Germany's Economic Woes and the Election

If Chancellor Gerhard Schröder is ousted from office in just over a week, it will largely be because he failed to address Germany's joblessness -- currently stuck at an alltime postwar high. Either Schröder or his conservative challenger, Angela Merkel, will need find a way to get people back to work in the eurozone's largest economy to help rekindle moribund domestic demand, which has been in the doldrums for years.

But the victor in the poll will also have to show Germany's EU partners that they are willing -- and able -- to make some progress in restoring order to the country's public finances, which have spiralled out of control in recent years as a result of the astronomic costs of unification, runaway unemployment and chronically weak growth.

"We're sitting on a powder keg," the head of Cologne-based economic think tank DIW, Winfried Fuest, warned in a newspaper interview this week. "Without some drastic measures, we'll march ever deeper into debt," Fuest, who has been asked by Merkel's Christian Democrats to look at the state of Germany's shaky public finances, told Berlin's daily Tagesspiegel.

In 2007 alone, Germany could face a structural deficit of 60 billion euros ($75 billion) that would not be reduced by the government simply selling off more of the family silver, Fuest said. Immediate spending cuts of around 8 billion euros are needed if Germany is to have any chance of bringing its deficit back within the limits laid down by the EU's Stability and Growth Pact, he estimated.

Conservatives vague

Ironically, the man the conservatives have tipped to become Merkel's future finance minister, Paul Kirchhof, has remained frustratingly vague on the likely timetable for those efforts. Many observers believe that Kirchhof's bold plans for a drastic streamlining of the tax system would slash tens of billions of euros from public revenues and push up the German deficit ratio even more.

The situation is something of a Catch-22. The deficit cannot come down until the economic recovery becomes self-sustaining, ensuring a healthy flow of tax revenues, and unemployment comes down, lowering the cost of benefit payouts. On the other hand, the government is fearful of cutting back further on spending so as not to choke off sluggish demand altogether.

Some economists also fear CDU plans to raise Germany's value added tax -- a general consumption tax -- by two percentage points in order to plug the budget deficit. Such a tax hike could completely snuff out Germany's already weak domestic demand, as people stop making purchases.

Selling the silverware

That's partly why the ruling center-left coalition has had such a hard time sorting out the country's finances over the years. As a result, much of German Finance Minister Hans Eichel's budget consolidation efforts have been more "cosmetic" in nature, with the government selling off state assets to fill some of the gaping holes in the public purse.

Between 1998 and 2005, Schröder's administration has sold off 63.6 billion euros worth of shares in former state-owned monopolies such as Deutsche Telekom and Deutsche Post. A further 23 billion euros in privatizations have been earmarked for 2006.

The problem for the incoming government, of whichever political persuasion, is that such one-off sources of financing are quickly drying up. The only company still to be privatized is the state-owned railway, Deutsche Bahn, and that is nowhere near fit enough for the stock exchange just yet.

"The new government won't be able to afford any further shortfalls in tax revenues," said Johannes Eeckhoff, economics professor at Cologne University. "The time for fudging is over."