Merkel Urged to Act Before It's Too Late

With dismal news continuing to roll in, pressure is mounting on Berlin to take additional steps to stimulate Germany's flagging economy

It's not often that one sees German Finance Minister Peer Steinbrück blushing. Until recently, after all, he had been showered with a certain amount of praise for his steady-handed approach to the financial crisis currently enveloping Germany, Europe and the world. But last Thursday, Steinbrück was on the stage at the "Tipi," a theater tent next to the Chancellery in Berlin, holding a silver trophy after being chosen as this year's winner of the Politician of the Year award. And his cheeks were bright red.

Steinbrück and Chancellor Angela Merkel have taken it upon themselves to show the world how to solve an economic crisis without significant spending programs—and by ignoring the experts' advice and going it alone. It is a bold experiment, and being given such an award was encouraging, even a partial victory.

The award itself is not an important one. The silver statuette presented to Steinbrück was donated by a publishing company called Helios Media, but this didn't seem to bother the minister. "Steinbrück is straightforward, reliable and smart," said the man presenting the award, Hesse Governor Roland Koch. "And he is cutting a fine figure in the current financial crisis."

Then came Steinbrück's acceptance speech, and it, like almost all of his recent public pronouncements, turned into a lecture. The debate over the economic crisis, he intoned, is getting out of hand and he finds it increasingly difficult to stomach. A steadily growing number of proposals to combat the crisis have turned into a bidding war, he said, and it must stop.

Steinbrück had delivered a similar lecture three days earlier, when he attended a meeting of European Union finance ministers in Brussels. There, he once again played the imperturbable politician. Who, Steinbrück asked his counterparts, seriously believes that the government can buy its way out of the crisis?

'Huge Waste of Money'

Measures taken merely to do something, as seen in a number of EU member states, Steinbrück said, were "unhelpful." The programs being established or requested everywhere are a "huge waste of money," the German finance minister railed, adding that he doesn't believe in programs aimed at boosting demand.

He will be present on Sunday at the chancellery in Berlin for a meeting called by Merkel to take a closer look at recent economic developments. A number of cabinet ministers will be present in addition to a handful of bank managers and economic experts. Still, the message has remained largely the same: Steinbrück and the rest of the German government will take a closer look in the first quarter of next year. Should it then become necessary, Steinbrück said in his speech last week, further action will then be taken. Not before.

One could see the speech as a continuation of the message that is increasingly trying the patience of his cabinet colleagues. But one could also see it as an initial, cautious effort to back off from the rigid attitude with which the Merkel/Steinbrück administration has confronted the most severe global economic crisis in decades. At least Steinbrück is now no longer ruling out all further action, delayed though it might be.

Initially, the message from Merkel and Steinbrück was that the initial stimulus package, approved in early November, was all that was needed. The package was billed as being worth €32 billion, but a closer look revealed that the new measures included in the package were worth just €5 billion a year.

Instead, they gave speeches and interviews in which they declared anyone who called for stronger economic stimulus programs to be reckless, if not downright insane. "The fact that all lemmings have chosen the same path doesn't automatically mean that it's the right path," Steinbrück said in a derogatory reference to his colleagues elsewhere in Europe.

Join the Lemmings

Now, more than a week later, Steinbrück and Merkel sense that they will be unable to remain contrarians, even if they have so far refrained from making a public U-turn. They sense that they too will have to join the lemmings.

The consequences of Germany's special approach to the economic crisis have already made themselves felt. On Monday, British Prime Gordon Brown, French President Nicolas Sarkozy and European Commission President Jos� Manuel Barroso met in London to prepare for the European Union summit later this week. And they didn't invite Merkel.

In the past, it would have been Germany and France getting together before an important summit in an effort to shape its outcome. Now, Berlin's presence at such important preliminary talks is apparently no longer desired. "Madame Non," as Merkel is referred to derisively in EU circles, isn't welcome anymore.

In Brussels these days, EU diplomats—whether from Britain, France or elsewhere—simply shrug their shoulders about the Germans, if not worse. Has the 2009 general election campaign already started, people in Brussels are asking themselves? "The Germans," says a high-ranking German representative in Brussels, "are moving at the speed of light from the center of activity to the margins." When it comes to generating ideas, says the diplomat, the Germans have been "a total failure" so far.

The pressure for more decisive economic stimulus measures is growing on the domestic front as well. The bad news continues to mount, and distress calls from the economy are piling up. According to the Federation of German Industries (BDI), orders have been cancelled in all sectors of the economy, and freight traffic with China has fallen drastically within weeks. The automobile industry is reporting a "downswing unprecedented in terms of magnitude and pace."

'Utterly Exceptional Situation'

The CEOs of the companies listed on Germany's DAX stock index are also watching the hesitancy at the Chancellery with great concern. "We're currently experiencing an utterly exceptional situation,"

says VW CEO Martin Winterkorn.

Regardless of the mood in the chancellery, many in Berlin have begun recognizing that the government must respond with a decisive stimulus program. But just what such a program should look like is a matter of some contention within Merkel's governing coalition, which pairs the center-left Social Democrats (SPD) with the center-right Christian Democrats (CDU). Absolutely no tax cuts, the SPD insists. No stimulus checks for consumers, the CDU says in response.

As a result, the German government's response to the worst crisis in decades has been indecisive. Instead of taking action, Berlin is simply making adjustments. Ultimately, it could end up waiting too long to implement an effective stimulus package, and the consequences could be serious. Consumers and investors will hold back even more, because they will be waiting for the government's additional bailout programs. The government itself is becoming a risk factor.

Opinion polls show that more than half of all Germans say that Berlin's comments on the economic crisis have made them feel more anxious than hopeful. "Politicians are playing an important role in making citizens feel uneasy," said Wolfgang Bosbach, deputy floor leader for the CDU, in a mocking tone.

Merkel and Steinbrück, for their part, continue to buy time by pointing to a meeting they have scheduled for Jan. 5. On that day, leaders from the CDU, the SPD and the Christian Social Union (the Bavarian sister party to the CDU) will meet in Berlin to discuss the crisis. Still, no decisions are planned for the meeting. Merkel and Steinbrück have made it clear that they simply intend to keep an eye on the situation. Any concrete measures aren't expected before later in the spring.

Yet even this distant prospect has been fuelling political creativity. Members of both the SPD and the CDU have lately been coming up with a never-ending fountain of ideas on how to enliven the German economy. The ideas are diverse—and incompatible.

Most Social Democrats want to see their party fill the leadership vacuum.

The party's left wing, led by Andrea Nahles, is complaining that Steinbrück, in particular, is standing in the way of an independent SPD approach—because of his proximity to Merkel. The 19 parliamentarians from the SPD's left wing recently introduced a two-page document demanding an enormous stimulus package. Given the dimensions of the world economic crisis taking shape, they write, the steps taken to date are inadequate. "Unless massive efforts are undertaken to counteract the crisis, we could see prolonged stagnation, mass unemployment and deflation." Two of the politicians who signed the document are Ottmar Schreiner and Hilde Mattheis. Until recently, they supported a bailout package worth €25 billion ($32 billion). Just a few days later, they had upped the demand to €50 billion ($64 billion).

The SPD document envisions a broadening of tax exemptions, an "expansive wage policy," massive expansion of the transportation infrastructure and an increase in the standard rates paid to those receiving social security. The paper proposes to pay for the package by reintroducing the wealth tax and raising the highest tax rate.

'We Must Act Quickly'

Meetings of the SPD parliamentary group have likewise turned into something resembling an open-mike night. At a meeting last Tuesday, for example, environmental expert Ulrich Kelber called for increased government subsidies for environmental protection.Then it was healthcare expert Karl Lauterbach's turn. He grimly reminded his fellow politicians of the 1929 world economic crisis and called for the distribution of stimulus checks. Each adult, Lauterbach proposed, should receive €500 ($645), while children and adolescents should receive half that amount. "We must act quickly," Lauterbach told his fellow Social Democrats.

The situation is no less confusing in the conservative camp. Education Minister Annette Schavan (CDU) wants to spend €4.6 billion ($5.9 billion) on the education system—€100,000 ($129,000) for every school and €500,000 ($645,000) for every university—for renovations and modernization. The CSU, for its part, is demanding prompt tax cuts, while others in the party want to see health insurance premiums reduced and tax cuts.

"We must act now, quickly and on a large scale," Jürgen Rüttgers, the governor of the state of North Rhine-Westphalia told fellow party members in Duisburg last Friday. He called for a program to counteract recession—an open affront to the chancellor, and not the only one by far. "We are approaching an economic slump, and the chancellor is not setting the tone. I see this as a serious lapse," complains Josef Schlarmann, the head of the CDU's small business association. Merkel had the opportunity to present her concept at last week's CDU convention, says Schlarmann. "Instead, she says that all options are on the table. This, of course, is an invitation to everyone to take part in the discussion."

Bavarian Governor Horst Seehofer, in particular, has played the role of Merkel's adversary. When Seehofer read in the paper last Friday about the French-British pre-summit meeting, to which Merkel was not invited, he could hardly contain his schadenfreude. The news merely confirmed Seehofer's view that Merkel's approach to the crisis has been far too weak. "Now we are totally isolated internationally. We look like fools," one of his advisors said.

Contradictory Voices

The broad range of contradictory voices with which the governing parties are responding to the economic crisis is also reflected in the ministries. The ministries of economics and finance, in particular, have come up with completely contrary proposals. Finance Minister Steinbrück had in fact imposed a ban on further proposals from his ministry. A recent memo from Steinbrück's office instructed all department managers to stop considering economic stimulus programs altogether.

But the prohibition came too late. The experts in Steinbrück's ministry had already discussed all possible instruments at length.

The most noticeable thing about their efforts is how far the majority of bureaucrats at the ministry are removed from their minister. When the government was debating its first stimulus package, they recommended large, decisive steps. But Steinbrück and Merkel opted for the small-scale solution.

The civil servants at the finance ministry are surprised by Steinbrück's stubbornness. But they are convinced that their ideas will be revived by no later than the spring. They propose an assortment of measures to combat the crisis, including the stimulus checks so popular with the left wing of the SPD. Steinbrück's subordinates do not see the risk that the recipients could simply save the money, especially in light of the fact that one third of all German households have a savings rate of zero. Steinbrück's people are also considering short-term tax cuts and fee reductions. The package could also include government investment programs, especially for municipalities.

Officials at the Ministry of Economics, headed by Michael Glos (CSU), are preparing completely different plans. In keeping with CSU policy, Glos's staff favors a permanent tax cut, which would remain in place after the downturn. If the measure were implemented soon, it would also help the ailing economy.

A flatter income tax rate would also boost growth in the long term, Glos's economists argue. The Germans' chronic aversion to consumption, they believe, must be offset by long-term tax relief and, for this reason, they are opposed to one-time efforts like stimulus checks or a temporary reduction in the value-added tax. These measures, they argue, would be nothing but a flash in the pan.

Mowing Down Everything in its Past

In the end, the dispute between the SPD and the CDU/CSU, and between the ministries of finance and economics, will likely end in a compromise, a package that encompasses the preferred instruments of both sides: a few stimulus checks, a bit of an investment program, a small cut in premiums, all intended to give consumers a larger take-home pay in the long term.

Government officials are planning, for example, to reduce health insurance premiums temporarily. To pay for this, the government will use debt financing to increase its subsidies to the health insurance system by several billions of euros. The measure is intended to benefit employees only, while the employer share of premiums would remain unchanged.

But no matter how balanced and generous such a package ends up being, it could ultimately fail to achieve the desired result because it would be coming a critical few months too late. By the time the proposed measures are enacted, sometime in the spring, the crisis will have ballooned to its full proportions, and it will be much more difficult to provide a cushion against its adverse effects.

In a mounting crisis, as most economists agree, it is critical that countermeasures are decisive and are taken early. If a government spends too much time watching a drastic downturn while doing nothing, it contributes to the negative development taking hold.

The current downturn could behave like a rock that threatens to roll down a hill. It should be stopped early on, recommends one government expert. But once the boulder has gained momentum, it will simply mow down everything in its path.

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