Commentary: When Will Germany Stop Sleepwalking?

The German economy is growing at a brisk 3% rate, and corporate profits should jump more than 40% this year. Anywhere else, it would be time to celebrate after four years of tough cost-cutting. But in Germany's executive suites, a deepening pessimism has doused the party mood. "This country is in trouble," asserts one prominent businessman.

Peer behind the economic data and you can see why business is in such a funk. Wages are high and rising, hefty social security taxes are increasing, and the over-valued German mark is menacing the export-led recovery. Worse yet, everyone is blaming someone else. Seen from the boardroom, the culprits are dilatory government and greedy labor unions. In union committee rooms and Bonn Cabinet offices, even if it sees the problems, each group fingers the other two as the guilty parties.

In reality, there are no innocents in Germany's slow-motion, but deep-running crisis. The key problem is that government, labor, and business all cling to the outmoded social consensus that ensured labor peace and nurtured economic success after 1945. Trouble is, the old social pact depended heavily on two hidden pillars: Relatively protected national markets and widespread capital controls that shielded Germans from too many outside pressures.

DISMAL RESULTS. But now the Asian Tigers have elbowed their way into world markets, while the fall of the Berlin Wall has allowed millions of skilled but low-paid workers to compete with Western Europe's laborers. In finance, billions of dollars of hot money now slosh around the globe daily, swiftly distorting one national economy after another. Even Germany risks punishment by the traders.

The trigger won't be bloated government debt of the sort that causes runs on the Italian currency. It will be the terrible performance of German companies burdened by their high costs. Return on equity in Germany, figures Morgan Stanley, is about 6.75%, well below the 16% in Britain and 17%-plus in the U.S. If such dismal results persist, investors will shun German securities for opportunities elsewhere. "[Foreign] capital is free to move and look for the best returns," says Markus Rusgen, Germany analyst at Morgan Stanley & Co. International Ltd. in London. "It doesn't care whether Germans believe in some sort of social [welfare] market capitalism."

Yet most Germans are curiously unaware of the gravity of their situation. And business leaders, who know what's at stake, don't seem to have the stomach to tackle the problems. One example: After two years of productivity gains and wage moderation, engineering and metal-working employers conceded huge pay increases this spring to the ig Metall union.

This makes a bad situation worse. The German Auto Makers Federation (vda), estimates that U.S. and Japanese unit labor costs will average 55% and 56%, respectively, of their German competitors' costs this year. The contrast with Eastern Europe is even more striking. Says Heinrich von Pierer, ceo of engineering giant Siemens: "Just the increase in hourly wages and benefits [this year] is more than half the total hourly cost of a Czech worker."

TAX ON TAXES. Adding to Germany's runaway costs is the gold-plated welfare state. Social levies already double average wage costs, but there is still no serious attempt to overhaul the system. Warns McKinsey & Co.'s Germany chairman, Herbert Henzler: "We are just muddling through."

Chancellor Helmut Kohl's government, faced by a strong Social Democrat contingent in parliament, is doing little. This year, instead of pruning benefits to finance the costs of long-term elderly care, the government slapped on an extra 1% payroll levy. This comes on top of a 7.5% surcharge added to every income tax bill, a sort of tax on taxes, starting on Jan. 1. The payroll taxes are so heavy that the jobless--now 9.6% of the workforce--are often better off staying on the dole. Idled workers with one child get 67% of their previous net pay for 15 months. Agrees a senior German official: "There are too many disincentives to work."

It's clear what government, business, and labor should be doing. Bonn needs to cut taxes and eliminate $100 billion in subsidies to special interest groups. Business must press on with the task of making German industry globally competitive. Unions must realize that fighting for a bigger slice of the national cake is self-defeating when the cake stops growing. Yes, it means a painful recrafting of Germany's cherished social consensus, which once produced an economic miracle. But unless Germans tackle this task, they risk massive social turmoil--with frightening implications for Germany, Europe, and the world.