Moment of Decision for Germany in Struggle for Economic Growth

His delivery trucks parked like a tiny army in waiting, Klaus Wiedemann pondered nut bread and the ever-infuriating German economy.

He’s the fourth generation of a family of bakers who survived two world wars and a city split by decades of communism. These days, he says, it’s social programs and binders of government regulations that thwart medium-sized businesses like his from competing in an economy weakened by years of wavering consumer spending and flat growth.

“There are too many rules. Labor costs are too high. Two to three million jobs have vanished in the last 10 years, which means fewer people are working to fund the social system,” said Wiedemann, sitting in his office beneath his great-grandfather’s baker’s diploma. “Big corporations can move jobs overseas to escape this. But companies like mine can’t do this. I can’t bake cakes in China and ship them to Germany.”

The German economy is the third-largest in the world and the muscle of Europe. Business confidence is up and car manufacturing has turned the nation into the globe’s leading exporter of goods. But these strengths are offset by high labor costs and a welfare state that accounts for 48% of the federal budget. The German public’s vision of social democracy and its entitlements have for decades hindered changes that might have spurred economic growth.

“The main disease is that Germans want to hold on to what they have,” Wiedemann said. “They don’t want to give up six weeks of paid vacation, 35-hour work weeks. And if you don’t want to give anything away, how can you compete in the bigger world?”

During last summer’s election campaign, Wiedemann was hopeful of a solution when Angela Merkel and her conservative Christian Democrats were well ahead of incumbent Chancellor Gerhard Schroeder and his left-leaning Social Democrats. But Merkel managed only a slim victory, forcing a coalition government that is unlikely to support the changes and cuts the new chancellor had envisioned.

“Merkel has all the right capabilities to take Germany into a promising future,” said Wiedemann, who has 27 bakeries and 240 employees in Berlin. “But she’s caught in the tight corset of this coalition.”

A physicist, Merkel has surprised much of the country since taking office in November. Her international trips and studious, hardworking nature won her an 80% approval rating -- the highest of any postwar chancellor.

The economy has shown stirrings of revival and is expected this year to grow 1.5% to 2%. But her government has yet to focus on reducing 12% unemployment, shrinking the welfare state and loosening labor laws.

“If we are not successful in making the labor market work, then all the other reforms will be marginal and won’t have a big impact on the economy,” said Thomas Straubhaar, president of the Hamburg Institute of International Economics. “Right now there’s no momentum in the government at all for this, and there’s no hope structural market reforms will start in the near future.”

The suntanned Wiedemann sat in his office on a recent cold afternoon. His delivery trucks would be silent until the hours before dawn, when they would rumble across the city to markets and bakeries. Bread has been rising in the family’s ovens since 1985. The business consisted of two shops 20 years ago, when Wiedemann began expanding and innovating by adding products, such as nut and bran breads and Valentine’s Day rolls shaped like hearts.

“It comes down to a simple baker man creating an idea suitable for the world,” he said. “We need more ingenuity. I think there’s too much negativity in Germany. We need some positive stories.... The German consumer is insecure and irritated because he’s worried that his job might vanish. He’s saving his money, not spending it.”

Apprehension over jobs and savings accounts has been hovering since Schroeder pushed some limited measures during his last term, including rolling back some labor protection and trimming unemployment compensation. The moves outraged unions and cost Schroeder politically. But they psychologically prepared Germans for the prospect of change spurred by global competition.

Raised in what was communist East Germany, Merkel faces a similar choice. Will she risk her political good fortune to champion a painful overhaul? Merkel often sounds at odds with herself over how to reinvent the social state. “We want to secure the future of the social market economy,” she said recently. “But we realize that with globalization, certain basic conditions have changed.”

This attempt to placate both sides underscores her need to hold together a fragile coalition. “Merkel is extremely loved by the German population, so why should she risk change?” Straubhaar said. “Why should she do something against all the confidence Germans have given her?”

Frank Becker doesn’t think Merkel will jeopardize it either.

“We are living in very interesting times,” said Becker, managing director of Collonil, which exports shoe polish and leather products to 80 countries. “The whole of Europe, especially France and Germany, suffer from neglect of reforms over the last 20 years. We were hoping Merkel’s coalition would make things happen. But I don’t see any action on the ground. There’s a stalemate between left and right on reforms.”

He added: “It will take a long, long time to change, but we still build a better car than Detroit.”

But German companies are moving jobs to other countries. Volkswagen recently announced it would cut 20,000 German workers. The carmaker and other manufacturers are increasingly looking to escape Germany’s high wages and rigid labor protection. For example, a worker at a VW plant in Slovakia may earn $700 to $1,000 a month compared with about $3,600 for a German worker, who may work 10 fewer hours a week.

The slow economy and foreign pressures are beginning to prompt sacrifices. German employees in many fields are working longer hours for the same pay, unions at mid-size and small industries are weakening, the retirement age will rise to 67 sooner than planned, and Merkel has proposed spending about $30 billion to stimulate the economy. Germany’s hosting of this summer’s World Cup soccer championship is boosting consumer confidence higher than it has been in years, although it’s far from robust.

But even a slight increase in spending may not last. Germans may be buying today because they don’t want to spend as much in 2007, when the country’s value-added tax will rise 3%.

There are also other troubling dynamics: a lagging educational system that isn’t preparing students for high-tech jobs, one of the world’s lowest fertility rates, and the former East Germany, which despite more than $1 trillion in aid since reunification in 1990 still has 19% unemployment and a landscape of abandoned factories.

Wiedemann believes that if he keeps coming up with ideas like heart-shaped rolls and grain breads, he will outlast this frustrating spell of economic uncertainty. But occasionally his entrepreneurial optimism is enveloped by the negative.

“I had two workers, janitors, minimally educated, but I paid them a good wage,” he said. “But they quit. How come? Because they can earn as much staying at home. They even got a little more from the welfare office. This burden on the employer has to shrink.”

He offered an analogy for his nation and its first female chancellor: “Before Margaret Thatcher became Britain’s prime minister, that country had a terrible economy. She took very unpopular measures in the 1980s and the people only understood reform was needed when the lights went out, the garbage piled high and the trains didn’t work.

“So I think it will have to stink, be dark and for the trains not to run before Germans accept change.”

Wiedemann stood, walked to a cabinet, held up a thick binder of new government regulations, and rolled his eyes.