German Chancellor Angela Merkel’s economic machine is beginning to show signs of neglect.
As the continent’s growth engine and self-appointed fiscal paragon orders budget cuts for its peers, investors, economists and policy makers are starting to warn Germany is turning a blind eye to its own weaknesses. Joerg Asmussen, a European Central Bank board member nominated by Merkel, has gone as far as to predict a return to the status of “Sick Man of Europe” should they go unfixed.
Without Merkel and a largely supportive German electorate ready to back over 300 billion euros ($393 billion) in bailouts and guarantees, Europe’s debt crisis could have already broken up the single currency. At the same time, the drive to rescue Europe has distracted her from signs of economic drift at home as labor costs rise at the fastest pace in a decade, erasing most of the progress made under predecessor Gerhard Schroeder.
“Merkel has had to work with the cards that history has dealt to her and Europe has been a priority,” said Irwin Collier, professor of economics at the Freie Universitaet in Berlin. “But you have to do a lot of things at the same time, and it’s clear now things have to change at home too.”
The chancellor, in office since 2005, thus far has had to do very little to the economy.
The unemployment rate sank to the lowest since east and west were reunited in 1990 as companies from Bayerische Motoren Werke AG to Siemens AG helped Germany maintain its place as the world’s largest exporter after China.
The benchmark DAX Index rose 29 percent in 2012, its best year in nine. The yield on 10-year benchmark bunds was 1.48 percent today, down 37 basis points from a year ago.
That boom is partly down to the so-called Agenda 2010 package under Schroeder, who cut taxes, unemployment benefits and health-care services from 2003 in what was seen as the biggest change to the German welfare system since World War II. It ultimately cost him his job.
Merkel, 58, now faces her third general election in September or October, with the economy projected by the Bundesbank to expand by as little as 0.4 percent over the course of the year. Industrial production increased less than economists predicted in November, rising 0.2 percent from the previous month, the Economy Ministry in Berlin said today.
In her New Year’s television address, she warned that the debt crisis is “far from over,” and the economic environment could be yet more difficult in 2013.
“Until now Merkel has been able to profit from the inheritance of her predecessor,” said Juergen Michels, chief euro-area economist at Citigroup Inc. in London. “But now something really has to happen, otherwise in a few years things are going to look quite different.”
Eurostat data show that the cost of Germany’s workforce is on an upward path while the competitiveness of euro area peers like Spain is improving.
Unit labor costs have risen more than 3 percent since 2009, compared with an almost 7 percent decline in Spain over the same period, figures from the European Union’s statistics arm show. The cost of German workers has risen an estimated 8.3 percent since Merkel came to power.
Germany has been in a similar situation before, with the political and economic burden of saving the euro akin to the effort of integrating the former East Germany after the fall of the Berlin Wall in 1989, according to Gerd Langguth, Professor of Political Science at the University of Bonn and Merkel’s biographer.
At that time, Helmut Kohl, chancellor from 1982 to 1998 and Merkel’s mentor, arguably let the economy stagnate while he was engaged elsewhere. Unemployment swelled to 11.1 percent in the reunited country in 1998 or 9.2 percent in Western Germany, from 6.4 percent in the West in 1990.
“When it came to Europe, Kohl at that time solved a lot of things by throwing money at the problem,” Langguth said. Now, even as Merkel has backed euro-area rescues with cash and guarantees, “Germany itself has to cut back, so she can’t really do this much longer.”
Germany’s looming difficulties are largely demographic. While there are currently four people of working age for every pensioner, within 20 years there could be as few as two, according to Eurostat. Though many European countries face a similarly ageing society, Germany’s problem is the most acute.
A decline in the maximum number of people employable in the economy also depresses potential growth.
At about 1 percent per year, the long-term forecast for gross domestic product growth is the lowest for any member of the Organization for Economic Cooperation and Development. Japan, which already suffers the effects of a population living longer, has the next lowest.
“Aging will clearly cost growth and there is no clear strategy on how to tackle this problem yet,” says Carsten Brzeski, an economist at ING Group in Brussels.
The problem of a shrinking workforce might be eased by encouraging people who can work, though don’t to take up jobs, lowering the cost of hiring and firing, and making it easier for companies and workers to agree on wage levels, according to the World Economic Forum. The WEF ranks Germany 112th out of 142 countries in terms of the flexibility of its labor rules.
While the percentage of women who work in Germany is high compared with the average of industrialized countries, more than 60 percent of those between 25 and 54 with children work part time, according to OECD figures. Only a quarter of French women in the same position choose to go part-time.
Merkel’s government pledged to increase the number of childcare places available for working parents. At the same time, the coalition in November approved new benefit payments for families looking after their children at home.
Christian Schulz, an economist at Berenberg Bank in London, describes that move as an “electoral gift.” “It is an example of policies that are backtracking on the reforms made earlier,” he said. “It does not promote employment.”
Then there’s the skills issue, according to ECB board member Asmussen. The workers of tomorrow aren’t getting the education they need to compete globally, he said.
A former state secretary in the finance ministry, Asmussen took the performance of German universities to task in a speech on Dec. 6 in Frankfurt. There isn’t a single German university in the world’s top 50, according to the 2012 U.S. News World’s Best Universities Ranking.
“Germany is seriously lagging behind in science and mathematics education,” said Asmussen, 46, with a master’s degree in business administration and a diploma degree in economics. “That is of course a problem for a country that prides itself on manufacturing high-quality products.”
Without reforms, “within five years Germany will again have the title ‘Sick Man of Europe,’” he said.
The success of the German economy has been down to more vocational training, the technical apprenticeship system, said Andreas Scheuerle, an economist at Deka Bank in Frankfurt.
“But when it comes to creating the products for the future, then we really need the universities,” he said.
Still, with unemployment near a 20-year-low and locally made high-technology machinery and automobiles achieving record sales across the globe, Germany doesn’t look like a country on the verge of economic malaise.
That’s bolstered Merkel’s popularity. Four out of five Germans think she is performing well as chancellor, according to the ZDF Politbarometer. If Germany’s election took place now, 40 percent would vote for Merkel’s Christian Democrats, leading the Social Democrats by 10 percentage points.
Merkel’s buoyancy in the polls might also be down to her government’s claim that wages rose an average 2.6 percent last year as unions brokered deals boosting pay by as much as 6.5 percent. Productivity isn’t keeping pace with wage deals either, with Eurostat estimating a decline of 0.2 percent in 2012 and growth of 0.5 percent in 2013.
That’s worsening Germany’s competitive position. Since 2010, the country has lost its top-five spot in the World Economic Forum’s competitiveness index to Japan.
“The worry that German competitiveness will be endangered over the long term if reform efforts aren’t begun is completely justified,” said Christoph Kind, head of asset allocation at Frankfurt Trust, which manages about $20 billion. “Since Merkel has been in power, there hasn’t been any reform at all.”