Gerhard Schroder: The Accidental Reformer

Schroder's bold moves are a welcome surprise to business

One evening a few years ago, future German Chancellor Gerhard Schroder and Daimler Benz CEO Jurgen Schrempp sat down to dinner at Kafer Schanke, a pricey Munich restaurant famous for its traditional Bavarian cuisine. On the agenda: Daimler's plans to close a plant in the north German state of Lower Saxony, where Schroder was Prime Minister. Over several bottles of wine capped by glasses of grappa, the two men puffed their cigars and talked. Before the night was over, they reached an agreement that ultimately kept the plant open and saved hundreds of jobs.

It was the beginning of a beautiful friendship. These days Schroder and Schrempp address each other with the familiar du as they drink and discuss affairs of business and state deep into the night at their favorite haunts around Germany. And Schrempp is by no means the only business leader who has the Chancellor's ear. Schroder also confers with such executives as Deutsche Telekom CEO Ron Sommer and Michael Frenzel, CEO of tourism-and-shipping giant Preussag.

After one such consultation with his business allies, the Chancellor gave the nod to Deutsche Bank CEO Rolf-Ernst Breuer, Allianz CEO Henning Schulte-Noelle, and Allianz CFO Paul Achleitner when they engineered their controversial Deutsche-Dresdner Bank merger in March. That deal collapsed in April, humiliating all parties involved. In the past, Schroder may have pounced on the botched deal as a chance to lambaste the country's capitalists and interfere. But this time, Schroder has left it to the banks and the markets to sort things out.

Call him the Accidental Reformer. As recently as October, the German business community had written Schroder off as an ineffective populist with a soft spot for government meddling. And after losing a half-dozen state elections in 1999 and control of the upper house of Parliament, his government was in danger of collapse. Now, Schroder suddenly seems to be Big Business' best friend. He's pushing through the broadest tax cuts since World War II and scrapping obstacles to corporate restructuring, sparking a merger-and-acquisition boom.

Partly as a result, the German economy is humming: Growth is expected to more than double this year, to 3%. Foreign investment has more than doubled in the past year, and venture capital is plentiful. The Ifo Institute of Economic Research's closely watched barometer of German business confidence is near a five-year high. And Wall Street's recent debacle has left Germany's DAX index relatively unscathed. Despite the Nasdaq dive and a battering of European dot-coms, German investors on Apr. 17 welcomed the big high-tech stock offering of Deutsche Telekom's Internet unit, T-Online. Shares rose 39% on the first day of trading.

Plenty could still happen in Germany to check Schroder's reformist ambitions: Many of his most dramatic proposals have yet to pass in Parliament. Yet if Schroder stays the course, he may not only spur the remaking of Germany Inc. but pressure France into changing its left-wing ways, too. Europe's two biggest economies could finally be on the way to dismantling the structures that stifle innovation and growth.

CHANGING TIMES. Schroder's conversion seems more a matter of tactical politics than ideological conviction. After all, this is the same guy who three years ago used the powers of government to shield German steelmaker Salzgitter from an Austrian predator. And in the early days after his election in September, 1998, Schroder went along when Finance Minister and Social Democratic Party (SPD) Chairman Oskar Lafontaine--a stalwart of the party's left--pushed for a rollback of even the modest reforms launched in the Kohl era.

But times are changing. Nearly 70% of Germans believe the country needs far-reaching reform to cope with globalization, according to a poll by Berlin's Forsa Institute. Labor unions are agreeing to wages of 3% or less, in line with productivity and inflation, and signing longer, two-year contracts that make it easier for companies to plan and to hold down costs. Schroder pushed the unions to show restraint and, for now, he has their trust. "Schroder has broken the blockade to change," says Hubertus Schmoldt, head of the union that represents workers in the chemical industry.

Perhaps the most important reason Schroder is listening to his kitchen cabinet of CEOs is that he desperately needs to slash Germany's 10% unemployment rate before nationwide elections in 2002. Execs such as Schrempp make a strong argument that bold moves are a prerequisite for creating jobs.

Schroder seems to understand. "He's not a visionary. He's not ideological. He's a very pragmatic politician," says Munich-based management consultant Roland Berger, who has advised Schroder for more than a decade. The pair still talk at least once a month by phone, Berger says. Finance Minister Hans Eichel, architect of many of the government's reforms, explains his boss differently. Asked whether Schroder is now truly a reformer, Eichel laughs and replies: "Is it important?" What is more important, Eichel says, is that "this is a government that wants to reform Germany."

And get reelected. But for this most political of politicians, Schroder is capable of gutsy moves. Consider what the Chancellor did when he heard from Siemens CEO Heinrich von Pierer, Schroder's occasional tennis doubles partner. In February, shortly after the electronics giant complained publicly that it couldn't find enough information-technology specialists, Schroder proposed letting German companies bring skilled workers from abroad. That's bold in a country with high unemployment and an ambivalent view of foreigners. Schroder "really listens," says von Pierer.

Schroder and Eichel promise more business-friendly moves. The government wants to keep cutting spending so that it can reduce borrowing and lower the cost of capital for business. The government is also planning measures to promote stock ownership and may allow tax breaks for people who put retirement savings into shares. And it plans to dismantle much of the red tape that bedevils startups.

There are still places Schroder is afraid to go. The Chancellor isn't willing--at least not yet--to undertake bold labor reforms. He hasn't touched regulations that make it tough to lay off workers, a key business concern that is politically sensitive. "That's not a subject we're working on now," concedes Eichel. The government is only starting to deal with the touchy issue of pensions. Within 20 years, more than half of Germany's adult population will be over 60, creating an unbearable strain on government resources.

Schroder could face a bigger problem. He may have unwittingly unleashed forces that neither he nor the titans of Germany Inc. can control. The recently ruined Deutsche Bank-Dresdner deal is a case in point. In phone calls just two days before the deal was announced, Deutsche's Breuer and Allianz' Schulte-Noelle sold Schroder on the megamerger--and its 16,000 job cuts--by arguing that they were essentially creating a national champion, a German bank that could withstand mounting global competition.

Schroder gave his blessing. Then the bankers started squabbling. Within four weeks, the deal was dead and all three financial institutions were weakened. Now, Dresdner is vulnerable to foreign takeover--a politically unpopular development. "I have seen more mature behavior by companies," Schroder noted curtly after the deal died.

"DIFFERENT WAVELENGTH." Schroder has kept his hands off the Dresdner affair. But if economic reform produces other such debacles, his political instincts may tell him to put the brakes on reform. "Once in a while, the stomach may take over for the brain," says Gerhard Schulmeyer, head of Siemens' U.S. unit and an acquaintance of Schroder's. "Don't forget, he has constituencies that are on a completely different wavelength."

For now, at least, Schroder seems inclined to let market forces take their course. By doing so, he is drawing on his own informal business education, which goes back to the days when he sat on the supervisory board of Volkswagen, 18.8% owned by the government of Lower Saxony. There, the then-state prime minister got to know von Pierer, also a member of the board, as well as VW CEO Ferdinand Piech. Von Pierer, for one, thinks Schroder is for real. "I think he knows exactly what he's doing," he says. "He has already set things in motion after only a few months, and there's going to be more."

While supervisory boards largely rubber-stamp the decisions of top management, Schroder's seat at VW gave him an inside look at the problems of Big Business--and a taste for the perks of corporate power. "He likes the red-carpet treatment, which he never experienced growing up," says Berger. Schroder's father was killed in the war, and he had few advantages as a child.

Schroder's thinking was also shaped by a 1997 tour of the U.S., where he traveled from Silicon Valley to New York, meeting with Microsoft Corp.'s William H. Gates III and IBM's Louis V. Gerstner Jr., among others. Until then, the future Chancellor had spent more time in Cuba than the U.S. But he came away impressed with the U.S. economy's ability to create jobs, says Jurgen Grossman, a businessman from Hamburg who was part of the tour group. "I think that opened his eyes a lot."

Schroder's approach contrasts with that of his Christian Democratic predecessor. While Helmut Kohl was never fond of discussing business and economics, Schroder has always made a point of meeting top businesspeople. While prime minister of Lower Saxony, he often invited business leaders to chats at a state-owned guest house in the capital city of Hanover.

Since his election, Schroder has continued to summon bosses to informal confabs. In October, he met with Breuer, Schrempp, Berger, Lufthansa CEO Jurgen Weber, and BASF CEO Jurgen F. Strube at Schloss Neuweier, a restored 16th century castle near the resort town of Baden-Baden. "He signaled very clearly that the new government would ally itself with business," Berger says. On a recent trip to Asia with a business entourage that included Telekom's Sommer, Schroder spent two hours discussing trade issues with execs before meeting top Chinese leaders.

IMPASSE. A turning point in Schroder's dealings with business leaders came last November. The Chancellor's rating in the polls had plunged to 32%, compared with 46% for the rival Christian Democratic Union. Then news emerged that Philipp Holzmann, once Germany's largest building concern, was near collapse. Deutsche Bank and other institutions that owned big stakes in the builder were balking at a bailout. They were fed up with Holzmann's managers, who ran up huge losses in ill-fated real estate investments. Still, 40,000 jobs were on the line at Holzmann and its subcontractors.

Schroder saw a chance to look like a hero. One of the first people he called was Berger, the Munich management consultant. The Chancellor wanted to know if a bailout could work. Yes, Berger replied. But the banks would have to pony up more cash. So Schroder went to Breuer.

The two men had known each other for years. But the initial conversation about rescuing Holzmann was frosty, according to sources inside Deutsche Bank. Schroder was angry that the bank was on the verge of letting Holzmann go under. Breuer demanded that the government put up money, too. In subsequent conversations, Breuer pointed out to the Chancellor that Holzmann was symptomatic of a deeper problem in the German economy: Punitive 54% capital-gains taxes kept Deutsche Bank from selling its 15% stake in Holzmann and other companies it no longer could properly manage. Breuer told Schroder that the bank and the construction company would probably have been better off without each other. Without Deutsche Bank's resources to fall back on, Holzmann would have been forced to take tougher measures years earlier.

The lecture didn't seem to have any effect on Schroder's political grandstanding. After a late-night negotiating session including Holzmann's banks, its unions, and a Schroder deputy, the Chancellor appeared on the pillared portico of the company's neo-Grecian headquarters in Frankfurt. Workers in hard hats cheered as he raised his arms in a victory salute. The scene was rebroadcast dozens of times on TV.

Investors hated Schroder's publicity stunt and revival of old-line government intervention. The DAX plunged the next day. But it turned out Schroder knew more about politics than the stock market. That's because the Holzmann rescue reassured Germans that reform didn't mean removal of the government safety net. And it allowed Schroder once again to look like a decisive leader. "That told people, `I'm back,"' says pollster Manfred Gullner of Berlin's Forsa Institute, an informal adviser to Schroder.

LANDSLIDE. Riding a surge in the polls, Schroder then won the SPD chairmanship in a landslide vote in December. That helped him quell the party's left wing and gave him political room to maneuver. He didn't waste any time. In late December, Schroder and Eichel unveiled a tax plan that will cut the top income-tax rate to 45% from 53% by 2005 and the corporate-tax rate to 38% from as much as 60%. Business leaders had participated on a government commission that provided advice on the tax-reform plan. But no one expected such deep cuts.

The real nugget was buried in the fine print. It turned out that Schroder had paid attention when Breuer complained about being saddled with unwanted industrial holdings. The government proposed elimination of the capital-gains tax that companies must pay when they sell their stakes in publicly listed German companies. Elimination of the tax is hugely significant in Germany, where a web of cross-holdings yokes institutions such as Allianz and Deutsche Bank to big swaths of industry. "The idea was to remove tax barriers to bringing things together that belong together--allowing companies to do what they do best," Eichel says. Within weeks, the tax proposal sparked the Deutsche-Dresdner merger. Even though that deal fell apart, others are sure to follow.

Since Schroder unveiled the tax-reform plan, business leaders have been amazed at how quickly he responds to their requests on other issues. Siemens' von Pierer remembers appearing with Schroder at a public event in Munich in March. Von Pierer complained that the annual Hanover Trade Fair, a showcase for traditional German industry, no longer attracts much attention in a world besotted with dot-coms. Schroder immediately sent an aide out of the room, rewrote his schedule, and appeared at the fair the next day.

Also significant is what Schroder hasn't done. When British mobile-phone company Vodafone AirTouch PLC made a hostile bid for Germany's Mannesmann at the end of last year, Schroder expressed concern but made no effort to intervene. Since that hotly contested takeover, Schroder has created a commission to study takeover law, with Breuer, Berger, and Mannesmann CEO Klaus Esser all participating. The commission is unlikely to turn back the clock. More likely, it will simply enshrine shareholder protections that are now voluntary--a plus for investors. Schroder shared a champagne toast with his longest-standing adviser, Berger, in the Chancellor's office before the first meeting. According to Berger, Schroder pledged to protect workers but said he understood that takeovers are a matter for shareholders to decide.

Where could the Accidental Reformer take Germany next? In part, it depends on the mood of the electorate. So far, thanks to his shrewd political instincts, Schroder's proposals have enjoyed remarkable support. For now, Germans seem to trust that the Chancellor can usher in change without trauma.

But both workers and managers can quickly turn into opponents if Schroder makes a wrong move. Railroad employees facing job cuts at government-owned Deutsche Bahn have already staged demonstrations and threatened to shut down major routes. And some entrepreneurs argue that Germany still isn't doing enough to nurture startups. "There are still a lot of problems with the business environment," complains Mathias Entenmann, CEO of Frankfurt-based, which has developed a system that lets people pay for goods and services with their mobile phones. "If the business climate becomes unfriendly, these companies are going to emigrate."

The political waters will get increasingly treacherous as Schroder presses on with reform. The opposition Christian Democrats are recovering from a campaign-finance scandal and have a charismatic new leader, Angela Merkel. No one can predict how quickly the Chancellor may find a new political opening--akin to the Holzmann situation--that will allow him to appeal to both workers and business simultaneously. Schroder may need a crisis to push through necessary pension and labor reforms. So the Chancellor and his business kitchen cabinet still have plenty to talk about over their wine and cigars.

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