Merkel’s marriage of inconvenience

Some updates to Germany at the Economist.

Merkel’s marriage of inconvenience

Nov 14th 2005
From The Economist Global Agenda

Almost two months after Germany’s inconclusive election, the proposed “grand coalition”, with Angela Merkel as chancellor, has been approved by the country’s three main parties. But their agreed programme of government is an awkward compromise and may do little to revive Europe’s largest economy

GERMAN media reports say that in recent days, leaders of the country’s three main parties have taken to addressing each other by the familiar “du” form. After weeks of stormy negotiations on a proposed “grand coalition” of centre-right and centre-left, which at several points seemed about to collapse, this was progress. At the end of last week, the improved atmosphere in the talks meant that the leaders of the Christian Democrats (CDU), Christian Social Union (CSU) and Social Democrats (SPD) could finally reach agreement on a programme of government. And on Monday November 14th, congresses of each of the three parties gave their strong approval to the deal. The question is, how long will the bonhomie last once the former rivals have to make the difficult decisions needed to revive Europe’s largest economy?

Under the deal, Angela Merkel, the CDU’s leader, will become Germany’s first woman chancellor—and its first from the former East Germany—while the SPD’s Peer Steinbrück, a former premier of North Rhine-Westphalia, will be finance minister. The parties have agreed that, to bring the country’s large budget deficit under control, taxes will rise. However, there will be only modest labour-market reforms, even though Germany urgently needs more of these to bring down its alarming unemployment rate—currently 11.6%.

A fortnight ago, the coalition talks seemed on the brink of collapse, following the resignation of Franz Müntefering as the SPD’s chairman. He quit after his party’s executive committee rejected his candidate for the SPD’s number two position. This prompted the leader of the Bavarian-based CSU, Edmund Stoiber, to declare that he no longer wanted to be economics minister in the new government. A carefully stitched deal to build a three-party cabinet suddenly looked like coming apart.

But things were soon patched up after Matthias Platzeck, the highly regarded premier of Brandenburg state, was nominated to succeed Mr Müntefering as SPD chief, and Michael Glos, the CSU’s parliamentary leader, took Mr Stoiber’s seat in the proposed cabinet as economics minister. Mr Müntefering, despite giving up his party role, still looks likely to become vice-chancellor and labour minister.

The programme of government thrashed out by the three parties runs to hundreds of pages. Overall it is a compromise, and not a very good one, between proposals the CDU/CSU and the SPD had presented in September’s election. On some matters, such as reform of Germany’s federal system, it goes into great, perhaps excessive, detail. But it is disappointingly thin on such vital matters as reforming the labour market and health system. In one area where it does go into specifics—planned increases in tax—it has caused dismay among business leaders, who fear the package may damage Germany’s anaemic economy instead of reviving it, as intended. They are particularly annoyed at the CDU, which had talked of tax cuts, not rises, in its election campaign.

To try to reduce the government’s budget deficit to 3% of GDP or less—as laid down in the widely flouted rules for countries in the euro currency area—there will be increases in both the value-added sales tax (VAT) and in income taxes. The VAT rate will rise from 16% to 19%, while (at the SPD’s insistence) the top rate of income tax, for those earning over €250,000 ($290,000) a year, will rise from 42% to 45%. Those on lower incomes will suffer the loss of several tax breaks; and workers will also have to make slightly higher contributions towards state pensions.

Businesses will gain a modest cut in their social-security contributions and a little more flexibility in hiring and firing: in future, new employees will undergo a two-year probationary period before gaining job security, instead of six months, as is typically the case now. But these small concessions that Ms Merkel has wrung out of the SPD fall far short of what many business leaders believe are needed to liberate Germany’s labour market and thus encourage firms to create jobs. And they do not compensate for the negative effects businesses expect from the tax rises.

The German economy is expected to grow by just 0.8% or so this year and the government’s panel of economic advisers predicted recently that next year’s growth might be no more than 1%. The threat of tax rises the year after seems likely to make gloomy German consumers tighten their belts even further. Thus a fiscal squeeze without structural reforms may simply push the economy back into recession, making it harder, not easier, to close the budget gap.

Although the grand coalition will nominally enjoy a crushing majority of over 280 seats in parliament, it is still unclear how closely the new government will follow its programme after taking office, on November 22nd. No such coalition of left and right has been tried since a short-lived and not terribly successful attempt in the 1960s, in what was then West Germany. The big policy differences between the parties mean the agreement may not last: the CDU had wanted more ambitious reforms of the labour market; the SPD had wanted to spend its way out of economic stagnation instead of bringing the deficit under control.

More important than what is written in their policy programme is whether the traditional rivals can build the trust that is needed to govern a country badly in need of a new direction. Only time will tell if they can. If the coalition does fall apart, fresh elections may have to be called. This could in theory lead to a clearer outcome, in which the CDU and CSU would form a more coherent, and reformist, government in coalition with the smaller, market-friendly Free Democrats. But it could just as easily drive voters away from the mainstream parties into the arms of more hardline parties to their left and right.