Merkel Seen Neglecting German Needs With Focus on Euro

Sept. 23 (Bloomberg) -- Chancellor Angela Merkel spoke with her Social Democratic opponents as she began the search for a third-term coalition partner that will allow her to leverage the biggest electoral victory in more than 20 years. Hans Nichols reports on Bloomberg Television's "In The Loop." (Source: Bloomberg)

Angela Merkel’s third term, after her overwhelming election victory yesterday, is likely to force a decision on where to spend political capital: on Europe’s ills or Germany’s.

While Germany ranks fourth in the global competitiveness study by the World Economic Forum thanks to policies enacted by her predecessor Gerhard Schroeder, the challenges are piling up. Merkel must address the aging population, shortfalls in education and infrastructure spending and ballooning pension costs, say policy makers, economists and investors.

The German Chancellor, who has guided Europe’s largest economy through its worst postwar recession and dominated the response to the euro area’s financial crisis, is drawing parallels with her mentor Helmut Kohl. The four-term leader entered history books as the architect of German unification and European integration, priorities that ultimately resulted in rising unemployment and recession.

“We ignore the fact that we’re wearing our resources down,” said Marcel Fratzscher, president of the DIW German Institute for Economic Research in Berlin. “There’s the danger that we’ll experience a similar reform stalemate to that of the 1990s.”

About half of the Germany’s growth over the past decade has come from exports and at $239.8 billion, the country ran the biggest external surplus in absolute terms, according to World Trade Organization data.

Photographer: Krisztian Bocsi/Bloomberg

German Chancellor Angela Merkel, party leader of the Christian Democratic Union, smiles during victory celebrations at the CDU headquarters after the German federal elections results were announced in Berlin, on Sept. 22, 2013. Close

German Chancellor Angela Merkel, party leader of the Christian Democratic Union, smiles... Read More

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Photographer: Krisztian Bocsi/Bloomberg

German Chancellor Angela Merkel, party leader of the Christian Democratic Union, smiles during victory celebrations at the CDU headquarters after the German federal elections results were announced in Berlin, on Sept. 22, 2013.

‘Sick Man’

“If we don’t continue reforming, we’ll be the ‘sick man of Europe’ again in five to 10 years,” European Central Bank Executive Board member Joerg Asmussen said in a speech in Dautphetal-Buchenau on Aug. 27.

Merkel has said her first post-election priority will be tackling surging energy costs that have resulted from her 550 billion-euro ($744 billion) plan to mothball atomic reactors and more than triple the share of renewable sources.

So far, Merkel has mostly reaped the benefits of Schroeder’s reforms as she pressed countries in Europe’s periphery to adopt similar policies, said Christoph Kind, head of asset allocation at Frankfurt Trust in Frankfurt.

“Germany has put up its feet in the past years while other countries embarked on a tough course of structural reforms,” he said. “That can’t continue forever but we haven’t yet reached the level of suffering that would set off reforms.”

Schroeder, Social Democratic chancellor from 1998 to 2005, cut taxes, unemployment benefits and health-care services from 2003 in the biggest change to the German welfare system since World War II. The so-called Agenda 2010 and flexible work models that allow companies to react to booms and busts turned Germany into Europe’s growth engine.

Outperformed Euro

Germany’s economy has outperformed the euro area since 2010. The European Commission predicts growth of 0.4 percent this year and 1.8 percent next, compared with a contraction of 0.4 percent and an expansion of 1.2 percent in the single-currency zone.

“What we did economically has made us stronger,” Schroeder, 69, said on Aug. 20. “Because of it, we navigated the financial crisis better than others. What’s worrying me now is that since then hardly anything has happened.”

Not much more will happen, Merkel herself has indicated.

“We don’t need fundamental, new social and economic reforms because social-insurance funds are well funded due to the pleasantly favorable employment situation,” she said in an interview with Superillu magazine published on Sept. 10.

Rising Risks

Merkel’s CDU has recognized the country’s challenges, yet tangible measures are absent in its election program, increasing the risk Germany will suffer from a Kohl-style reform stalemate.

Kohl, 83, who served as German chancellor from 1982 to 1998, oversaw the country’s 1990 reunification and was a driving force behind Europe’s economic and monetary union. He also underestimated the impact of the eastern states posed to the German economy.

Instead of the “flourishing landscapes” he promised, economic growth in the East faltered and unemployment surged to twice that of the western level. As the decade progressed, the slowdown spread.

“After setting the political course following Germany’s reunification, Kohl’s will to shape the country languished and was replaced by a sense of lethargy,” said Andreas Scheuerle, an economist at Dekabank in Frankfurt. “He was a European of outstanding merit without being a man of action at home.”

Small Steps

Merkel has steered clear of groundbreaking changes after a set of proposed market reforms dubbed the Leipzig Program flopped and almost cost her the 2005 election. Her reform efforts are not so much a “big bang” but a “series of small steps,” the Cologne Institute for Economic Research institute said in March.

Fratzscher’s DIW calculates that Germany has accumulated an investment lag of 1 trillion euros since 1999, more than 37 percent of last year’s output. About 20 percent of freeways, 41 percent of federal highways and 46 percent of freeway bridges are in critical condition, the institute said. Net investment declined in eight of the past 12 years and, at 56 billion euros in 2012, was about a third of that of 1991, according to the Federal Statistics Office.

Demographic shifts are adding to the challenges. Germany already has the world’s second-oldest population and one of the lowest birth rates, according to the CIA Factbook. The consulting firm McKinsey & Co. estimates that the country will lack at least 4 million skilled workers by 2025 and recommends targeted immigration and increasing labor-market participation of women and pensioners to fill the holes.

Aging Society

The aging society is also threatening to shake the social-welfare system. The share of people above the age of 60 will jump to 37 percent by 2050 from 27 percent last year, while the number of working-age people supporting one pensioner will drop to two from three, according to the United Nations’ Department of Economic and Social Affairs.

Room for reform also exists in the country’s health-care system, the regulated services sector and the sprawling bureaucracy of regional administrations. Yet, the chance for action in the next four years is rather slim, said Holger Sandte, chief European analyst at Nordea Markets in Copenhagen.

“Merkel doesn’t have the drive to reform the world and economic policy isn’t close to her heart,” he said. “She won’t enter history books as a reform chancellor, rather as a preserver. But she could have also screwed up.”

To contact the reporters on this story: Jana Randow in Frankfurt at jrandow@bloomberg.net; Birgit Jennen in Berlin at bjennen1@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net

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