Germany: Is This Schroder's Moment?

A Socialist may take the reins at a turning point for Germany--and Europe

By the time the candidate arrives just after 5 on this dank Friday evening in Frankfurt, a cold rain is falling. But the crowd gathered to rally for Gerhard Schroder, the Socialist who aims to oust Helmut Kohl as Germany's Chancellor, is unfazed. As Schroder pushes onto the stage, his craggy features glowing in the spotlights, the applause is wild. Never mind that his speech is little more than slogans about "modernizing" the economy and ensuring "fairness" for Working people. The crowd loves it. "The Socialists will taKe from the rich so that everyone can live," says Svenja Haeder, 18, a high-schooler who came in from the suburbs with her parents to cheer Schroder. "That's fair. Everyone should be safe."

Meet Continental Europe's rising political star. His "New Middle" program aimed at bridging the gap between business and labor is vague, and his Social Democratic Party (SPD) may win by only a narrow margin when Germans head to the polls for parliamentary elections on Sept. 27. But this onetime radical lawyer from the state of Lower Saxony has touched a nerve with his countrymen, who after 16 years are tired of government by Kohl and his Christian Democrats--and worried about their economic future. Although Kohl has a chance to pull off a last-minute victory in the German vote, polls show that Schroder could win by at least a three-point margin. Some say the election is too close to call.

PIVOTAL POINT. The election is a watershed event for Germany--and for Europe. If Schroder wins, the media-savvy, 54-year-old will be the first representative of Germany's postwar generation to govern the country. His goals and style of leadership would contrast with those of the 68-year-old Kohl, who has earned a place in history by shepherding grand projects such as German reunification, aimed at undoing the damage of the cold war. Perhaps most important, Schroder would take the reins at a turning point, just as Germany jettisons its beloved mark and Europe launches its single currency, the euro.

How Schroder leads Germany would have a decisive impact on Europe's economic and political direction into the next century. He would not only head the largest economy but would play a key role in defining Europe's relationships with the U.S. and Asia. His policies would help determine whether Europe as a whole is competitive, whether its currency will be strong, and whether its trade policies will be open. Germany's political agenda on expanding the European Union eastward will also matter greatly, especially as Germany's government moves to Berlin in 2000.

At the same time, though, Schroder faces dangerous and unpredictable economic forces, many of them largely beyond his control. Germany's recovery is already sluggish (charts, page 21). But now, the financial crises in Asia and nearby Russia are threatening to slow growth further and wipe out any prospect of cutting the punishing 10.9% jobless rate. The uncertainty has driven up the mark by 6% in a matter of weeks, potentially hurting exports. Deutsche Bank economists figure there's a 40% chance that the global crisis will cut Germany's economic growth from close to 3% next year to around 2%.

That these crises loom just as Europe is grappling with key decisions on the euro is profoundly worrying to business and political leaders alike. "There's a lack of leadership worldwide right now," says Horst Telschik, a BMW board member, once a top aide to Kohl. "That's a major concern in Europe with the euro coming." Adds a Frankfurt financial executive: "If Germany swings in the wrong direction, it's going to be a pretty tough few years for Europe."

As Chancellor, Schroder would face a stark choice: He could cast himself as a new-style Social Democratic Chancellor and use his considerable communications skills to convince Germans--his own left-wing supporters, above all--that their government must whittle away at the cushy benefits they've enjoyed since the 1960s. That would mean spurring growth with sharp cutbacks in social benefits such as sick pay and state pension contributions and flexible hiring and firing rules. In essence, Schroder would try to pull left-wingers to the center of the political spectrum, just as Britain's Labor Prime Minister Tony Blair has done. Or Schroder can cater to the core of his party, which is controlled by old-line Socialist Oskar Lafontaine. That would mean opting for populist measures such as wealth taxes and high-spending jobs programs.

Schroder, who has served as prime minister of the state of Lower Saxony since 1990, will likely choose the populist route--at least initially. As a regional politician, he has often opposed tough or radical changes, then flip-flopped once the public accepted them. He proposed delaying the introduction of the euro, for instance, then later changed his mind. Meanwhile, to win votes during his reelection campaign in Lower Saxony earlier this year, he used state funds to rescue a local steelmaker from a threatened takeover by an Austrian company. Christian Wulff, the leader of Lower Saxony's Christian Democrats, who lost to Schroder, derides him as an opportunistic "Zeitgeist surfer." Adds Christoph Bettag, CEO of Siso Textil, a Mittelstand company in Aachen: Schroder "doesn't seem to have a real opinion on most things."

What's unknown, of course, is how the new Chancellor would govern once he settles into his office and comes to understand better the economic challenges facing Germany. His room for maneuver would be determined partly by the election's results. If the SPD gains a large bloc of seats, he is expected to form a government with the Green Party--giving the Socialists a majority in the Bundestag, or Lower House, which Kohl currently controls, as well as in the Upper House. That would break the legislative gridlock that has paralyzed the German government. But it would also put Schroder under the sway of Lafontaine and the left-wing Greens.

The other possibility is a grand coalition between the Social Democrats and the Christian Democrats, only likely if the Socialists' margin of victory is narrow. Then, Schroder would not only have to deal with factions in his own party but would have to constantly compromise with Wolfgang Schauble, a tough, probusiness conservative. Kohl is expected to hand over leadership of the party to Schauble if the Christian Democratic Union doesn't win enough votes to form the government.

For now, Schroder's program tilts strongly to the left. He has pledged to roll back some of the limited reforms that Kohl implemented, such as cutbacks in sick pay and pension payouts. He plans only modest cuts in the top corporate and personal tax rates, which range up to 45% and 53%, respectively. He says he will not cut Germany's overall tax base or slash social spending sharply. Any income-tax cuts will likely be offset by hikes in the tax on gasoline, which already costs $3.60 per gallon.

DUTCH MODEL. To battle unemployment, Schroder wants government, labor, and business to devise a plan that would exchange wage moderation and labor flexibility for more hiring by companies. "Labor flexibility? Fine. But the companies have to share the benefits," Schroder says. Such an approach has cut joblessness in the Netherlands to under 5%, he points out. Although labor leaders publicly back the idea, many executives doubt Germany's unions will accept low wage hikes and part-time work, as the Dutch unions did. Even Jost Stollmann, the entrepreneur Schroder has tapped as his Economics Minister, worries that government and labor might dictate hiring policy to companies. The plan "can be a forum for dialogue, but not for decisions about jobs, not in a market economy," Stollmann says.

Another controversial proposal, which has been pushed hard by Lafontaine, is to reinstate a wealth tax that would cover unrealized gains on shareholdings. While the measure is popular with grassroots Socialists, executives hate the idea. Declares Hasso Plattner, co-founder of software giant SAP: "I would have to pay $75 million to $85 million a year, depending on the share price." If such a measure passes, he warns, "Germany will lose its high-tech industry."

Many German corporations are hoping for a grand coalition--or best of all, a last-minute Kohl win. Business leaders blame Kohl for waiting until the past two years to try to rEform the country's tax and welfare systems. But they think He finally understands the need for reforms and would make a strong push for change if reelected. Failing that, they think Schauble could act as a moderating influence on Schroder and Lafontaine in a grand coalition. "I do not see much tax and pension reform coming under a Socialist-Green coalition," says Jurgen Dormann, CEO of drug giant Hoechst. "A grand coalition has a chance, especially with Schauble playing a strong role."

Up to now, German companies have been restructuring the economy largely on their own--without government help. Thanks to corporate efforts to boost productivity, the return on capital for German business has jumped to an estimated 15% this year, up from 12.1% in 1993, according to estimates by the Organization for Economic Cooperation & Development. That's partly because local union representatives, fearing further job losses, cooperated in granting breaks in wage and work rules. By one count, more than half of the nation's smaller Mittelstand companies have opted out of nationwide bargaining agreements. As a result, Germany's unit labor costs have dropped nearly 1% annually on average over the past three years, estimates Goldman, Sachs & Co.

The trouble is, German restructuring has never entered the important second phase--the one where investment leads to real job creation. The unemployment rate has dropped a full point this year, to 10.9% recently, but that's largely because of preelection spending on makework programs in the East. With labor so expensive, German companies have been channeling their new investment funds to lower-cost places such as Central Europe. Indeed, last year, the net outflow of investment totaled $34 billion--nearly three times more than in 1994.

Many executives believe Germany must cut taxes, slash government spending, and revamp labor rules far more than Schroder is likely to do. Their hope is that market forces already gathering pace--from global mergers to deregulation--will force even a Socialist government to implement some of these reforms. German auto giants such as BMW, which produces its sexy Z3 roadster in the U.S., and Daimler Benz, which recently merged with Chrysler Corp., already pay more attention to American than German rules of competition. These companies could put pressure on the government to change everything from executive compensation to union rules.

Schroder would have to react, too, to sweeping economic changes inside the European Union, from deregulation to the euro. Under an EU mandate, for example, Germany opened its telecommunications market in January, creating what Deutsche Telekom Chairman Ron Sommer calls "the most liberal telecom market in the world." Some 200 rivals are nipping at Deutsche Telekom's heels, forcing down prices as much as 50%. With deregulation planned in energy and postal deliveries, "it's too late for backtracking," says Ulrich Hartmann, CEO of utility giant VEBA. If he becomes Chancellor, Schroder would have to decide whether to encourage deregulation or buck his EU partners and try to slow it.

SHACKLED. He would face a similar dilemma on macronomic policy. Once the euro is introduced, the new European Central Bank will steer monetary policy. With the German mark gone, the government's main control mechanism will be fiscal policy--in other words, controlling spending. But the European Monetary Union limits government budget deficits to 3% of gross national product. It would mark a giant, and controversial, step, if Schroder were to relax the budget rules. Indeed, it's the business lobby's greatest fear, but most executives hope monetary union would keep a Schroder government in line--if not spur reform. "The euro will lead to more deregulation, more open markets, and less bureaucracy," predicts Commerzbank CEO Martin Kohlhaussen.

In Germany, as in other leading industrialized countries, what's needed right now is a real leader. No matter how close the race, if Schroder wins, it will be because Germans believe he can finally provide jobs in a country that's been losing them for years. True to his slogans, the new Socialist Chancellor may feint left at first, but harsh realities are bound to soon limit his options. Like Lionel Jospin, France's Socialist Prime Minister, Schroder could well be forced to move toward the center, even if many in his own party don't like it. How he chooses to get there could set the tone for German--and European--politics for years to come.

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