Coalition must tackle cycle of unemployment and low growth, writes Derek Scally in Berlin
Ahead of last month's general election, German voters made it clear there was only one key issue - the economy. No other issue got a look-in: not the Iraq war; not Turkey's EU ambitions; not the environment. And the economy will remain the focus of the coalition talks that begin on Monday between the Christian Democrats (CDU) and the Social Democrats (SPD).
The new government is under pressure to improve on the economic legacy of the Schröder government, with average growth of just 1.2 per cent over its seven years, unemployment above 10 per cent and a federal deficit of €1.5 trillion.
New borrowing this year is likely to reach €34 billion, breaching the euro-zone ceiling of 3 per cent of GDP for the fourth consecutive year and Berlin is on course to do the same in 2006 unless drastic steps are taken.
Drastic steps are exactly what EU officials have demanded in recent days, threatening a multibillion euro fine if Berlin's financial house isn't in order by 2007.
The question now is whether the new grand coalition will be capable of avoiding political squabbling and make bold moves to break the vicious circle of growth too low to create jobs, and the fear of unemployment that is choking spending and growth. "It's been shown that this country is ready for change but, please, not without giving up our social cohesion," said Gerhard Schröder on Wednesday, summing up the election result in an impromptu farewell speech in Hanover.
It's a lesson the CDU learned the hard way on election night. The party responded to voter concern about the economy by running a campaign devoted almost entirely to that issue. It promised to cut taxes - income and corporate - loosen labour laws to enable easier hiring and firing, and to make it easier for companies to opt out of collective-bargaining wage agreements.
It said it would pay for a reduction in non-wage costs by raising VAT two points to 18 per cent and wanted to abolish giveaways such as the tax-free status of shift work. Its economic promises were a bit too liberal for many of its voters, however, and made it look too much like the liberal Free Democrats (FDP).
"Reforms have to happen but they cannot be presented to the public as though the CDU was a bloated FDP.
"It was for exactly this reason that the CDU lost the election," said Heiner Geißler, a former CDU general secretary. "A change in course was necessary even without a government with the SPD. "Angela Merkel who stood for this [ liberal] course has to yank the rudder around. It's part of democracy that one listens to the voters."
The SPD opposed the CDU's plans point by point and, even before talks begin, has already won agreement on several points, including retaining tax-free shift work.
But the CDU will want more reform than the SPD's wait-and-see election manifesto. Dr Merkel may get her way on the VAT hike and there is hope of simplifying the complex German tax system.
A grand coalition may also tackle the long-promised federal system reform to speed up decision-making by reducing the number of Berlin decisions that need to be rubber-stamped by the federal states. Hans-Werner Sinn of the Ifo economic think-tank suggested that a grand coalition had more strength to prescribe "the necessary medicine" to revive the economy than a regular government. That is, of course, if reforms don't fall victim to political personality clashes.
The economics ministry, stripped of its labour competence, will be headed by Bavarian premier Edmund Stoiber, head of the CDU sister party the Christian Social Union (CSU).
Meanwhile, the ministries for labour and finance will be in SPD hands, most likely party leader Franz Müntefering and Peer Steinbrück, former state premier in North-Rhine Westphalia. The result is that the CDU will have little direct influence over economic policy in the next government.
"The reform process will not really win any momentum," said Stefan Beilmeier, analyst at Deutsche Bank.
Only "timid" progress will be possible on labour market reforms, he said, adding that he was "rather pessimistic" about further economic improvement in Germany, with a fudge likely on labour law reform.
But many analysts are more optimistic about the coalition's prospects and financial markets appear to be warming to the idea of a grand coalition, with the blue-chip DAX 30 index back at its highest level in around three and a half years.
Business confidence is on the rise and a new study from the German Institute for Economic Research (DIW) has shown that booming exports and growing consumer confidence may push growth up to 1.7 per cent this year after growth of 0.5 per cent in the summer quarter, with even stronger growth forecast for 2006.
"It's possible to be confident in Germany again," said Michael Heise, chief economist with Dresdner Bank. "The chances haven't been so good for a long time that Germany will come out of bringing up the economic rear in Europe."
Few managers regretted the end of the Schröder era, but it could be a while before the male-dominated world of German business can get used to a woman chancellor.
And it's likely to be even longer before a Merkel effect can be seen in Germany's blue-chip companies. Two women serve on the boards of the country's DAX-listed companies, and neither is German.
