Schröder Pushes Reforms as Germany Slides into Recession

Now as much as ever, the world’s third-largest economy needs reform. The latest data, released on Thursday, show Germany's gross domestic product shrank in the second quarter of 2003, officially pushing the economy back into recession.

Despite general agreement some kind of reforms are urgently needed to spark growth, the conservative opposition has attacked Schröder’s package of painful welfare cuts and labor market reforms. And since the Christian Democrats control the upper house of parliament, the chancellor’s so-called Agenda 2010 is likely have a rough legislative ride ahead of it.

The ruling center-left coalition of Social Democrats and Greens had hoped to stimulate growth by bringing forward to 2004 €15.6 billion ($17.6 billion) of tax cuts planned for 2005. But the cabinet proposed financing the tax cuts mostly through new borrowing, raising fears it will breach European Union budget deficit rules again next year. It also says it will cover some of the cost by curbing tax breaks and subsidies.

The measures adopted by the cabinet will affect private home owners and builders as well as commuters, as both groups would lose tax allowances. In addition, the plan calls for a new municipal business tax on the self-employed, as well as a reduction in currently generous unemployment benefits, bringing them down to the level of welfare benefits. It is hoped that the move will encourage the unemployed to be more active in seeking a job.

The main Christian Democrat Union (CDU) opposition says the tax cuts should be financed by slashing government spending and that ending tax breaks for home owners and others will create a fiscal drag on the economy by some €34 billion between 2005 and 2007. Since many of the reforms and the tax cuts proposed by Schröder affect the finances of Germany’s 16 states, which are represented in the upper house the Bundesrat, will have to be approved by the opposition.

Home-team doubts

But even among ruling coalition members, there are doubts that the reform package will achieve its goal of spurring the economy and lowering unemployment, and it is unlikely to leave the Bundestag in its current form.

Heide Simonis, Social Democratic premier of the northern state of Schleswig-Holstein, criticized the package, saying the reform of municipal funding, the labor market and income taxes "can hardly be called a unified whole." In the end, she said, expenditures would be intolerable for state and local governments.

And Greens party parliamentary leader Katrin Göring-Eckardt told the Thüringer Allgemeinen newspaper that the measures would "in no way leave the Bundestag in this form," without rent and interest income taken into account for those paying local commercial tax.

Following the vote, Schröder called for "constructive cooperation" between the red-green coalition, the opposition, and the states. Speaking on the ARD television, he said the ruling coalition is "ready to talk," and advised the CDU to unify behind a consistent policy.

"Just saying no, just making a blockade," doesn't help, Schröder said.

Critics fear bureaucracy

Yet Thuringia's Minister President Dieter Althaus said he is not interested in any such round table. "We have talked enough. Our proposals are on the table, those of the government as well. And now its the Bundestag turn," he said.

Critics in the CDU say the plan will only serve to creating more bureaucracy, and is also too centralized, not giving enough say to the states.

Rolf Peffekoven, professor of economics at the University of Mainz, told Deutsche Welle he thought an agreement will be extremely unlikely, given the opposition in the Bundesrat.

He said financing a tax reform via new debt would be a false move. "Normally you would have to finance tax reform through reductions in public spending," because the German debt is already so high, he said. He noted that 2004 would be the third year in a row where Germany exceeds the three percent budget-deficit rule allowed under the Maastricht Treaty for euro-zone countries.

While he agreed with the government plan to reduce welfare benefits, Peffekoven noted that such a scheme will work only if the government and industry can succeed in creating more jobs. "Jobs are made by companies, but companies only make jobs when they can have certain expectations for the future. And this constant back and forth in fiscal politics has destroyed a lot of that."

Distress signals

Yet even as disagreement continues on how to fix its problems, the German economy continued to show even more signs of distress on Thursday. The Federal Statistics Office reported that German real gross domestic product (GDP) shrank by 0.1 percent in the second quarter from the previous three months. GDP in the second quarter also declined 0.6 percent when compared with the same period a year earlier.

Germany's GDP had already contracted by 0.2 percent on a quarterly basis in the first quarter of 2003 and stagnated in the last quarter of 2002. The new data effectively mean that Germany has officially slipped into recession, which is usually defined as two consecutive quarters of negative growth.

The statistics office blamed the development on weakening exports, as the strong euro made German goods less competitive abroad. The second-quarter GDP was in line, or even slightly worse, than economists had expected.