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March 08, 2006

New Hope in Germany
by Hans F. Sennholz

Ever since a new administration assumed power in November 2005, the mood has much improved. The economy seems to be stirring again after many years of stagnation and frustration. A new chancellor, a lady doctor of physics of the University of Leipzig in former East Germany, Ms. Angela Merkel, managed to win over both major political parties, the Christian Democratic Union (CDU) and the Social Democrats (SPD), to form a coalition administration and embark upon some reforms. She promised to bring new life to a stubbornly weak economy and reduce the high rate of unemployment that is plaguing the country. She also pledged to cope with the government's chronic inability to bring its budget deficit under the ceiling of 3% of GDP, set by the European Union's Stability and Growth Pact.

Politics is a place of humble hopes and modest expectations. This year she intends to spend a bit more, which once again will cause the German government to exceed the limit. But in the coming years she plans not only to reduce government spending but also increase the value-added tax rate from 16 percent to 19 percent. This tax is a common European fixture and the major source of revenue for the European Union. It is an equivalent of a national sales tax, but differs from a flat sales tax as it taxes every phase and part of the production process.

The new chancellor undoubtedly raised public expectations for the coming year. The Institute for Economic Research in Halle is now forecasting economic expansion of 1.4% to 1.7% in 2006, which greatly exceeds the average of 0.6% in the years 2001 to 2005. Of course, such statistics never consider the numerous make-work and make-believe employment projects of various levels of government. Their deduction probably would reveal actual economic contraction and decline. Nevertheless, there is new hope and new courage; a strong export demand is likely to stimulate investment. But above all, the boost in value-added taxes, which is scheduled for January 2007, is likely to stimulate business in 2006; it may even raise government revenue and lower the deficits below the 3% ceiling. Few politicians care to consider the consequences of the 3% tax boost in 2007 and thereafter.

Many Germans undoubtedly accept the need for economic reforms, but most are reluctant to suffer any reform that would reduce their legal benefits. Germany, after all, is a welfare state par excellence. In 2003, Chancellor Gerhard Schröder introduced a reform package, known as Agenda 2010 and Hartz reforms named after the former VW Labor Director, in order to save social security from bankruptcy and stimulate the economy after three consecutive quarters of contraction. Hundreds of thousands of Germans immediately demonstrated in protest; they marched in protest especially against the most unpopular features of the reform, a proposed boost in healthcare charges and a reduction in long-term unemployment benefits. Although a few modest changes were enacted they proved to be rather ineffective in reducing the unemployment.

The Hartz reforms actually provided for a reduction of the top income tax rate from 48.5 percent to 42 percent, but whatever positive employment effect it had was offset immediately by higher budget deficits that drained the capital market. Other reform provisions constituted an unusual, curious, and quaint collection of bureaucratic concoctions that actually aggravated the unemployment. One feature transferred many unemployed workers to a special agency, the Personal Service Agency, and then leased them to corporations for purposes of training and potential employment. Another created and issued coupons to the unemployed which enabled them to seek the services of private employment agencies. The government also invented and created "mini-jobs" and "special jobs" for elderly workers. It financed more occupational training, introduced new wage subsidy programs and job creation programs, all of which were managed by the country's largest bureaucracy, the Federal Employment Agency (BA) with more than 90,000 employees. Representatives of labor unions and employer associations in effect control the Agency which is pouring billions of euros into huge training firms operated by one or the other.

The creation of part-time mini-jobs that pay a maximum of 400 euros ($480) a month and reduce social security contributions from 40 percent to only 25 percent of wages was surprisingly successful. They now amount to nearly seven million or 14 percent of German labor. The Hartz legislators who introduced these jobs now wonder whether they created new employment opportunities or merely reduced full-time jobs to mini-status. They also may have prevented the official unemployment rate of some 11 percent from rising to 20 percent or even higher.

A new organization called Arge looks after the long-term unemployed. They now receive greatly reduced flat-rate benefits provided they are seriously seeking work. A single person is entitled to only 345 euros a month ($414) plus health insurance, and rent and utilities paid for, which makes it rather attractive for young people to leave their parents' home and be unemployed. The number of unemployed Germans now exceeds 5 million of which 3.7 million belong to Arge.

Most labor market reforms proved to be just empty promises, yet both political parties never tire of devising and proposing new programs. Some legislators are considering new "combi-wages", that is, a combination of low market wages plus appropriate government subsidies. They are looking forward to determining the proper wage and a fair subsidy for every occupation in question. Many legislators even argue in favor of a return to traditional policies: wages should be raised and government should spend more on the infrastructure. Michael Glos, the new CDU economics minister, agrees; he is calling for wage increases, echoing many politicians who believe that the time of belt-tightening is over. Angela Merkel's new administration already announced a new program that will spend 25 billion euros on various infrastructure programs over the next four years.

Mighty Labor Unions

In Germany, the future seems to be the past again, entering through another gate. The most powerful labor union with some 3.5 million members in the metallic and electric industry, IG Metall, readily agrees with the economics minister and recently announced that it is tired of past moderation in its demands; its hourly wages amount to only 27.60 euros an hour ($33.00). It is calling for new wage increases of five percent, for "new qualification and innovation conditions" and for a reduction of contract time to only twelve months. IG Metall, like all other unions, obviously wants to partake in rising productivity and falling unit costs. Unfortunately, they consistently ignore the closing of German businesses and the loss of jobs that make headlines nearly every day.

Labor unions are threatening to strike across most of Germany. IG Metall may paralyze manufacturing and construction at any time. Verdi, the service trade union with more than one million members, already called the largest public-sector strike in 14 years. Although such strikes tend to be unpopular because they disrupt basic services and immediately lead to price and tax increases, the union usually gets what it wants. Moreover, the new government was formed by both large political parties and is headed by a lady chancellor from the Christian Democratic Union, which has given new courage and strength to unions many of which are led by militant Social Democrats. The people obviously must brace for more labor trouble in the months ahead.

Labor unions are associations of workers organized for the purpose of improving their working conditions. Their power springs from popular labor ideology that depicts unions as valiant protectors of workers from the greed and power of employers; this labor ideology then gives rise to labor legislation and regulation. A 1951 labor law organized the coal, iron, and steel industries that were managed by German trustees and their allied occupation authority; the law provided employee representation equal to that of the owners on corporate supervisory boards which appoint the boards of directors, supervise them, and receive their reports. A 1952 labor law gave representative powers to the employees and their unions in all businesses with more than five employees. Both laws and countless regulations that followed created two key parts of Germany's economic system: union codetermination in corporate management and industry-wide wage negotiations and contracts. No other country in Europe can pride itself on such compassion and good will toward labor unions and no other country yields so readily to their demands.

Protected Insiders and Unemployed Outsiders

The trade mark "Made in Germany" may still be a mark of quality and distinction for the German export industry. It sells more goods in the world market than any other foreign competitor, valued at nearly $1 trillion in 2005. But many other German industries unfortunately have lost their luster; they stagnate or barely move but constitute an essential part of a new welfare system. The old welfare state rested on the common belief in a basic conflict between capital and labor, which spawned massive legislation for the protection and benefit of labor. Several generations of such protection finally have given rise to a new brand of welfare state in which organized labor together with organized industry, in return for labor peace, confront the masses of unemployed and unorganized labor. A large wedge now separates the well-provided insiders from the unemployed outsiders. According to official statistics, the rate of unemployment presently amounts to 11.3 percent. If we were to add all kinds of government training schemes and job-creation programs, the true rate would be much higher.

Germany surely is in a better shape than many other countries. The crime rate is remarkably low, the cultural infrastructure is admirable, and its public transportation system is functioning rather well. But legislation and regulation paralyze the labor market which is made to carry the main burden of the welfare state. The payroll tax with matching contributions from workers and employers adds up to over 40 percent of gross income. When the tax was raised to provide more benefits it caused more unemployment. The government then sent hundreds of thousands of workers into early retirement. Government and labor unions cooperated in forcing employers into reducing working hours to 35 per week, at undiminished 40-hour pay. Rising unemployment and early retirement obviously raised the costs of support which in turn were readily placed on employed labor - in a vicious circle of rising labor costs and rising unemployment.

German reunification in 1990 aggravated this vicious circle. Welcome though it was, it compounded the economic and social maladjustments. Under communist rule and occupied by military forces of the Soviet Union, the East German economy had labored in a sad state of primitive gyration. Real income of most East Germans probably did not exceed 20 percent of that of West Germans. Unification of both parts, in freedom, would have triggered a rush of East German labor to West Germany and a scramble of West German capital to East Germany. The counter movements of labor and capital would have equalized their productivity in a few years; it would have raised East German wage rates to West German levels and lowered all West German rates to reflect the lower per-capita productivity and income in all of Germany. But such a reduction was totally unacceptable to West German labor unions and their political representatives. They devised a system that prevented the readjustment - labor legislation and regulation immediately raised the costs of East German labor to West German levels, that is, far above its productivity levels, which condemned many to instant unemployment. The political powers of West Germany preferred to support and sustain the unemployed with massive transfer welfare payments rather than set them free. Since reunification, West Germany has pumped some 1.3 trillion euros ($1.5 trillion) into East Germany, or some 97,000 euros ($115,000) for every man, woman, and child. Even now East German states receive annual subsidies of 80 billion euros ($95 billion) or some 6,000 euros ($7,000) per person, which amounts to four percent of Germany's GDP. If Germany is a classic welfare state, East Germany is its part excellence.

EU Citizens May Come and Go

On May 1, 2004, The European Union, which used to be an association of 15 Western European nations, opened its doors to 10 new members, eight countries from the former Eastern European communist bloc, (the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Slovakia, and Slovenia) and the Mediterranean islands of Malta and Cyprus. Most Germans were concerned about the flow of immigrant labor from the poorer entrant countries, moving across borders en masse and throwing Germans out of jobs by undercutting their labor costs. After all, in 1990 and thereafter, West German labor unions had done everything in their power to prevent the movement of fellow Germans from East Germany to the West; they now would not tolerate the arrival and competition of millions of Checks, Estonians, Hungarians, etc. Therefore, the German government immediately placed restrictions on the arrival of EU workers for a maximum transitional period of five years. But such restrictions on the immigration of young workers actually aggravate the demographic situation in aging Germany. The country already counts 50 retirees for every 100 workers. If we add five million unemployed workers, we count 60 or more for every 100 workers; and if we add the army of civil servants and members of the armed forces, we probably count 70 people who are supported by 100 workers. This astonishing conclusion is supported by the fact that social spending alone exceeds 30 percent of German GDP and total government spending approaches 50 percent; it is higher than that of any country in Europe, except Sweden.

According to reliable demographic projections, there probably will be 104 German retirees for every 100 workers by 2050; if we add all others who live on the labors of the employed, we may arrive at 120-130 retirees who expect to be supported by 100 working people. But such ratios of workers and drop-outs clearly contradict human nature; the system will self-destruct as more and more workers seek to escape the growing burden by joining the lines of beneficiaries. Some may emigrate to other countries of the European Union where the burdens are lower; some may even find their way to the United States, as did this writer many years ago.

Freedom of movement supposedly is a fundamental right of all EU citizens. But 12 of 15 old EU member countries immediately imposed some transitional limitations on labor coming from the new members. Britain, Ireland, and Sweden stand alone in opening their borders to new EU citizens. Yet although the number of immigrants who are streaming into these three countries barely differs from those who enter countries with labor restrictions, their modes of employment and association diverge fundamentally. In Britain, Ireland, and Sweden they find legal employment and ready acceptance as welcome members of society. In countries with tight restrictions many immigrants work illegally, declare themselves as self-employed, or merely "visit" friends and relatives. They have made Germany a land of immigrants just like the United states. Indeed, after World War II Germany experienced a huge influx of foreigners mostly from communist countries in the east. Individuals of German ancestry and descent, some seven million of them, were welcomed immediately; all others were accepted as "guest-workers" who were expected to go home when they were no longer needed. Some fourteen million were invited; many stayed on. In 2004, The Federal Statistics Agency counted 1.7 million immigrants from Turkey, some 600,000 from Italy, 400,000 from former Yugoslavia, 300,000 from Greece and Poland each, and some 200,000 from Croatia and Russia each; it did not count the visitors. Some have found employment, some have taken their places in the long lines of unemployed, and many have found a new beginning in the underground economy. According to various estimates, some 15 percent of German production actually is "underground," "off-the-books," and on "black markets." If we consider an extraordinarily large volume of euro currency "in circulation" in Germany, we must infer an even larger underground component. In Frankfurt, the country's most diverse city with many foreign company offices and financial headquarters, 40 percent of its population of 655,000 hold a foreign passport or have an immigrant background. No one can know how many are laboring and earning their living in the underground economy.

The German Miracle

Underground activity has been an intrinsic part of German economic life ever since the 19th century "Historical School" paved the way for "national economics" and social policies. This school, which held forth at German universities throughout most of the 19th century, willingly sustained and reinforced the teaching of socialist writers such as Karl Marx and his many disciples. The Nationalists together with the Marxians prompted Chancellor Otto von Bismarck to institute a program of sweeping economic reforms which redistributed income and wealth and spawned an underground economy. Nationalism and socialism have been the predominate ideological patterns and guiding lights for most economic policies ever since. They were the polestar and lodestar for Hitler's National Socialism (Nazism) which meant to conquer Lebensraum. The crushing defeat in World War II banished and erased the nationalist component of the ideology but left the features of socialism unaffected. They continue to guide many German politicians even today.

This sad ideological history obviously raises the question of the miraculous recovery of West Germany from the devastation of the war. There are numerous explanations that dwell on clever political work and influence. This writer likes to suggest a fortunate historical coincidence. In 1948, soon after the currency reform that voided some 90 percent of the German currency, Ludwig Erhard, a scholar of the Austrian School of Economics and the economic official of the German Economic Council, suddenly abolished all price and wage controls and thereby set the economy free. It surprised and upset not only many Germans who were accustomed to rigid controls but also the American and British military authorities who liked to impose and manage controls. Liberated at last, the economy immediately sprang to life. Within a few months in 1948 industrial production nearly doubled and thereafter doubled again and again; it became the "German miracle." Most Germans credited the currency reform for the miracle and denounced the abolition of controls. Yet they admired and supported Ludwig Erhard for having staunchly defied the occupation authorities that favored the continuation of tight controls and loathed and feared an unhampered market order. He remained West German economics minister from 1949 to 1957 when he became vice chancellor. In 1963 he succeeded Konrad Adenauer as chancellor. His administration fell three years later when public opinion and the political forces which it engendered had returned to the ways of old: social welfare by party rule and administration. It signaled the end of the German miracle.

A New Beginning

Most observers like to point at political parties and their leaders as the root cause of the German quandary. Many may find special fault with past chancellors for having led their parties on the way, with Kurt Keisinger (1966-69), Willy Brandt (1969-74), Helmut Schmidt (1974-82), Helmut Kohl (1982-98), and Gerhard Schröder (1998-2005). But few observers ever fault educators, authors, and media spokesmen for creating the ideological setting that molds political views and party politics. Few blame the tenured professors at state universities. In Germany, the "Socialists of the Chair" formed a large intellectual movement that rejected "Classical Economics" and its principles of a market order. The chancellors emulated them or looked towards Britain where John Maynard Keynes and his many disciples had developed "consumption economics" and "multiplier economics." The thought of following in Ludwig Erhard's footsteps probably never occurred to them.

Whenever they were in power, both major parties, the Christian Democrats and the Social Democrats, busily expanded and amplified their intervention and thus created an anemic economy with a vibrant underground. Both parties cooperated in the formation of a coalition that lasted from 1966 to 1969. It was a time of much disagreement and controversy ending in alienation and confrontation. If it is the function of government to redistribute income and wealth by law and regulation, it is in the vital interest of all members of society to participate in the political struggle. Participation becomes ever more important with every boost in the give-and-take that increases the social conflict. In the end, it may lead to bloody fighting in the streets and the arrival of a strong man who restores and enforces social peace.

We now wonder how Chancellor Angela Merkel will fare in the bitter struggle. No matter in what direction she may turn to redistribute the benefits and the burdens, she will engender political conflict. Welfare-state and labor-market reforms are especially unpopular. If she should choose to become very active in reducing the welfare load and lead the way, the confrontation may cause her coalition partner, the Social Democratic Party, to leave her administration and thus cause it to fall. Old socialists once again would lead the way.

A few economists still remember the "economic miracle." They are aware that the height of wages is not affected by employer greed and power but is determined in the same way in which the prices of all economic goods are determined. Employers deal with labor as they do with all other costs because consumers make no distinction between the great variety of costs. Wage rates just like the prices of other factors of production are determined by the market. They are subject to an upper limit that is determined by the worker's productivity, that is, the price which the employer hopes to get for the worker's contribution to production. The lower limit is determined by the bids of competing employers who themselves are guided by the same considerations. In a freely adjusted economy without collective coercion and restriction, the upper and lower limits tend to coincide. If the costs of labor are made to exceed the productivity of labor, the employer, whoever he may be, is bound to suffer losses which, sooner or later, may force him to halt production. He may call a halt when the costs of labor dissipate the return on his capital investment. Surely, capital usually is less mobile than labor and therefore rather vulnerable to labor assault. But when deprived of its market return it may cease to function or try to move to safer environments.

The difficulties which Chancellor Angela Merkel will face in the months ahead will show what kind of leader she is. Most politicians merely march in front, marshaling the people on the way they are going. But there are men and women who, by their attraction and intellect, guide their people and lead them toward the light. There is new hope in Germany. But will there be new light?

Hans F. Sennholz
www.sennholz.com

Copyright © 2002-2007 Hans F. Sennholz

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