so much, will not be so readily to hand a few years ahead.

The gaps in the pensions and health budgets will, without substantial interim reform, be widening; and the postponed servicing of east German debt will be coming home to roost.

On indirect tax, both Schröder and Helmut Kohl argued in their campaigns against a hike in value added tax. Both were being economical with the truth. German VAT will go up - 7.6 billion ecu worth of revenue from 1&percent; on a standard rate well below most of its EU neighbours is too big a carrot to resist.

The only difference under the present administration is that the hike is more likely to be wrapped up in a package aimed at penalising polluters, although not necessarily all polluters or to any great extent.

On employment, immediate moves will be made to launch a new 'unity for jobs' initiative under the guidance of Labour Minister and (now) ex-IG Metall deputy president Walter Riester.

Riester is, in many ways, a kindred spirit to Schröder: a high-profile, media-savvy professional who has rarely struggled with too heavy a conscience when departing from party or union policy and who is charged with 'thinking the unthinkable' - or at least speaking it.

It can be assumed that the SPD has learned sufficiently from the CDU's example not to incorporate specific job creation targets into its own programme. Kohl's promise to halve unemployment by the year 2000 ranks second only to his “blossoming landscape” reference in the annals of examples of what not to say when you become a minister.

Alison Cottrell is chief economist at PaineWebber International (UK).