How Far Left Will Europe Lean?

Business fears Europe's new leaders will derail tough economic policies

It was hardly the debut that business had hoped for. On Oct. 11, the leftist coalition of German Chancellor-elect Gerhard Schroder announced a tax plan so tepid as to be ineffectual. Although personal and corporate tax rates technically will fall, the cut will phase in over three agonizing years. Meanwhile, the plan closes so many business tax loopholes that companies are likely to come out losers. "Everybody had expected more drastic tax cuts," says Horst Teltschik, a BMW board member and former aide to Helmut Kohl.

The move sent a disheartening signal to those anxiously wondering which way Europe's left will tilt in setting policy. Self-styled center-left governments now control 13 European nations. In good economic times, the centrists have held sway. But in a climate of slowing growth, Schroder and French Prime Minister Lionel Jospin face a credibility crisis. Elected on promises to reverse chronic unemployment that hovers around 11.5%, they must cover their flanks on the left or watch their popularity erode. Business fears that under such economic and political pressure, Continental Europe will drift toward high government spending, delay reforms, and remain indifferent to the plight of companies already squeezed by sky-high costs.

TAX HIKES? When British Prime Minister Tony Blair took office in May, 1997, the Labour Party's agenda included a program to create jobs and some spending increases. But his first move was to make the Bank of England independent, and he made clear that he was business-friendly with corporate tax cuts. By contrast, Jospin must contend with Communist and Green coalition members who are demanding greater social gains. To counter unemployment, French government officials have proposed cutting payroll taxes on low-income workers and raising them for higher-paid employees--a move that would push more high-technology companies out of France.

Schroder, meanwhile, faces pressure for leftist economic solutions from former party chief Oskar Lafontaine, his appointee for Finance Minister. "Lafontaine and Jospin are two key figures who could be seen tilting to the Old Left," says Jonathan Story, professor of political science at Fontainebleu-based management school INSEAD.

Already, signs of newfound belligerence from the left are popping up on the Continent. On Oct. 9, Italian Prime Minister Romano Prodi's government was toppled by radical Communists wanting more social padding in the 1999 budget. The Communists bowed out of the coalition when Prodi returned to power. But he and Jospin are lobbying European Union officials in Brussels for a huge, Europewide infrastructure or technology program to create jobs and stimulate demand. Prodi proposed using central bank reserves to finance the project, while Jospin suggested that EU institutions raise debt in Europe's capital markets. And on Oct. 13, French Finance Minister Dominique Strauss-Kahn proposed $365 million in tax cuts for home improvement--to be partially offset by closing corporate tax loopholes.

Outside of government, traditional supporters of the left are feeling their oats. IG Metall, Germany's largest union, is demanding a 6.5% pay increase in its next contract. Experts expect it to settle for 3% or less, but that would still be a major hike from the 2.5% and 1.5% it accepted in 1997 and 1996--especially since Germany's recovery looks shaky. In France, protests in two small southern towns calling for more public spending on high-school teachers and supplies have snowballed into a national movement, with students expected to demonstrate nationwide on Oct. 15.

More ominous, if growth slows sharply in 1999 and unemployment creeps up, the left could put political pressure on the new European Central Bank after monetary union formally starts on Jan. 1. Lafontaine already has called for lower interest rates. In France, some politicians are even more direct. "We do not accept the independence of the central bank," fumes Alain Lipietz, the Green party member of Jospin's economic advisory council.

ECB Governor Wim Duisenberg insists his bank will not be influenced by Germany's left or any other politicians. But such outbursts upset central bankers and industry leaders who desperately want the new single currency launched with a solid underpinning of monetary discipline. "The stability of the euro is at stake," warns Hans-Olaf Henkel, president of the Federation of German Industry.

JOBLESS PRESSURE. Another sacrosanct foundation of monetary union could come under attack if Europe's left insists on stimulating growth with public spending. The Maastricht Treaty stipulates that member nations' budget deficits may not exceed 3% of gross domestic product, and an agreed-upon Stability Pact would fine countries exceeding the limit. But under mounting pressure from the jobless, leftist politicians could lobby for relaxation of the rules. With all the political muscle involved in creating EMU, it is unlikely to be derailed. Yet veering away from its strict terms could undermine global confidence in the euro from the start.

European governments, fearful of eroding consumer confidence, still mouth rosy forecasts for 1999 to boost morale. But economists are steadily revising their growth estimates downward. The crunch could become most perilous for France, which lags behind other EU members in making structural reforms, from tax cuts to labor-market liberalization. With independent analysts now predicting 2% growth or less next year if the dollar's slide continues to punish exports, few believe Jospin will have the stomach to make needed changes. "The only medicine [for Europe] is to cut taxes, and everyone will do that except France," says Paris-based economist Christian Saint-Etienne.

In Germany, Schroder's gesture toward cutting personal taxes was intended to show he would resist the kind of spending old-liners in his party are likely to favor. But he convinced no one, and after winning an early and embarrassing power struggle within the new government, the pro-spending Lafontaine is likely to throw his weight around. Indeed, he is already maneuvering to increase the finance ministry's powers. "I have no doubt that Oskar Lafontaine is the strong man in Germany right now," says Stefanie Wahl, senior researcher with the Bonn Institute for Economic & Social Research. "I predict he will run the country."

Ironically, the French Socialists have presided over more privatization, regulatory changes, and other reforms than their conservative predecessors. So a radical swing to the left would be a sorry unraveling of progress to date. Indeed, throughout Europe, the forces of globalization have gradually overcome ideology in the past few years, and the business climate is slowly improving. Now execs can only bite their nails and hope the so-called new left doesn't undo it all.

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