Online Extra: Hans Eichel on What's Plaguing Germany

While claiming we have an extraordinarily productive economy, the Finance Minister points to reunification costs as the big drag

As Germany enters a second decade of stagnation, the world wants to know: Will it ever again become Europe's economic driving force? One of the people who's job is to make sure the answer is "yes" is Hans Eichel, German Finance Minister. During his first term in office, Eichel -- who keeps a collection of piggy banks on his desk -- won praise for getting Germany's budget deficit under control and pushing for tax cuts.

However, since the Social Democratic Party led by Chancellor Gerhard Schröder won a second term in September, Eichel's reputation has suffered. The deficit far exceeded projections, and a series of stopgap tax hikes annoyed voters -- so much so that they humbled the Social Democrats in state elections on Feb. 2. In an interview with BusinessWeek Editor-in-Chief Stephen B. Shepard and Frankfurt Bureau Chief Jack Ewing, Eichel spoke about the causes of Germany's malaise and the prospects for improvement. Following are edited excerpts of their conversation:

Q: What is the effect of the state elections in Hesse and Lower Saxony [in which the opposition Christian Democrats (CDU) won by huge margins] on politics in Berlin?


There is no influence. The CDU already has a majority in the Bundesrat, and a majority is a majority. There is not now a two-thirds blocking majority, and there won't be. As far as power relationships and policymaking are concerned, there is no difference.

Q: Around the world, many people are concerned about the state of the German economy. What is your response?


The German economy is by international standards extraordinarily competitive. In a shrinking world economy, Germany's share is rising. That means because of our products and their priceworthiness, even with a stronger euro, we have an extraordinarily productive economy. We have a weak domestic economy. We have a very strong economy, but weak domestic demand. That has a lot to do with German reunification. And -- despite all the efforts that we are making and have made -- that is not so easy to resolve.

Q: Did you have any idea in 1990 that reunification would be as expensive as it turned out to be?


There were people who had an idea. Some who weren't successful in the elections [laughs]. The Bundesbank president had an idea. [Chancellor] Helmut Kohl had no idea. One person said currency union would amount to 80% destruction of East German industry, which was on target. But in the euphoria, hardly anyone heard such people.

Q: What are the main problems in East Germany?


East Germany has a very fully staffed public service, which is being continually reduced. No other European country has this problem. This places a continuous burden on the economy because it raises unemployment and reduces demand.

The other element from reunification is the short, very strong boom in the construction industry, which was not sustainable. It was created by enormous tax breaks. Since the mid-1990s, the overcapacity has been in the process of falling back to normal levels, but this process will last two or three more years.

Reunification was financed -- and this was a fundamental mistake -- by means of the social security system. The transfers from West to East corresponded to 1.5% of gross domestic product. Nonwage costs would be a lot lower [without this burden], and it creates an obstacle to employment. It's not something you can get rid of overnight.

The last point is the high debt. That means high interest payments. It limits government's ability to invest in the future -- family, education, research, transportation, and infrastructure.

Those are the problems. In sum, it shows how strong the German economy really is. It is able to handle this huge task and still be the world's second-largest exporter. And it has a lower unemployment rate than France or Italy, which have none of these challenges.

Q: How long will East Germany be a burden?


It's going to last a generation. Starting from 1990, that means it will last until 2020 to conclude the process of reuniting Germany. A positive thing you can say is that industrial production in the East is growing much faster, albeit from a narrower base. By 2010 it will reach something like 25% of the total. The growth rate in exports and international competitiveness is really impressive. However, it is concealed by the decline in construction and the decline in public-service employment.

Q: Do we have to wait until 2020 until Germany is again the growth motor of Europe?


No, but one should be aware that the burden [of East Germany] can't be eliminated overnight. The overcapacity in the construction industry will be eliminated in two or three years, which means that the negative growth effect -- minus 2% in the East and minus 0.6% in the West -- will be gone. You can add then add that figure to growth.

Likewise, the overcapacity in the civil service will be eliminated in, it's hard to say, but perhaps five years. There will be further privatization at both the municipal and federal level. There will be further liberalization of markets in line with the European Union. Germany is a driving force. The opening of financial markets will open up growth opportunities.

That is another area where Germany is setting the pace. Expansion of the European Union into Eastern Europe is a growth program for Europe and especially Germany. We are by far the biggest trading partner of the Eastern European countries, and we are making the most direct investment. These are countries that are growing very quickly, and German trade with them will develop at a corresponding rate. We have stronger exports today to the countries of Eastern Europe than we do to the U.S. Those are all positive developments.

Q: What is Germany's growth potential?


Germany, France, and Italy won't have the same growth rates as smaller countries that are starting from a lower level of gross domestic product. I can only quote the European Commission: According to their predictions in 2004 or 2005, our growth will be in line with the European average [vs. last place today].

A bit of our growth weakness is also due to the aging of society. That is the result of decades of policy that was not family-friendly or child-friendly. We have raised the allowance that parents receive for children and expanded the number of all-day schools and the number of kindergarten places. That allows women to reconcile family and work, and opens new potential for women to contribute to the economy.

Q: Should the European Growth & Stability Pact, which limits deficit spending, be relaxed?


No. We don't want to loosen the stability pact. I'm familiar with the discussion, which sometimes reflects a lack of awareness of what the stability pact is. What we need, and we have made this clear in Brussels, is that we shouldn't just look at the deficit criteria. Of course we must examine the deficit very closely, but we should also look at other criteria: economic policy, overall debt, and inflation, for example.

When the countries with higher inflation rates, particularly in the South, are able to achieve lower rates, then it will be possible for the European Central Bank to pursue a monetary policy that is more advantageous for German growth. The key isn't solely in our hands. It belongs to the overall economic coordination of the euro zone. That means every country is responsible -- either to maintain a prudent budget or to achieve a lower inflation rate, which Germany has. From Germany's point of view, naturally the European Central Bank could pursue a different monetary policy.

Q: In retrospect, did the euro arrive at the right moment for Germany?


I would put it this way: It was a political decision in connection with reunification. That was a French condition, and I understand the reasons. Europeans did not have a good experience with a greater Germany. For the European neighbors, reunification could only be justified politically if Germany linked itself definitively to Europe.

What is clear is that the euro has improved the competitiveness of the other countries in relation to Germany. With its deutsche mark, Germany had lower interest rates, and the others had higher interest rates. With the introduction of the euro, they all had lower interest rates. In that respect, Germany did not profit, but the others did. The euro also helped the government budgets in countries such as Italy and Belgium because they had to pay much lower interest rates.

The deutsche mark used to be the benchmark currency, and all the other countries had to follow the lead of the Bundesbank -- which used to annoy them. So, of course, Germany no longer determines European monetary policy. One must also say that in the interests of a continent without war, a continent that is free and prosperous, everyone has to make sacrifices. We sacrificed our currency, and the others sacrificed by accepting reunification.

Q: How concerned are you about the dollar/euro exchange rate?


What worries me is the speed -- that is a general principle. It also applies, for example, to oil prices. What is dangerous is not so much the absolute level but the speed of the increase. Every economy requires time to adjust to change. When the change is sudden, that can be disruptive. That's not an indication of mistrust in the financial markets.

Another problem that we are all watching with concern is the double deficit in the U.S. -- a current-account deficit and a budget deficit. All the European Finance Ministers have said from the beginning that the euro had a lot of potential because the fundamental data are very solid. America may be more growth-oriented, but when you look at Europe -- at savings rates, government budgets, household debt -- the fundamental data is very solid. But as I said, what worries us is the speed of change.

Q: Is there anything you can do about it?


We have very few options. We are very reluctant to intervene in currency markets. The Japanese do that frequently, though without any apparent success. It's a question of international coordination. It's a matter for the G7, in respect to which I accept that other partners will ask Europe and Germany: What are you doing for growth? Naturally the opposite question arises: America, what are you doing about your double deficit?

Q: Is the prospect of war with Iraq affecting the economic climate in Europe and Germany?


Everyone in Europe is concerned about the possible economic consequences of war. But I would also like to make one comment so that there is no misunderstanding.

There is a fundamental friendship and gratitude by the Germans toward the Americans. We have not forgotten that we would not have shaken off National Socialism without the efforts of the Americans and the Allies, that Berlin wouldn't have remained free without the Berlin airlift -- this Ministry incidentally is in the eastern zone of the city -- that the Marshall Plan got the economy going again, and that the Americans were very helpful in bringing us back into the community of free, democratic peoples. They were also very helpful in reunification.

We do not want to create a fundamental disturbance in the German-American relationship. That would make no sense. But it's true that we have a different position on Iraq, which is not a terribly homogeneous land. That means when the dictatorship -- as wretched as it is, there is no argument about that -- is gone, whoever governs will have to contend with very strong centrifugal forces. We don't know how the Arab masses will react.

If the war is quick and ends successfully from the Americans' point of view, then there could be no long-term negative consequences for the world economy. When the insecurity is gone, the world economy will develop differently. But if that scenario doesn't occur, if the many sceptics in the Europe and also in America are correct, and it is a longer war, then we could have a very big economic problem -- all of us.

Q: How are dealings with the U.S.?


In my area, between Finance Ministries, there has been absolutely no effect, no disturbance. Which is as it should be.

Are we a partner with the U.S. in creating a peaceful world? Absolutely, yes. A strong, united Europe is a more reliable partner but perhaps also a more independent partner. That could well be. Sometimes I have the impression America isn't sure it wants a strong Europe. That's a decision for America.

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