Reform At Last?

Germany's Kohl has started down a painful but necessary path

It was a most German way of fomenting revolution. At private meetings and industrial powwows earlier this year, Germany's top industrialists repeated their refrain. Battered by the world's highest labor costs, toughest work rules, and most punishing social taxes, many had decided they couldn't invest another pfennig profitably in the homeland. The time had come for a rethinking of Germany's economic rules. Individually and in groups, they met with Chancellor Helmut Kohl at the steel-and-glass chancellery in Bonn. Their message: Germany's social contract wasn't working, and they were ready to abandon it.

A revolt by Germany Inc.'s bosses is under way, one that is calling into question the manner in which the country has done business for nearly 50 years. What began as a mutiny among owners of the Mittelstand, or small and midsize companies, has turned into a movement for deep reform. The key principles of the country's postwar social consensus--sacred tenets such as nationwide pay bargaining, sick-pay rules, and the co-determination system that gives workers seats on corporate boards--are all coming under fire. The very organizations that helped create and manage the social pact, the influential Federation of German Industry (BDI) and Confederation of German Employers' Assns. (BDA) are rallying to shake things up.

Feeling the corporate heat, Kohl has made a decision that now is the time to push for major change. Having reknit the divided nation a few years ago, he is looking to ensure Germany's future prosperity. He wants to lay the groundwork for a newly competitive Germany that will shape European economic, monetary, and political integration. His "Program for Growth and Employment" calls for a remake of Germany's tax system, an overhaul of the welfare state, far-reaching deregulation, and huge cuts in state spending (table). "The welfare state is only as good as its economic basis," Kohl argues. "The vast majority recognizes the need for cuts."

Kohl aims for spending cuts of $46 billion next year--equal to 2% of Germany's gross national product. His government readied the first package of social-welfare cuts and deregulation measures for a Bundestag vote on Sept. 13. By yearend, Bonn will also come up with a plan to simplify and cut taxes and to restore the finances of Germany's huge state pension system.

Taken together, Kohl's reforms would free Germany Inc. of many regulations, taxes, and labor rules that have shackled business and hurt competitiveness. But the reforms would also create a Germany that many workers find uncomfortable: a nation of lower taxes but fewer subsidies. An economy with greater wage inequality and less job security. And a country in which national labor leaders have far less influence, while unions at the plant level come into their own.

The system once worked well. Government handouts and employee benefits softened the rigors of the market and brought industrial peace and prosperity, especially in the Wirtschafts-wunder--economic miracle--years of the 1950s and '60s. But as global competition soared, the social pact became a job-killer, trapping Germany with the highest labor costs among major industrial economies (charts). As a result, such leading companies as Daimler Benz and Siemens have laid off thousands of workers at home while expanding abroad.

Reunification accelerated the country's tilt toward radical reform. The government is pouring $100 billion a year into eastern Germany, which has struggled to revive its economy while adopting rigid labor rules common in western Germany. Since German unemployment hit 4 million, or 11%, last spring, even the opposition Social Democratic Party (SPD) and labor leaders have been frightened into considering new ideas. Kohl realizes that failure to act now could cost him politically later on. Says Wolfgang Mainz, president of the Federation of Young Entrepreneurs: "With such high unemployment, German reunification would begin to look like a failure."

Meanwhile, a new generation of managers is adding to the momentum for change. Executives such as Daimler Benz's Jurgen E. Schrempp and Siemens' Heinrich von Pierer want to build flexibility into the postwar system of labor-employer consensus. With experience in the U.S. and in fast-growing Asian markets, they have come to view their home country's business practices as backward. They have finally convinced Kohl that the old system must be radically overhauled. Others, including thousands of owners of Mittelstand companies, are urging the chancellor to scrap the social pact altogether.

IMPASSE. Kohl's awakening began last year, when unemployment sailed into double digits for the first time since the 1930s. His first impulse was to work with the unions. Klaus Zwickel, head of the militant metal-workers' union, IG Metall, proposed an "Alliance for Jobs." It was a typical old-style solution: Unions, employers, and government would fix the problem together. Zwickel agreed to settle for no real pay raises in return for promises from employers to create jobs and from Bonn to maintain most welfare benefits. But for the first time, Kohl and big business groups refused to play ball. The main obstacle was that the unions demanded jobs before they would accept wage curbs. After talks fell through, Kohl huddled with his aides and came up with his reform plan, incorporating much of what business wanted.

As he moves to rally support around his plan, Kohl is sure to face opposition. To win approval, he may have to marshal his "Chancellor's majority" of a slim four votes to overrule the Bundesrat (the upper house), which is controlled by the opposition. Kohl will face many tough legislative battles as he pushes through his 1997 budget, tax, and welfare reforms next year. Oskar Lafontaine, Prime Minister of the Saarland and leader of the SPD, has vowed to oppose Kohl's efforts. Germany, he says, is in "a disastrous downward spiral: Real incomes are dropping, and social services are being eliminated. We have to ensure that globalization doesn't lead to a destruction of the social [welfare] state."

WELCOME SHOPPERS. Despite such warnings, Germany is already in the throes of change. The ghost-town atmosphere of most city centers in the evenings and on weekends will soon disappear. Shopkeepers are preparing for Nov. 1, when they will be allowed to stay open until 8 p.m. on weekdays and all day Saturday. Until now, stores have closed at 6:30 p.m. during the week and 2 p.m. on Saturday. After years of debate over the law, Kohl rammed it through the Bundestag in June.

It may seem a modest measure, but it's a symbolic victory. "I am convinced that things are changing more than at any other time in the 22 years I've lived here," says Thomas R. Holmes, a managing director of Frankfurt bank Schroder Munchmeyer Hengst. Adds Robert Koehler, CEO of SGL Carbon, a chemical company: "[Making] change in Germany is such a tedious and elaborate process. But now, the floodgates are starting to open."

Kohl has a big political window for his shakeup. Since he doesn't face a national election until October, 1998, he can afford to champion unpopular measures. The economy is picking up after a short recession, and there's a growing mood that reform is inevitable. For instance, while SPD leader Lafontaine rejects Kohl's plan, there are dissident views on the left. In a remarkable turnabout, for example, the SPD's Rudolf Scharping, who ran against Kohl for Chancellor in 1994, has come out in support of slashing Germany's top income-tax rate. That's a turn from the SPD's traditional "soak-the-rich" stance. Even IG Metall appears to be willing to admit the old ways must go. Says Deputy President Walter Riester: "We can't just simply continue with the passive, affluent society that we have today."

Indeed, unions are settling for flat real wages for only the second time since 1980 because they fear for their members' jobs. After IG Metall won a 6% pay raise for its workers in 1995, unions for construction, chemical, and public-sector workers have gained 1% to 2% pay increases, about the current 1.3% inflation rate. With workers running scared, employers are seizing the initiative. On Aug. 30, for example, the Construction Industry Employers' Assn. canceled a contract signed just six months ago. The employers couldn't afford to pay 5% pay raises because orders have slumped 8%.

And that's only the beginning. Companies and employer groups are pushing to scale back the national contract-bargaining system that sets hours, wages, overtime rules, and benefits for all companies in an industry, whatever their size or financial condition. Germany's corporate chiefs want to limit national bargaining to the basics: a minimum wage, an indicated pay raise, and a flexible range of hours for workweeks. Everything else, they say, should be handled by plant negotiators who understand their companies' needs. While union leaders say they'll talk about reforms, they are likely to fight to hang on to their bargaining power over wages and benefits.

The first major battle is shaping up over sick pay. Under the generous German system, workers are allowed six weeks eff with 100% pay. Because compensation is based on the amount of pay, overtime, and bonuses received before the sick leave, sick workers can earn more than they would on the job. General Motors Corp.'s Adam Opel unit reckons it routinely pays about 120% of base pay.

BIG STICK. Kohl wants to change that by slashing payouts to 80%. Companies figure that alone would save billions of dollars. Changing the law regulating sick pay also sends a clear signal to the unions, which have long deemed the benefit nonnegotiable. "They pulled out the biggest cudgel that could be swung against the unions," says Ursula Engelen-Kefer, vice-president of the German Trade Union Federation. "That was a calculated action to say: `That's the end of consensual politics. We're going to make war."'

That war has already been going on for some time at several big German companies. At Robert Bosch, the maker of appliances and auto components, managers persuaded workers to agree to seven-day, around-the-clock shifts at a $150 million chip plant that opened at Reutlingen, near Stuttgart, last October. Most German plants work no more than two eight-hour shifts, five days a week. Bosch won the concessions after threatening to build the plant, its biggest investment in a decade, in Scotland.

Media giant Bertelsmann also wrung an effective pay cut from employees. At its Mohndruck offset-printing plant in Gutersloh, workers passed up a nationally agreed upon two-hour cut in their 37-hour workweek. "For them, nothing is more important than keeping their jobs," says Bertelsmann board member Thomas Middlehof. "The first thing is to raise awareness that an entitlements mentality no longer fits the times."

For workers at Lufthansa, the situation is no better. Chairman Jurgen Weber told his 59,000 employees they may have to accept cuts in pay, vacations, and other benefits, or the airline will go bankrupt. Weber says he needs to cut costs by $1 billion over five years.

None of this comes as a surprise to the fiery new leaders of Germany's employers' organizations. "We have to cut wage costs by 20%," says Werner Stumpfe, head of the Gesamtmetall employers' federation. "The unions have to realize the present system will come to a terrible end [without changes]," he adds.

Hans-Olaf Henkel, the new president of the BDI employers' group, is also warning that the golden days of labor-management cooperation may be over. He is known for labor-bashing from his time as a CEO, when he pulled IBM Deutschland out of union contracts.

Yet even as Corporate Germany presses its campaign, there are limits to what it can achieve without Kohl paving the way. Germany is not unlike Britain and the U.S., where pressures for fundamental change first came from business, but Margaret Thatcher and Ronald Reagan pushed through major tax reforms and deregulation. Kohl, too, is launching his reforms with a tax cut to gain support among middle-class Germans. He wants to slash the top personal income-tax rate from 57% to 40% and slice the top corporate rate from 65% to 40%, beginning in 1999. That could put as much as $20 billion into taxpayers' pockets.

TOSSING THE BOOK. Meanwhile, Kohl must build support for rolling back the welfare state. Already in 1997, he is planning a $13 billion cut in spending on health and social welfare. At the same time, he aims to cut the government bureaucracy by 1.5% a year. And as the government shrinks, so should red tape. Kohl is planning to throw out many of the 84,000 federal rules and regulations affecting business.

As Kohl readies Germany for momentous change, all of Europe is watching. A more competitive Germany, with lower taxes and less onerous regulations, could become a magnet for investment and job creation for the first time in years. It's no coincidence that across the Rhine, French Prime Minister Alain Juppe is now promising tax cuts and reforms that echo Kohl's.

Of course, Kohl's reform effort has a long way to go. But luckily for the chancellor, his electorate is one of the few in the world with a record of voting for austerity when it's necessary. Clearly, German business leaders and Kohl believe the comfortable days of labor-management consensus are over. Now, they must convince ordinary Germans that there's no turning back.

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