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Schr?der: All Boxed In

With his narrow, come-from-behind victory in national elections, German Chancellor Gerhard Schr?der has proven once again that he's a great campaigner. Can he bring the same savvy and drive to fixing Germany's economy?

It's doubtful. Schr?der's victory was hardly a mandate for decisive change. His nine-vote margin in Parliament is enough to govern, but it's not enough to push through unpopular legislation. Not surprisingly, no one in German business is expecting much from Schr?der II. "There is currently no reason to be too optimistic," says Bernhard Scheuble, CEO of Darmstadt-based pharmaceutical and chemicals maker Merck.

While Schr?der was off shaking hands and courting the peace vote by opposing a U.S. invasion of Iraq, Germany's economy--and European markets--continued to tank. Germany's growth in 2002 will be just 0.3%, Deutsche Bank estimates. Unemployment, already at 4 million, is expected to keep rising. Germany was on its way to violating the self-imposed budget constraints of euro countries until the European Commission, declaring an emergency, loosened the criteria. Faced with so many financial pressures, Schr?der may be forced to further delay planned income tax cuts, which will hurt consumer spending. "The place is really in a mess," says Jean-Paul Betbeze, chief economist of Cr?dit Lyonnais in Paris. Without Germany as an economic motor, growth in the euro zone is likely to be only 0.8% this year, according to Deutsche Bank.

Is there any good news? Yes, some. The Party of Democratic Socialism, successor to the Communists who ran East Germany, was all but kicked out of Parliament: Its delegation will shrink from 32 members to 2. That removes pressure from the far left.

Another possible plus: The Green Party and its articulate standard-bearer, Foreign Minister Joschka Fischer, are poised to play a more crucial role as the Social Democrats' partner in the ruling coalition. After saving Schr?der's bacon by winning enough votes to offset the SPD's own electoral erosion, the Greens are in a position to act as a counterweight to Big Labor--if it chooses. Historically, the Greens have put more emphasis on the environment than the economy. But the party is less encumbered than Schr?der's Social Democrats by ties to special interests. "They are much more [pro-free market] than the Social Democrats, but I don't know how strongly they will push economic issues," says Peter Glotz, a former general secretary of the party.

Unless the Greens surprise and push hard for economic reforms, expectations for major changes will remain low. Business has long since given up hoping for any radical shift in the way the German economy works. Adopting a scaled-down agenda, Germany Inc. is urging the government to give business a break by, for example, allowing older workers to opt out of some of the regulations that make it almost impossible to fire them. In return, they would be promised severance packages if they're axed. That might help address unemployment among workers over 50, who account for a quarter of the total, or more than a million people. Such tweaks to the system may help, but they're unlikely to boost German growth enough to radically cut unemployment. "That won't be enough to change the mood," says Lothar Sp?th, CEO of technology conglomerate Jenoptik, who ran on the conservative ticket as designated Economics Minister but is now returning full-time to business.

The government will also seek to push through reforms designed to put more pressure on unemployed people to accept jobs. Leaders vow that the legislation, announced before the election, will pass quickly and won't be watered down by labor and other interest groups. "That will be an important signal," says Rainer Wend, a member of Parliament and the Social Democrats' expert on economic issues.

Schr?der is also moving fast to patch up relations with the U.S. He pushed out a minister who, according to press reports, likened President George W. Bush's tactics to those of Adolf Hitler, saying both used foreign crises to distract from troubles at home. Eventually, Schr?der and Fischer are likely to go to Washington to try to mend fences, aides say. "Over the next couple of weeks, people will rediscover that on most issues, we are very close," says Karsten D. Voigt, coordinator for German-American cooperation in the Foreign Ministry. He had better be right: Among German companies that do business in the U.S., there is rising uneasiness that the sour atmosphere between the U.S. and Germany could start to hurt sales.

Every little bit helps, of course. Yet economists are nearly unanimous that Germany must do things Schr?der isn't even discussing. A major loosening in labor rules. Big cuts in pension benefits. An end to subsidies for industries such as mining and construction. "Schr?der knows what needs to be done. Let's see if he can do it," says John C. Kornblum, a former U.S. ambassador who is chairman of Lazard Germany. Unfortunately, the betting is that he can't. By Jack Ewing in Berlin, with John Rossant in Paris

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