Germany’s election. The battle of the chancellorship

It has been a mostly uninspiring campaign - and the result remains uncertain

IT IS hard to exaggerate how much is at stake in the German election on September 18th. Will Germany spend the next four years tackling further reforms, embracing change and globalisation not as threats but as opportunities? Or will it continue to muddle through, running the risk that reforms peter out, and even of a lurch towards economic nationalism?

Which path it takes will depend largely on whether Angela Merkel, leader of the opposition Christian Democrats (CDU), which is all-but certain to be the largest party, wins a big enough majority over Chancellor Gerhard Schroder's Social Democrats (SPD) to form a government with her Christian Social Union (CSU) sister party and the Free Democrats (FDP). If she does, and can then show that “reform in a big rich country” is possible, argues Adam Posen of the Washington, DC-based Institute for International Economics (IIE), who is writing a book on the subject, Germany could become a model for other big European Union countries, such as France and Italy. Conversely, if Ms Merkel loses, or is forced into a do-little “grand coalition” with the SPD, the German experience could become an excuse for much of the rest of Europe to do nothing too.

Given such stakes, the election campaign has been parochial - and increasingly content-free. Often, the details of electoral programmes have seemed to matter less than pop music. Mr Schroder's stump speeches are preceded by Die Prinzen, a popular east German pop band, one reason why he has drawn crowds of thousands. Not to be outdone, the CDU staged a coronation mass for Ms Merkel, with an ersatz Queen band warming up the crowd. Her speeches were followed by the Rolling Stones song, “Angie”. Only Joschka Fischer, Germany's Green foreign minister, who is crisscrossing the country by bus, has dispensed with a warm-up act - he is something of a political rock star himself.

Only in the past two weeks has the campaign itself warmed up, mainly because the opinion polls have narrowed sharply. When Mr Schroder called the election on May 22nd, after the SPD's disastrous loss in the state election in North Rhine-Westphalia, the polls pointed to a big win for the CDU/CSU and the FDP. Now they are no longer sure of even a narrow majority (this week most polls put their combined score at around 48%) - which is why pundits think the CDU and the SPD might be forced into a grand coalition.

What went wrong? Ms Merkel is not an inspiring campaigner. And it may not have been a good idea to recruit Paul Kirchhof, a former judge who favours a flat tax, as potential finance minister, because it gave Mr Schroder an easy target. Mr Schroder has used two televised debates to launch withering attacks on the “professor from Heidelberg” and his “radically unsocial” reform. Such language resonates with Germans who love consensus and dread too much change. In response, the CDU has now reactivated Friedrich Merz, its former leading economic thinker, who is popular with voters if not with Ms Merkel.

Scenting a chance to survive, Mr Schroder has also shown, yet again, that he is a magician on the campaign trail. In interviews with journalists, he has planted doubts about the widespread belief that he is a goner. “There is a majority - for me”, he has said, adding that he wants the SPD to reach 38%. Such a result would not be enough for him to form another coalition with the Greens, but it could lead to a grand coalition - conceivably with Mr Schroder himself as chancellor.

German voters seem unable to make up their minds what they want. Judging by the polls, what they would like is a CDU government, but with Mr Schroder, not Ms Merkel, as chancellor. Many think the SPD and Greens have done a bad job through seven years of slow growth and high unemployment, but they are not sure the opposition would do better. Germans are just “resigned” to a change in government, says Renate Kocher, co-head of the Allensbach Institute, a polling firm.

What Schroder leaves behind

Such a contradictory mood fits Mr Schroder's legacy. It is too early to assess his place in history. But today Mr Schroder is best thought of as a man who took too long to grasp the need for economic reform. And even though, once he had done so, he stood firm behind the limited reforms he proposed, he also knew that it was time to go when electoral setbacks had driven his agenda into the sands.

For those who have followed Mr Schroder's career closely, this turn of events is hardly a surprise. It reflects his approach to politics, argues Franz Walter, a political scientist at Gottingen University. Most SPD leaders, he says, have been predictable. But Mr Schroder “trusted his instincts more than any principle. He was a master at taking people by surprise.” Mr Schroder did not work his way up the party machine, but imposed himself from outside, using his popularity as a lever. He prepared neither the party nor the public for his reform programme, called Agenda 2010, and he presented it in March 2003 as a mere laundry list. Nor did he consult widely before calling an early election.

This method has cost the SPD dear. The party has lost almost every state election since Agenda 2010 was unveiled. The chancellor's stop-go habit meant that reforms were not only poorly sold, but haphazardly implemented and badly timed - taking effect as recession hit. In hindsight, it would have been better to start Agenda 2010 early in Mr Schroder's first term, though he was at first stuck with Oskar Lafontaine, now co-leader of the Left Party, as finance minister and SPD chairman.

It is always hard to push reform through Germany's political system, which has grown ever more inflexible and deadlocked. A more typical SPD man than Mr Schroder could have got so mired in the bogs of German federalism (the Bundesrat, the upper house, gives the states a say on most important laws) as to achieve nothing at all. In Germany, it seems, any would-be reformer loses his majority in the Bundesrat - and Mr Schroder was no exception.

Yet the reforms Mr Schroder got through were a big step in the right direction. Even before Agenda 2010, he passed a pension reform whose effects are underestimated. He cut income- and corporate-tax rates. His health-care changes improved the finances of public health insurers. His much-criticised reform of unemployment benefits is yielding results in the form of lower take-up. In part thanks to these reforms, there are signs of economic revival. Unemployment, which climbed above 5m early this year, is falling. Exports are at record levels. Even domestic demand could soon rebound, presaging a return of economic growth.

Most important, Mr Schroder has created the conditions for further reform, albeit by falling on his own sword. Germans still seem likely to vote him out of office this weekend, but most now accept the case for change. And because the SPD has lost most state governments, there is no risk of the party regaining a majority in the Bundesrat soon, so it will be unable to obstruct a new government.

All this ought to make life easier for Ms Merkel, should she win. Just as Mr Schroder seemed right for the job in the late 1990s, she seems right now. “If Mr Schroder is a sprinter, Ms Merkel is a long-distance runner,” says Wolfgang Nowak, head of the Alfred Herrhausen Society, a think-tank linked to Deutsche Bank. The east German politician, who has a degree in physics, is methodical, going through all options before making a decision. Insiders call her a “learning machine”. She has certainly learnt much since Helmut Kohl plucked her out of obscurity in 1991 - not least from Mr Schroder's experience. As early as November 2003, she was preparing her party for change, persuading it to commit itself to an overhaul of the tax and health-care systems. Last July, she published one of the more honest election programmes in post-war Germany: not a list of expensive promises, it includes unpopular measures such as a two-point rise in value-added tax (VAT).

Not radical enough

Given this rare opportunity and her political assets, Ms Merkel's reform plans may not be sufficiently bold. A CDU-led government would try first to bring in more labour-market reforms. One would strengthen the rights of firms and staff to negotiate company-level wage deals. Another would chip away at laws protecting workers against dismissal, by, for instance, confining some protections to people in companies with more than 20 employees. A third would cut unemployment-insurance contributions from 6.5% of gross salaries to 4.5%, paid for by the VAT increase.

Later, probably in early 2007, Ms Merkel's agenda gets more ambitious. One big reform would be to make the income-tax system simpler and more competitive internationally. Most loopholes and subsidies would go, and rates would be cut - the top rate going from 42% to 39%. Next come plans for radical change in health-care financing. Instead of basing contributions on salaries, Ms Merkel wants a flat-rate health premium for all Germans, ensuring that health-care costs no longer act as a tax on employment.

Yet there are big items missing from this list. Ms Merkel has no specific plans to deal with Germany's mushrooming fiscal deficit. By the CDU's own estimate, next year's federal deficit will be over €60 billion ($75 billion), pushing Germany's overall deficit close to 4% of GDP. It is an open question how some of her reforms will be paid for. Even the VAT increase may not actually happen, because of rising fuel prices and resistance from the FDP.

Both the CDU and the FDP are also timid on deregulation. They are long on plans to cut red tape and make labour markets more flexible, but short on tackling the network of subsidies and protection that impede competition, says the IIE's Mr Posen. Gutting this underbelly of corporate Germany would hurt part of the centre-right's constituency. Then there is the reform of Germany's federal system to make it easier to respond to change. A CDU-led coalition might push through a constitutional amendment to disentangle the powers of federal and state governments. But a politically tricky reform of Germany's “financial constitution ” - -a cobweb of tax-revenue equalisation and joint public spending - is not on the agenda.

Ms Merkel has an excuse: she must be elected before she can do anything, and being too candid would diminish her chances. She can be surprisingly willing to take political risks if the time is right. In 1999 she broke ranks to become the first CDU leader openly to attack Helmut Kohl, a move that helped her to the leadership. But there is a risk that she may not implement even the reforms she has proposed. “With a centre-right coalition, you just don't know exactly what you will get”, comments Klaus Gunter Deutsch, an economist at Deutsche Bank's research arm.

One impediment is something Ms Merkel cannot do much about: the economy. Another rise in oil prices, or a plunge in the dollar, could kill Germany's fledgling recovery and make it even harder to bring in and pay for ambitious reforms. The trade unions could also cause trouble. Although they disliked Mr Schroder's Agenda 2010, they did not try hard to block it. Perhaps only an SPD chancellor could have begun reform in Germany. With a CDU one, the unions may put up a real fight, with strikes and street protests.

A bigger risk for Ms Merkel may come from her own party. Most conservative heavyweights are state premiers who will defend their regional interests, particularly over money. They agreed to the VAT increase only because they will get half the proceeds. What is more, their enthusiasm for reform is limited. The CSU leader in Bavaria, Edmund Stoiber, is not keen on the flat-rate health premium. And if Ms Merkel is successful and sticks around, she may prevent some state premiers from ever having a shot at the chancellorship.

Ms Merkel is vulnerable to friendly fire because she - like Mr Schroder - lacks a real power basis within her party. She became leader unexpectedly in the wake of a party-financing scandal. Being less of a media charmer than Mr Schroder, she cannot use popular support as a counterweight. Her best bet may be to disarm rivals by giving them jobs in her cabinet and to use the FDP, which is more pro-reform, to counteract the forces of reaction.

Some still argue that a grand coalition may be a better route to reform. Many German voters like the idea of all parties coming together to form a consensus for tackling big issues. Were a grand coalition to include centrist SPD politicians such as Peer Steinbruck, a former premier of North Rhine-Westphalia, many would approve and hope that it might tackle Germany's fiscal quagmire, reform corporate tax and modernise federalism.

Yet it is more likely that a grand coalition run by a weakened Ms Merkel with a disgruntled SPD would end in paralysis - rather as has the current government, with the opposition in control of the upper house. There is little common ground between the parties. Each would be manoeuvring to blame the other for unpopular measures. A grand coalition could well split the SPD. And it would boost more extreme parties, notably the Left Party, which aspires to join a new left-wing coalition at the election after this one (the SPD insists it will not work with the Left Party this time).

German voters, unwilling to choose decisively one side over the other, may end up backing neither. In which case the country's stuttering process of reform and recovery could be in jeopardy. The stakes are indeed high this weekend.

Article reviews the campaign just before the German general election on the 18 September 2005

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