Kohl: Damned If He Does...

The Chancellor's choice: Hang tough on EMU--or appease voters

It's almost as if the water in the government offices of Paris and Bonn contains chemicals that induce self-destructive behavior. First, former French President Jacques Chirac called early elections to cement his power--only to be trounced by the Socialist opposition. Now, German Chancellor Helmut Kohl is finding that the goal on which he built his political identity, European monetary union, could cause his government to collapse.

The trouble is that with the German economy faltering, EMU puts Kohl in a bind that is straining his center-right governing coalition nearly to the breaking point. If he sticks to his vision of a single European currency that's as highly valued and stable as the German mark, German voters will rebel against the austerity needed to achieve it. If he backs down, allowing easier terms for EMU and a weaker new currency, voters will revolt against exchanging their trustworthy marks for the new euros. The cracks in his government could force Kohl into forming a new coalition or even calling elections in the next month or two--more than a year ahead of their fall 1998 timetable.

MIXED SIGNALS. Aggravating Kohl's political crisis are mixed signals from France's new Socialist government on how tough the EMU rules should be. On June 9, new French Finance Minister Dominique Strauss-Kahn strode into a meeting of European Union finance ministers in Luxembourg and announced that France wasn't ready to sign the so-called stability pact they were assembled to approve. That agreement, so far staunchly supported by Germany, would fine EMU countries that don't adhere to strict fiscal limits on deficits and inflation. The next day, the French made reassuring noises that they didn't intend to modify the pact, while German and EU officials scrambled to add phrases about growth and job creation to its language.

But while the politicians in Paris see-saw between playing to their constituencies and acting like euro boosters, Kohl's clock is running out. Right now, Germany itself does not meet the criteria for EMU, which call for a budget deficit no higher than 3% of gross domestic product. The German number is forecast to come in at 3.4% this year. German Finance Minister Theodor Waigel is desperately trying to avoid tax hikes, since they would enrage the Freedom Democratic Party, a minority partner in Kohl's center-right coalition. Instead, to help plug the $10.6 billion budget gap, Waigel is considering unpopular--and not very effective--measures such as cutting the Christmas bonuses of public employees.

The possibility that France may call for looser terms for EMU when European leaders meet at an Amsterdam summit on June 16-17 makes more likely a political showdown in Bonn between the tough-euro and pro-growth factions. Like the French, German voters are fed up with budget cuts at a time when 11.4% of them are out of work. On June 6, Bonn announced that German joblessness had unexpectedly jumped in May by a seasonally adjusted 56,000, raising unemployment to a postwar record of 4.36 million.

The financial markets' gyrations in response to the news illustrate the risks for Kohl of a faltering euro. When the French signaled they may turn thumbs-down on the stability pact, the German mark jumped by 1% against the U.S. dollar and the French franc, as investors sought security in Europe's strongest currency. If the mark keeps appreciating, it could strangle German exports, depressing the nation's already feeble 2%-or-so economic growth this year. "The risks this summer for Germany are considerable," says Deutsche Bank chief economist Norbert Walter.

Yet Kohl may opt for a weaker euro to keep his coalition government alive. Some analysts predict a compromise that would let countries enter EMU with a deficit of 3.5% or 4% of GDP. That would ease the strain on Kohl's own budget and probably maintain the support of the Free Democrats. It's a move many companies might support. They want a working euro because it would make capital markets more efficient. And a weak euro would boost their exports. "I don't think Europe has any alternative but to push ahead with the euro if we want to compete with Asia and America," says Horst Waesche, a member of the management board at drug and chemical giant Hoechst.

Even if Kohl can save face on EMU, he still has the dicey task of getting his domestic economy back on track. German economic growth won't relieve unemployment by much, so despite his budget woes, Kohl will try to stimulate the economy. Waigel is expected to introduce the first draft of his 1998 budget on July 11, and business groups expect him to try to boost investment by slashing corporate income taxes to 35%, from 45% now. There also may be some easing of the personal income tax, which has a top rate of about 57%.

"CRISIS TO CRISIS." It will take bolder reforms, however, to make Germany grow again. Labor regulations are business' biggest problem. The nation's chemical workers recently agreed to a widely hailed, flexible labor contract that reduces pattern bargaining and allows distressed companies to pay lower wages. But such an accord may not save many jobs. Costs are so high that, over the next few years, chemical giant Bayer plans to cut its 66,000-member German workforce by about 1,000 employees a year. And it plans to invest $3.45 billion in the U.S. through 2000, vs. about $2.35 billion in Germany. "What we need urgently is a breaking up of the labor cartels," says Thomas Mayer, a Goldman, Sachs & Co. economist in Frankfurt.

Given his political woes, though, few expect Kohl to attempt the structural reforms Germany needs. "Political reforms will come slower than we hoped," laments Gerd Scholze, owner of an engineering company in Stuttgart. "The flight of capital and jobs will increase." Adds Klaus Friedrich, chief economist at Dresdner Bank: "We seem to be moving from crisis to crisis. That's a difficult environment in which to do structural reforms."

Indeed, as Kohl struggles with the EMU dilemma, German competitiveness continues to erode. Hourly manufacturing wages in Germany have soared nearly 40% since 1988, to $31.44 last year, compared with about $15 in Britain and the U.S., where they hardly budged over the same period. And benefits amount to 80% of German wages vs. about 40% in the U.S. and Britain. "We have to reform our tax system, health-care system, and pensions," says Hoechst's Waesche. "These are the prerequisites to turning Germany around." With Kohl fighting for his political life, though, these aren't the issues he's likely to tackle first.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE