Why Germany and France Are Veering Left

As elections approach, Schröder and Jospin shelve modernization to woo voters

Europe's business executives have had plenty of pleasant surprises in the past few years: low inflation, decent growth, and best of all, reform-minded governments. Even the center-left administrations of French Premier Lionel Jospin and German Chancellor Gerhard Schröder came through with tax cuts, extra deregulation, and other measures to zip up growth.

But reform is stalling this year, for the simple reason that voters don't like pain. National elections are coming up next year in France and Germany, and the Jospin and Schröder governments are already backpedaling on the drive to overhaul their economies. From shelved privatizations to increased social spending to a French law penalizing companies for laying off workers, the leaders of Europe's two biggest economies are scrambling to keep their left-wing constituents happy--even if that means leaving economic modernization by the roadside. "The speed of reform definitely has slowed," frets Ulrich Schumacher, chief executive of Munich-based semiconductor maker Infineon Technologies. "I hope it doesn't move in the other direction."

The timing could hardly be worse. For five years, Europe's governments have chipped away at the onerous laws and high taxes that weighed down commerce. The region is now the world's most dynamic major economy, forecast to grow 2.5% this year, ahead of an expected 2% in the U.S. But Europe's transformation is far from finished, and what's happening now in Paris and Berlin could put it seriously off track.

The trend is especially clear in France, where Jospin faces a tough race for President next year against Jacques Chirac. The Prime Minister, who usually steers a middle course between the leftist and centrist wings of his ruling coalition, has veered sharply to the left since the Socialists made a surprisingly weak showing in March municipal elections. Even though unemployment in France is at 8.7%, its lowest level in 18 years, recent announcements of layoffs by Danone, Marks & Spencer, and other companies have spurred protests. In response, Jospin and his labor minister, Elisabeth Guigou, developed a proposal that will require large employers planning layoffs to double severance-pay packages and provide at least six months' job retraining to laid-off workers.

Aghast, business leaders warned that the legislation would further deter investment in France. And the new costs will make it even harder for companies to carry out needed restructuring that could ensure their survival. "To avoid 20% job losses, you wind up with a situation in which the company is forced to close down in a year with 100% job losses," warns Thierry Desmarest, chief executive of oil giant TotalFinaElf.

Even before the layoff brouhaha, France was already easing up on reform. Despite a $16.5 billion, 3-year tax cut enacted last year, the government has done little to trim public-sector spending that accounts for 51% of the economy. And Jospin has just released a 2002 budget that breaches earlier promises to curtail spending and puts off the biggest reductions until after the election.

PARALYZED BY FEAR. Privatization has slowed, too. In April, the government bowed to pressure from the left when it delayed plans to privatize Gaz de France. And a long-standing push for pension reform has been shelved until after the election. "Elections should reward boldness," says Jean-René Fourtou, the vice-chairman of French-German pharmaceutical company Aventis. But politicians, sighs Fourtou, "think that if they make a move, they will lose."

The picture in Germany is less grim, though still disturbing. Chancellor Schröder's electoral position is relatively strong, with recent polls showing he could easily fend off potential challengers. But he's paying extra attention to economically depressed eastern Germany, where disillusionment is high and his support is flagging. He has already promised to continue economic aid to the region well beyond 2005, the scheduled expiration. He's also expected to shower the east with high-visibility projects such as road improvements and playgrounds.

Executives are still holding out hope that Schröder will not ditch reform altogether. The chancellor is a master tactician who has cultivated close ties with corporate leaders, and often veers left to pick up support before attempting business-friendly reforms. In 1999, for example, he delighted old-line Socialists by bailing out struggling builder Philipp Holzmann--only to use the political capital he had gained to push through tax cuts that will total $20 billion this year. This time, Schröder has hinted he would like to trim unemployment benefits. Critics say the generous German system gives people an incentive not to work.

In France, there seems to be little that could slow Jospin's leftward drift. The rightist political parties are in disarray, and the clout of MEDEF, the French employers' group and a leading voice for reform, has diminished recently. What could Jospin do next? One possibility is a big boost in the minimum wage. It's scheduled for an automatic 3.5% increase in July, but leftists want it increased as much as 20%.

France's elections won't take place until May, 2002, and Germany's will follow in autumn--leaving plenty of time for backtracking on reforms. And the pressure to hand out goodies could mount in the next few months if, as expected, the economies in both countries slow this year. But more handouts mean more costs--and that would delay recovery. Not only France's and Germany's fortunes are at stake. Doubts about Europe's commitment to reform are already dragging down the euro's value. The risk now is that Jospin and Schröder will mortgage the continent's economic comeback for short-term political gain.

By Carol Matlack in Paris, with Jack Ewing in Frankfurt

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