`A Fiasco For Germany'

As Kohl's tax reform stalls, CEOs send jobs and capital abroad

Just when it seemed things couldn't get much worse for Germany, they did. Despite forecasts of accelerating economic growth, the country's woes--punishing unemployment, a plummeting currency, and government paralysis--have cast a pall over the summer holidays. Then, in late July, the Bundesbank signaled it might raise interest rates for the first time since 1992. And a political showdown snuffed out Chancellor Helmut Kohl's tax reform package, which business badly needed.

In a country that has waited six years for its economy to regain vitality, the malaise may be reaching a crisis point. It's not just the 4.4 million jobless who feel the system has let them down. The upper echelons of business and academia are growing more negative by the day on Germany's "consensus capitalism." And politicians have so far refused to risk decisive action. Indeed, the impasse over taxes has sent a frightening signal that other needed economic reforms will stay on the back burner until after parliamentary elections in September, 1998.

Executives are furious at Bonn. "We need the politicians to give us a reasonable framework and the freedom to [compete]," says Manfred Schneider, CEO of chemical giant Bayer Group. Adds Peer Schatz, chief financial officer of biotech company Qiagen: "Just when we need leadership, we have a government that can't get anything done. It's very disillusioning." A BMW exec calls reform's failure "a fiasco for Germany."

Corporate ire will drive Germany into worse trouble. So far, the recovery has been propelled by exports, made more competitive on world markets by the weak mark. With unemployment stuck around 11%, consumer demand has been sluggish. As exports lifted profits, the government had hoped companies would start expanding domestic factories and adding personnel later this year.

Instead, disgusted CEOs are likely to keep sending jobs and capital abroad, where wages and taxes are lower. The outflow of direct investment from Germany hit $25 billion in 1996, double the 1993 level. That stream could turn into a torrent if Europe, as planned, shifts to a single currency in 1999, because German companies will no longer face any exchange-rate risk if they relocate to, say, Spain or Portugal.

Economists had predicted that tax reform would offset the relocation trend, adding as much as a percentage point to gross domestic product growth in 1999. No more. "This is a disaster for the German economy," says Bank Julius Baer economist Gerhard Grebe. He predicts GDP growth will top out at 2.7% next year and drop again in 1999 to 2.5%. Such growth rates aren't nearly enough to make a dent in joblessness.

LOOKING FOR HAVENS. Fears of an interest-rate hike are adding to the negative vibes. The mark has plunged 21% this year, to about 1.88 per dollar. If it keeps dropping, many analysts believe that inflation worries will force the Bundesbank to phase in higher short-term bank rates. Most analysts figure the central bank will do all it can to avoid raising rates, but "the odds are going up" that it will have to act, says Kermit Schoenholtz, London-based global chief economist for Salomon Brothers Inc.

No wonder capital is going on strike against Germany. Last year, foreign companies repatriated all their German profits--a net $2.6 billion. That's the first outflow in years. Domestic companies aren't spending as expected, either. And some are taking radical action. Geers Horakustik, a 470-employee German hearing-aid company, may move its purchasing operations to a tax haven abroad. Says CEO Volker Geers: "It's clear now that costs [in Germany] are only going to rise."

Ironically, Germany's stock index keeps reaching new highs. While Bonn dithers, corporate chieftains have shouldered the burden of trimming costs and focusing on shareholder value. As a result, the DAX is up 49% year-to-date. But since companies are boosting profits largely by exporting employees and capital, the stock euphoria doesn't reflect the economic climate. Without reform, more German companies will keep trying to flee high taxes and wages. Stock boom or no, that means the German economy will only get hollower.

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