Merkel’s Reform Crown Slips While Turning Europe German

The political heirs to a decade-old strategy that turned Germany into the economic powerhouse of Europe risk squandering the gains.

Ten years to the day since Gerhard Schroeder unveiled a welfare and labor-market overhaul that economists credit with reinvigorating the German economy, his Social Democratic Party is backtracking while his successor as chancellor, Angela Merkel, may not be doing enough to keep the reform flame alive.

“We simply don’t have the pain in Germany right now to force a reform agenda,” Jan Techau, director of the Brussels center of the Carnegie Endowment, said by telephone. With the economy outpacing the euro-area average each year since 2010 and unemployment near a two-decade low, “everybody in Germany feels very smug and wants others to do the dirty work,” he said.

The impact of the program, known as Agenda 2010, has taken on fresh significance as Merkel’s Christian Democrats and the Social Democrats spar over Schroeder’s economic legacy before federal elections on Sept. 22. Lawmakers are due to debate Agenda 2010 today after Finance Minister Wolfgang Schaeuble addresses Bloomberg’s Germany Day conference in Berlin.

“Germany learned its lesson and reformed, and has had a very long time in which to pay the price,” Bundesbank President Jens Weidmann said in a March 12 interview. “Reforms do pay off in the end; it should be a positive example to some of the peripheral countries.”

Reform Mantle

The mantle of reform may be passing to southern Europe as a result of the euro-area crisis. Since 2009, German unit-labor costs have risen more than 3 percent while Spain’s have fallen almost 7 percent, Eurostat data show. In Germany, productivity isn’t keeping pace with wage increases either, declining 0.2 percent in 2012 and forecast to rise 0.5 percent in 2013, according to Eurostat. Last year, German unions brokered deals boosting pay by as much as 6.5 percent.

Back in 2003, with the economy forecast to contract after stalling the previous year, Schroeder announced a reform package meant to kick-start a country that had gone from post-World War II miracle to the sick man of Europe. It was the biggest shift in labor rules and social programs since the federal republic’s foundation in 1949.

Lauded by Merkel and her party, which supported it when in opposition, for the SPD’s organized-labor backers the program spelled an end to job security. They blame it for ushering in temporary, poorly-paid work that has boosted the share of low-wage earners in Germany above that of the U.K. The reforms divided Schroeder’s party and prompted a backlash that helped Merkel defeat him in 2005.

DAX Gains

As the program took effect, the jobless rate declined from a postwar high of 12.1 percent in March 2005 to 6.8 percent in December 2011, the lowest since reunification in 1990. Unemployment held at 6.9 percent in February 2013. Germany’s benchmark DAX index gained 64 percent in the past 10 years, almost double the 34 percent rise in the Stoxx Europe 600 Index.

Those gains are now at risk as productivity stagnates in the service sector and wage flexibility evaporates, said Fredrik Erixon, head of the European Centre for International Political Economy in Brussels.

“There’s an atmosphere in Germany that targets undoing many of the Agenda 2010 reforms,” Erixon said by phone. “If you look ahead 10 to 15 years, Germany must get more dynamic in its services sector. If they don’t, Germany will face pretty serious economic problems.”

Peer Steinbrueck, Merkel’s first-term finance minister and her Social Democratic challenger, announced an election platform on March 11 that includes plans to increase the top tax rate to 49 percent from 45 percent and a minimum wage of 8.50 euros per hour, unpicking elements of the Schroeder agenda.

‘Almost Ashamed’

“Agenda 2010 was a success because it brought back jobs that had been lost,” Reiner Haseloff, the CDU prime minister of Saxony-Anhalt, said in a March 6 interview in the state capital, Magdeburg, the scene of street protests against Schroeder’s government in 2005. “The SPD looks at these reforms today and they’re almost ashamed.”

Economists and Merkel herself credit Schroeder’s agenda for giving Germany the jolt needed for economic recovery. New rules freed up temporary labor, eased firing and enabled low-paid jobs. Unemployment benefits were restricted for older workers and recipients were prodded to work in return for welfare.

European Push

Merkel got the ammunition to push economic overhauls across Europe to raise competitiveness, a reform agenda that’s triggered a continent-wide split over austerity versus growth.

Struggling euro countries need to go through a “period of adjustment that is painful, as did Germany twice,” following reunification and Agenda 2010, Merkel told CDU members March 1.

It certainly seemed to work for Germany, where the economy is forecast to grow 2.4 percent in 2014 after 1.3 percent this year as unemployment declines, the Halle-based IWH institute and Kiel Economics said today in a joint outlook. They forecast the overall budget deficit to turn into a surplus of 0.5 percent of gross domestic product next year.

“At the moment we have a very robust labor market,” Labor Minister Ursula von der Leyen said in a Bloomberg Television interview from Berlin. “We have the highest employment rate since ever, actually we have 1 million vacant jobs.”

For all the gains, “real problems” exist that need to be addressed, said Techau, citing Germany’s social-welfare system that “cannot survive in the medium term unless it’s revamped.”

‘Sick Man’

Joerg Asmussen, a European Central Bank board member from Germany, went further in a Dec. 6 speech, saying that without reforms “within five years Germany will again have the title ‘Sick Man of Europe.’”

In response to critics, Merkel cites her plan to abandon nuclear power and double Germany’s use of renewable energy to 35 percent by 2020 as a project that will keep the country cutting-edge. Her government says it has boosted funding for research by 46 percent to 13.2 billion euros in 2011.

While polls show that Germans like it when Merkel tells Europe to reform, a negative view of Agenda 2010 persists among the German electorate, according to the DIW institute in Berlin.

Schroeder, addressing lawmakers of his party on March 12, said that kinks in his reform program were inevitable.

“I’ve always said that Agenda 2010 wasn’t the Ten Commandments,” Schroeder said. “And I’m no Moses.”