Research Dept. News
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Monthly Report, num 285 - November 2005
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European Union - Germany
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Germany: Does «Grand Coalition» mean grand reforms?
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Germany tries out first coalition between Christian Democrats and Social Democrats since 1966-69.
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October 10 brought about the «Grand Coalition» between the Christian Democratic Party (CDU/CSU) and the Social Democratic Party (SPD). If the past may serve as an example, it should be remembered that in the history of the Federal Republic of Germany the only precedent was the CDU-SPD coalition which lasted from December 1966 to October 1969, the results of which in economic terms were satisfactory.
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The immediate challenge at that time was to lift Germany out of economic recession and consolidate what, back in 1966, was the embryo of recovery and over time to reduce the public deficit that was considered excessive. The precondition, as perceived in the mid-Sixties, was to restore the German people’s own confidence in their economic future. Nearly 40 years later, the economic and political context shows little similarity but the basic historical analogy, overcoming the crisis of confidence, is indeed relevant.
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Then, as now, big challenge was to recover country’s self-confidence, something handsomely achieved.
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Will the new coalition be able to consolidate recovery, as much at an early stage as in 1966, thanks to an improvement in corporate confidence as well as in consumer confidence? Apart from the figure of Angela Merkel, the first woman to be chancellor in German history, and the breakdown of cabinet posts (with 8 Social Democrat ministers and 7 from the CDU/CSU as well as post of chancellor), the basic factor is the economic content of the government programme, which is still under negotiation as we go to press.
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Leaving electoral rhetoric aside, both parties coincide in the need to increase fiscal consolidation in order to put the government deficit back under the limit of 3% of the GDP set under the EU Stability and Growth Pact and to increase government spending on research and development. There is also agreement on simplifying income tax and a reduction of corporate taxes.
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Now, differences among partners of «Grand Coalition», especially in tax and labour matters, outweigh points of contact in other questions, which likely will hinder reform hopes of new German government.
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The differences, however, would seem greater than the areas of agreement. The CDU is proposing a cut in income tax, in sharp contrast to a desire to increase the tax load on higher income levels, as advocated by the Social Democrats. At the same time, the Christian Democrats are proposing an increase in value added tax (VAT) from 16% to 18%, and using the increase in collections to compensate for the drop in revenues that would come from a reduction in social security contributions, a measure aimed at reducing non-wage costs falling on companies. The most likely solution, according to early reports of the negotiations, will be to postpone the main fiscal reforms to the next legislature.
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There is also strong opposition from the SPD to the CDU proposal to allow, under certain circumstances, that companies can withdraw from some aspects of their individual collective bargaining agreements (basically wage reviews and work days) established under sector labour agreements. The policy gaps also spread to reconsideration of the closing of nuclear power stations decided in 2000 and how to reduce the cost of the public health system. There is thus a lot of negotiation still to be done before the second half of November (after both the extraordinary congress of the CDU and that of the SPD have agreed to the government pact) for Angela Merkel to be invested as chancellor of the federal parliament.
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At least, economic situation presents more favourable state which may facilitate some costly political decisions.
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In this situation, the improvement in the economic situation, that now is starting to be noticeable, could facilitate stronger measures by the government than might be hoped for in view of the major differences between the coalition partners. Recovery seems to be taking a shape that is usual in the German economic cycle: the rise in foreign demand is leading companies to increase their rates of investment. Later on, increased corporate activity will lead to improvements in employment and private consumption. For the moment, the export-investment flow channel is what seems to be operating.
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In this respect, exports in July and August grew above 8% year-to-year, nearly twice the rate in the second quarter, while the capital goods component in industrial production and industrial orders, although erratic, appear as a background trend in the maintenance of investment growth in the first half-year. Even the weak private consumption level, which still shows no signs of recovery, likely will end up reflecting the improvement in consumer confidence reported in August and September.
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Recovery of industry and corporate confidence confirm improved German scenario.
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The improvement in industry (industrial production grew by 2.5% year-to-year on average in July and August), together with the recovery of corporate confidence measured by the IFO index (going to the 98.7 points level in October), are other elements supporting a recovery scenario. Nevertheless, in keeping with what has happened in the euro area as a whole, the increase in consumer prices (2.4% in September compared with 1.9% in August) and a still high unemployment rate (11.7% in September) are negative factors dragging down the potential of the German economy.
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