Sputtering German Economy Stalls Interlaced Neighbors

With rising auto sales providing a rare glimmer of hope on Europe’s gloomy economic horizon, Volkswagen sparked jubilation when it offered to hire 5,000 workers from among the long-term unemployed and pay them each 5,000 marks a month.

Thousands from among Germany’s nearly 3.85 million jobless--about 9% of the work force--flocked to company headquarters in Wolfsburg the next day to build a new minivan model for the equivalent monthly pay of about $2,270.

But IG Metall, the union representing auto workers that won wage hikes and a shorter workweek last year on promises of greater flexibility, quashed the project, part of a program called “5,000 Times 5,000.” The labor bosses who sit on the board of directors--by law in German companies--vetoed the new hires because they would be paid below union scale and the jobs were guaranteed only for three years, not the usual lifetime.

As the failed VW bid demonstrates, this country, which has long been the locomotive of Europe, is now acting more like an overloaded caboose, burdened by its overprotected labor force and dragging down growth throughout the 15-nation European Union.

Production and trade are so integrated within the EU, every setback for the German economy delivers woe to its neighbors because every car not built at Wolfsburg means that many fewer sales of Dutch headlights or French dashboard electronics.

Germany’s protected work force is a major barrier to investment needed to create jobs, boost production and get the economic engine of Europe moving. And its failure to loosen the shackles that prevent employers from hiring and firing is likely to come up for criticism this weekend when German leaders meet their counterparts at the Group of 8 summit in Genoa, Italy, to ponder how to speed up the sputtering euro zone.

German officials blame the slowdown from last year’s 3% growth to 1% this year on the rapid U.S. deceleration and other “outside” influences such as high oil prices and soaring food costs caused by a sweep of agricultural crises, including “mad-cow” disease.

But, in truth--and Chancellor Gerhard Schroeder has said it out loud--Germans don’t want to make the labor reforms that their allies and trading partners say are needed.

“If we look at the claims for flexibility . . . each is connected with a demand that the government take away from large groups of working people parts of their security and ability to plan for their lives,” Schroeder insisted last week. “We do not want this kind of change. This would contradict all German and European traditions. We do not want an American labor market.”

In the three years since he became chancellor, Schroeder has been taking fellow Germans on what Deutsche Bank’s chief economist, Norbert Walter, calls “a roller-coaster ride.” It began disastrously with the tax-and-spend excesses of his first finance minister, Oskar Lafontaine, who sought to bring down unemployment by swelling an already bloated public sector.

Hans Eichel, who succeeded Lafontaine two years ago, shepherded through a tax reform that this year returned to German households more than $20 billion, which was expected to boost consumer spending and fuel further growth.

But inflation more than ate up the windfall. Although taxpayers got to keep an average 1.5% more of their income, inflation has been riding well above 3%.

Easing Resistance to Immigration

Analysts concede that global influences are part of the problem. But they contend that the government has failed to build on its few successes.

One of those improvements has been Germany’s easing fear about immigration. Schroeder broke through that long-standing barrier when he introduced a green-card program this year to attract technology experts from countries such as India and Russia.

“People are starting to wake up to the fact that just because you’ve got 10% or 12% unemployment doesn’t mean that every job can be filled from within the country,” Walter said.

Still, many continue to resist a total liberalization to encourage a healthy flow of workers throughout Europe. Schroeder himself has spearheaded efforts to delay by seven years the right to labor mobility for Eastern Europeans who soon will join the EU. “The mentality has not yet been reset,” Walter said.

Schroeder and his left-of-center team are banking on a drop in global oil prices and a U.S. economic upswing to allow the desired spending spree to happen next year, when another step of the phased five-year cut in the top personal income tax from 53% to 42% goes into effect. They insist that German growth of 2% to 3% will be back on track, allowing other struggling economies of the euro zone to surge in its slipstream.

In fact, the other EU countries that will adopt the common euro currency next year are outperforming this so-called economic engine. Combined growth for the euro zone is expected to be between 2% and 2.5% this year, Belgian Finance Minister Didier Reynders told his EU colleagues last week.

EU Economic and Monetary Affairs Commissioner Pedro Solbes also confidently predicted that “the European economy will rebound at the end of the year.” The U.N. Economic and Social Council echoed that forecast in a study of the world economic outlook released this month. But economists say Germany won’t be the driver because it is still its own worst enemy in protecting labor.

Business confidence in the German economy is at a two-year low, according to the Munich-based Ifo index that polls 7,000 companies each month. Unemployment, though down from the start of Schroeder’s term, has edged up slightly in each of the last six months, rendering his goal of only 3.5 million jobless in a year nearly impossible. And 2002 being an election year, fears are rife that the government will spend even more on social programs and roll back its few achievements.

The developments in Germany reflect some fundamental differences between the economic ways of Americans and Germans. Consumer demand is still relatively healthy in the United States despite the slowdown and was positively robust until a few months ago. Germans, however, have mostly stashed what remained of their tax rebates in passbook savings accounts rather than spending or investing.

“Savings rates in German households are much higher,” DaimlerChrysler chief economist Ruediger Puf said in explaining the drop in manufacturing orders across the country. “Germans simply do not spend money they don’t have.”

In fact, consumer credit here is an alien concept. Most shoppers still use cash or debit cards when making purchases, and even expensive items such as cars and appliances are often paid for upfront rather than in installments.

That fiscal conservatism plays a role in the stock market as well. Until Deutsche Telekom conducted the country’s first major push to get Germans to buy shares in its initial public offering five years ago, there was no pursuit of the small investor. The percentage of households with stock holdings is still in the low single digits.

Together with industry’s reluctance to invest in German companies because of the strict protections for labor, the lack of grass-roots funding means businesses have to borrow if they are bold enough to count on a short-term improvement. And interest rates are still comparatively high, with the benchmark rate at 4.5%, adding another deterrent to job-creating investment.

Key economic analysts lately have been pushing the European Central Bank to cut interest rates to encourage business borrowing to finance expansion. But with inflation above 3%, the Central Bank fears a rate cut would support union demands for bigger wage hikes next year, adding to employers’ costs in what is already the world’s most expensive labor market. And unlike U.S. Federal Reserve Chairman Alan Greenspan, Central Bank chief Wim Duisenberg is seen as considerably more influenced by the wishes of politicians than by impartial analysts’ projections.

Germany’s economic woes are likely to be a sensitive subject at the G-8 meeting this weekend. The nation’s inflation rate and deficit ratio both exceed limits imposed on the euro zone and are setting a bad example for other countries having trouble staying in line, such as host Italy.

The four Western European G-8 members--Germany, France, Britain and Italy--are hoping for good news on the U.S. economy from President Bush because the slowdown across the Atlantic has been the primary influence on Europe’s shrinkage.

“The long upswing in the U.S. economy ended with a rather rough landing, which has had enormous consequences for the rest of the world,” said Gustav Horn, head of economic forecasting for the German Institute for Economic Research here.

“The United States is the locomotive of the world economy; and when it stalled, the euro area was unable to replace it.”

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Unemployment Rates

Economists are concerned about unemployment rates. Here is a comparison of some European rates with the United States’, as of May 31.

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Germany: 7.8%

U.S.: 4.3%

Source: Bloomberg News