A New Deal in Europe?

With labor's power flagging, serious reforms may be around the corner

Labor leaders called it a gesture of solidarity, but many Germans saw it as an act of economic insanity. The militant IG Metall union last year demanded that auto, steel, and engineering workers in eastern Germany work the same 35 hours a week as their comrades in the West -- a move that would have encouraged companies to flee across the border to Poland or other low-cost countries. When talks went nowhere, the union in June backed up its demand with strikes, forcing auto maker BMW, among others, to shut down some production lines.

Dumb move. Even some union members were appalled by the walkouts in a region that badly needs investment and where many companies are barely surviving. The public reaction was overwhelmingly negative, a sign that ordinary Germans have come to see unions not as defenders of the common man but as obstacles to urgently needed change. Even union members condemned the strikes by a margin of more than 2 to 1, according to a poll for broadcaster ZDF by Mannheim-based Elections Research Group. The debacle has already set off an internal power struggle that could bring a more moderate generation of labor leaders to the fore. And it follows earlier failure by the unions to derail labor-market reforms proposed by Chancellor Gerhard Schröder. "The unions are taking it on the chin everywhere," says John C. Kornblum, chairman of the German unit of investment bank Lazard Frères & Co. and former U.S. ambassador to Germany.

Germany isn't the only country where unions are feeling the sting of defeat. Left-wing labor defenders of the status quo have suffered serious setbacks recently in France and Italy, two other European countries where excess regulation smothers growth. In the past few weeks, France's center-right government faced down once-powerful unions to win the overhaul of the publicly financed pension system. And in Italy, voters rebuffed a union-backed effort to increase job protections. These suggest that voters in core Europe may finally be willing to accept rollbacks in the cherished welfare state to get the region's stagnant economy rolling again.

The big question is whether the politicians can seize the moment. They're under more pressure than ever. Germany's economy will shrink 0.1% this year, according to the Berlin-based German Institute for Economic Research, while the euro zone will grow only 0.5%. German Chancellor Schröder seems to have realized that his political survival depends on boosting growth and is showing new zeal for reform. "We know that people are expecting us to provide a signal," he told reporters June 29 as his government backed a proposal to push forward planned income-tax cuts to spur consumer spending. That follows reforms proposed by Schröder in March, dubbed Agenda 2010, that would make it easier for companies to hire and fire while trimming jobless, health, and pension benefits. Schröder and Wolfgang Clement, the popular Economics & Labor Minister, have even been discussing lengthening the workweek, pushing back retirement age, and reducing holidays.

Of course, even if all the reforms go through, Germans and French will still work less than Americans or Britons and enjoy more generous benefits. Still, the signs are clear that Europeans have begun swinging away from reflexive social protectionism. "We just can't ask for everything from the government any more," says Béatrice Fages, a Paris-based corporate communications specialist. The Italian left suffered a decisive defeat when only 23% of voters turned out for a mid-June referendum on increasing job protections for workers at small companies. Even the center-left Democratic Left advised people to stay home, worried about the referendum's lack of popularity. The proposal's main backer, the CGIL union federation, Italy's largest labor group, was isolated.

Now what? A lot still has to happen. Schröder's Agenda 2010 cuts unemployment benefits, but it falls far short of dismantling the system that makes layoffs costly and time-consuming. To fix the economy, Schröder needs to shift up a couple of gears. "What's currently being talked about isn't adequate," says Diether Klingelnberg, president of the German Engineering Federation. Business people are becoming more optimistic that Schröder will do more to dismantle obstacles to hiring and firing. "The government has understood the message," says Klingelnberg. Meanwhile, more moderate labor leaders are increasingly open to change. "We can't present ourselves as unable or unwilling to reform," says Hubertus Schmoldt, president of the chemical workers union.

France also has to do more. Prime Minister Jean-Pierre Raffarin got off to a promising start with pension reform. And the recent pickup in equity markets will make it easier for him to proceed with long-planned privatizations of companies such as Air France and auto maker Renault that are still partly controlled by the state. But Raffarin still has a long list of reforms to tackle, starting with the national health insurance system that is expected to run a $9 billion deficit this year. He has promised to offer details by the end of this year, probably requiring beneficiaries to pay more for their care. Such measures will be a tough sell for Raffarin, whose popularity ratings have fallen below 50%. And French President Jacques Chirac is under pressure to suspend a promised program of tax cuts.

Reforms won't go forward unless the political opposition plays along. In Germany, conservatives control the upper house of Parliament and can veto many of the reforms. Angela Merkel, chairman of the center-right Christian Democratic Union, met face-to-face with Schröder on June 25, a rare event that raised hopes of cooperation. But the CDU is divided, and other influential leaders such as Edmund Stoiber, Prime Minister of Bavaria, have spoken out against reforms that hit conservative voters, such as moves to curb subsidies for commuters and new homes.

Sobering stuff. But just a few weeks ago, few would have predicted that IG Metall would give in or that a French Prime Minister would stare down the unions. The far left is weaker than it has been in decades. Politicians across the spectrum realize they must launch reforms to save their jobs -- always the best incentive. The mood favors change -- change that could yet set the stage for growth.

By Jack Ewing in Frankfurt and Carol Matlack in Paris, with John Rossant in Paris

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