Rough Ride for German Economy

Looking back over the year 2002 you can only shake your head in disbelief at the optimism emanating from the German government at the beginning of the year. Indeed in January the government believed Germany had reached an economic turning point and was heading for a new upturn.

Speaking in Berlin at the end of January, German Finance Minister, Hans Eichel, declared that the economy would stay weak for a while, but would pick up strongly by the middle of the year at the latest.

He was, however, realistic enough to predict that economic weakness would continue to have an effect on employment.

'The average for unemployment over the year should be just under four million and the unemployment rate, at 9.5 per cent, about the same level as last year. This is certainly not satisfactory but I would like to remind you that in January 1998 there were around 4.8 million jobless, that's over 500,000 more.'

Budget deficit headache

Eichel (photo) aimed to reduce debt by 2005 and, in 2006 - for the first time in decades - be able to present a balanced budget.

With an overall state deficit of 2.7 per cent, financial planning at the beginning of the year foresaw Germany keeping within the limits of the EU stability pact. The EU's Stability and Growth Pact stipulates that states' deficits may not exceed three percent of gross domestic product, and member countries must aim for broadly balanced budgets.

As Germany came dangerously close to breaching the stability pact’s 3 percent deficit ceiling, it narrowly escaped a formal warning from Brussels - a move that would have proved embarrassing for Germany.

Despite the close shave in February, critical voices were being raised about Germany's poor growth rate and its effects.

Eckhardt Wohlers, economic expert from the Hamburg world economic archives, HWWA, said, "With this growth rate, Germany is at the lower end of the European league. Such a growth rate will not be enough to improve the situation on the job market. The number of those out of work will increase this year and the yearly average will climb to almost four million."

Fears that Euro could trigger price rises

Along with rising unemployment, the German public began to find fault with the new currency, the Euro.

Millions of consumers in Germany had been complaining about price rises since the beginning of the year. They suspected that retailers had used the changeover from marks to Euro to make hefty price increases. The euro quickly gained the reputation of being an inflation-maker.

The pessimistic mood among consumers had its effect on retail markets. The spokesman for the retailer traders' association, Hermann Franzen once again reduced the forecast turnover levels, in a sector which has been suffering for years.

"Consumers are pessimistic, fearful and despondent. They are seriously worried about their future and, unfortunately, they are daily confirmed in their convictions by negative reports. Necessities are being purchased, but no extras, no luxuries or fun items," Franzen said.

Unemployment scandal sets alarm bells ringing

In addition to Euro worries, a scandal involving the procedures of the Federal Labor Office broke out in March, further undermining the public’s confidence.

It was discovered that the local bureaus of the Labor Office had been dramatically inflating job-placement statistics, by as much as 70 percent ; they had found jobs for far fewer people than they claimed.

The labor office scandal forced the government to taken swift action. In a first step it was decided to use more of the office's workforce for finding employment for job-seekers. The Federal Employment office also received a new man at the helm, Social Democrat Florian Gerster.

In addition a commission led by Peter Hartz, a member of the board of Volkswagen, was set up to propose widespread reforms of the Federal Employment Office and the job market.

The aim of the Hartz commission was ambitious: within three years the number of unemployed in Germany was to be halved from the current four million to two million people

The former federal employment minister, Walter Riester, was clear that the government was anxious for good results."You see, the legislature is proceeding as quickly as possible, and the fact that we have asked the commission to come up with a solution by the August 15 or 16, is pointing in the same direction. We have a great interest in coming to good solutions quickly and translating them quickly and well into policy," he said.

It's the economy stupid!

Germany’s poor economy also paid a central role in the election campaign which picked up in August for the elections scheduled on September 22.

The conservative opposition Christian Democrats (CDU) and its smaller Bavarian sister party, the Christian Social Union (CSU) raced past Chancellor Schröder’s Social Democrats in opinion polls with their emphasis on the economy.

As the economic mood in Germany worsened, opposition Chancellor candidate Edmund Stoiber had an easy task, portraying the Chancellors’s "politics with a steady hand" as simply doing nothing.

Stoiber said a change of mood among the middleclasses was needed, as well as a new political framework for economic growth. "The middle classes are deeply disappointed with this government and the whole depressing climate is, so to speak, raining on the whole population. A change of government will without doubt mean a psychological boost."

Floods a blessing in disguise for Schröder

A change of government seemed almost certain in Germany.

But things turned out quite differently with the onslaught of heavy floods in the middle of August, which inundated large parts of eastern Germany and wreaked its economy.

Amidst this national disaster, Chancellor Schröder was able to confirm his reputation as a driving force as he proclaimed his solidarity with the flood victims and freed up huge sums of money in rapid aid.

In order to pay for the damages worth billions caused by the flood disaster, the tax reform with its planned reductions for individuals and businesses, which was due to come into effect in 2003, was postponed for a year. An extraordinary situation demanded extraordinary measures, Schröder said at the time.

"We have decided, to postpone by a year, the tax reductions due to come into force in 2003. This will make 6.9 billion Euro available. Of this a little more than three billion Euro will come from the federal sources, 2.8 billion from the regions, and a billion from local authorities," he said in a speech.

Schröder’s handling of the floods gained him a lot of sympathy from voters in eastern Germany. The electorate also rewarded Schröder for the fact that he had no intention of getting involved in a war against Iraq. Schröder's Social Democrats together with their junior coalition partner, the Greens managed a narrow election victory.

Government in for rude shock

But trouble was in store for the newly reelected government as the true state of the country’s dire financial state came to light.

Coalition talks with the Greens in mid-October revealed that Germany needed to borrow more than planned, and taxes for companies and private individuals would rise.

The tightrope walk between borrowing and saving, agreed between the Social Democrats and the Greens, came up against virulent protests from the opposition and from employers' associations. The leader of the CSU, Edmund Stoiber said that millions of people felt they had been cheated by a government that was blatantly reneging on its electoral promises.

The CDU leader, Angela Merkel, came to a similar conclusion. "The new rules for the environment tax, alone, lead to a further weakening of Germany as a location for investment, and like a red thread running through the coalition agreement are the missing power, the missing courage, to truly renew Germany, to cut through the knots and set the signals for growth and employment," she said.

Inevitable tax hikes

Amongt other things, the government intends to limit the opportunity for businesses to offset past losses against later profits.

Economic expert Herbert Hax, a member of the economic ministry's scientific advisory committee, said that the abolition of this 'loss carried forward' means that a part of the latest tax reform will be withdrawn.

'It is not a tax reduction, just normal taxation according to ability to pay. If that is now limited, it will be a considerable extra burden on business.'

The contributions to pension insurance are also set to rise – from 19.1 to 19.5 per cent of wages.

The president of the Munich Ifo Institute Hans-Werner Sinn said it would be damaging to employment. "Businesses already have great incentives to lay people off, because they are too expensive. And this just adds to that," he said.

"It couldn't be worse"

'It couldn't be worse' - that was the conclusion of the economic survey carried out in the autum by the German chamber for industry and commerce, DIHK, amongst 25,000 businesses from across the country. The mood is at a low ebb, according to the general manager of the DIHK, Martin Wansleben.

'We didn't expect it to get that bad. It caused a certain bewilderment and for a short while a certain helplessness as well. What has now been agreed by the coalition is economically crazy and aimed short-sightedly at the year 2003. Germany will lose potential for growth, if that is all that the government has offer in the way of signals for more employment and more growth.'

Black Wednesday for government

But there was worse ahead for Finance Minister Hans Eichel. In what is now known as "black Wednesday", November 13 brought a torrent of bad economic news.

The government's independent council of economic advisers, the so-called five wise men, informed Schröder that Germany would register little or no growth for this year and predicted an almost negligible increase for 2003. Germany, they said, was heading for recession in the first half of next year.

Schröder and his cabinet were still reeling from the impact, when the EU Commission piled on even more agony. Brussels announced that it was initiating its so-called excessive deficit procedure against Germany, a formal warning over its budget deficit.

Given this bleak economic data, it's hard to find any remains of the optimism with which the government began the year.