Nation's In-Box Germany: What Needs to be Done Now

Germany’s economy is booming, jobs abound and companies are logging record profits. But the changing geopolitical climate means politicians in Berlin must get on with urgently needed reforms and avoid complacency.
Angela Merkel and Martin Schulz. One will be the next German chancellor. But are they prepared for the challenges to come?

Amid the global existential crisis of establishment politics, Germany's Social Democratic Party may have found the perfect candidate to win back working-class voters before federal elections this fall.

Martin Schulz, the son of a miner, dropped out of high school and turned to alcohol when his aspirations of playing professional soccer fell flat. After getting back on his feet, he became a bookseller, got himself elected mayor and then became first a member of the European Parliament and then its president.

And come this fall, he even stands a chance of becoming Germany’s next chancellor.

"In contrast to the chancellor candidates we've had until now, who have all faced opposition within the ranks of the SPD, he has the potential to unite the entire party behind him," said Phillip Töpsch, an economics student who has been a member of a local SPD association for two years.

Mr. Töpsch isn't alone either. Many SPD members are glad to finally have someone with proletarian roots leading their party again. With Martin Schulz at the helm, anything seems possible. According to the latest polls, Mr. Schulz has an even higher popularity rating than German Chancellor Angela Merkel, and the SPD has seen a surge of support to 28 percent, just 6 points behind Ms. Merkel’s conservative Christian Democrats.

But times are changing. The era marked by Germany's feel-good economy - with its modest yet steady growth rate, booming labor market, budget surpluses and record company profits - could soon draw to a close. The world outside of Germany is undergoing a period of rude and dramatic transformation.

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The European Union, for one, is experiencing its worst-ever crisis since its inception. After Brexit, Germany stands to lose not only an important trading partner but also its most important ally in the fight for a liberal, market-oriented European Union. And if the far-right French candidate Marine Le Pen manages to get elected this spring, the European Union could fall apart.

There are also geostrategic threats lurking outside Europe's borders. Turkey is on its way to becoming an autocracy. There are never-ending wars still raging in the Middle East. Russia's President Vladimir Putin is still playing his war games in Ukraine. And in the South China Sea, tensions between China and the United States are close to boiling over.

But the most dangerous threat of all that Germany faces is Donald Trump. The new U.S. president's protectionist inclinations - and indeed outright policy promises - are endangering the economic system upon which the Federal Republic of Germany has built itself for the past seven decades. It has relied on free markets, strong international institutions and multilateral free trade agreements, and now all of that is in peril.

A policy of more of the same just won't do any more for Germany. So far, however, there is little evidence that the leadership of the parties in the ruling coalition, the SPD and the CDU, along with their Bavarian allies, the Christian Social Union, are drawing the appropriate conclusions.

The SPD, for one, has been so energized by its positive poll numbers that it has been putting concrete policy proposals on the back burner. The party intends to publish at least part of its election program this month, with "redistribution" expected to be a major focus.

As for the CDU, the center-right party has demonstrated little appetite for reforms. Their main concern has been to not put too much pressure on voters so close to the election.

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All in all, this government will be remembered as a coalition that strived for comfort above all else. The coalition partners were quick to agree when it came to doing favors for their electoral base. The SPD got its retirement at the age of 63, while the CDU was allowed to dish out its maternity pensions for housewives. As for the costs of both initiatives, they were left for future generations to pay off.

When it came to matters on which the coalition partners simply could not agree, they have preferred to err on the side of doing nothing, like they did with healthcare and tax policy.

In areas relevant to Germany's long-term success, such as finance, social affairs and the labor market, the country is struggling with too much of a good thing. The political consensus goes something like this: The German economy is booming - why push through tough reforms now and spoil all the fun? Public budgets are in the black, employment is at record levels and Germany continues to set new export records.

Marcel Fratzscher isn't one of those economists who preach their doctrine from lecture halls and then take it personally when policymakers don't follow their advice. As arguably the most important economic adviser to the former German economics minister and now foreign minister, Sigmar Gabriel, Mr. Fratzscher understands that politicians also have to worry about getting elected.

But for all his proximity to the government, Mr. Fratzscher, who heads the German Institute for Economic Research in Berlin, isn't exactly thrilled with its performance in the last few years.

"The grand coalition hasn't adequately exploited the opportunities that were presented to it by the favorable economic situation and the high surplus in the federal budget," he said.

In his opinion, the Social Democrats and the Christian Democrats should have refrained from lavishing voters with things like "an expensive pension reform worth €10 billion ($10.8 billion) annually," and instead "secured Germany's economic future by investing in things like education, infrastructure and innovation."

To be sure, €10 billion could go a long way. For instance, it could pay for establishing three world-class universities in Germany that could compete with the likes of Harvard or Stanford. The country could then reap the steady economic benefits that come with hosting such venerable institutions. Or if that seems too elitist, the €10 billion could always be used to renovate every public school in the country within four years.

But while Mr. Fratzscher expects the state to play a more hands-on role in the economy, his colleague Clemens Fuest from the Munich-based Ifo institute is more skeptical of government interventions.

Where the two agree is when it comes to more investment in education. After all, they both know that a robust education system is the best way to combat inequality and create equal opportunities in any society.

"The weakness of our education system is in the fact that children from uneducated families have an especially difficult time doing well in school," Mr. Fuest said, adding that it was "urgently necessary that these children receive stronger support."

Such a policy would be more sustainable in terms of social justice than "a mere redistribution of taxes," Mr. Fuest said.

The sad thing about these realizations is that they have long been part of every political party's election program. Yet there are still regions in Germany in which one in every 10 children leaves school without graduating, putting them at risk of falling below the poverty line later in life, becoming dependent on welfare - even succumbing to premature death.

By the same token, these are typically the same people who at some point lose faith in democracy and the free market, become resentful of free trade and the free movement of labor, and who tend to vote for populist parties like the far-right Alternative for Germany.

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Apart from being tragic on a human level, the rate of high school dropouts also has grave economic consequences. According to the German Council of Experts, the lack of qualified workers is one of the biggest obstacles to private investment in Germany. Fifteen years ago, German workers were too expensive - now they're too scarce. This is why German companies make a disproportionate amount of their investments abroad.

In the last five years, the 30 blue-chip companies listed on Germany's blue-chip DAX stock exchange hired 300,000 new employees abroad. In Germany, they hired only 124,000 new workers.

Too often, companies overlook Germany when deciding where to build a new factory or research facility. This is a problem that is highlighted by one statistic in particular: Germany's massive current account surplus of nearly 9 percent.

That number means that in the last year, the value of goods exported out of Germany was higher than the value of the goods it imported. How much higher? Nine percent of the country's gross domestic product.

The current account surplus, however, could also be seen from a different perspective: Capital is flowing out of Germany at a rapid pace. Money that is earned in Germany is, unfortunately for Europe's largest economy, not spent in Germany. Instead, Germans make their capital available to foreigners in the hopes that they will one day be rewarded in the form of interest or dividends. But too often, this doesn't turn out to be the case.

Thomas Mayer, the director of a research institute at the Cologne-based wealth management firm Flossbach von Storch, calculated that for every €1 generated by Germany's trade surplus since 1999, €0.30 is lost after being spent on some investment abroad. Overall, Germany has missed out on some €670 billion - more than twice as much as the government's annual budget. The money was wasted on poorly produced Hollywood films, securitized real estate loans, overpriced office buildings and Argentine bonds. The worst part is that the money could have been spent at home, in Germany, where it's sorely needed.

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Nowhere is the sad contrast between the German export miracle and the German investment laggard more pronounced than in the harbor city of Bremerhaven.

Outside the Bremerhaven car terminal is a lot the size of 240 football fields, with space for 95,000 vehicles. Massive container ships dock at the terminal, ready to carry as many as 6,500 cars and other vehicles to customers around the world. It takes four to six weeks for a ship to travel from Bremerhaven to the United States and back. BLG Logistics, an international logistics company with an annual turnover of €939 million, estimates that in 2016, some 2.1 million vehicles passed through Bremerhaven. That's more than twice the number that were moved in 2000.

"Germany is exporting like crazy," said Holger Föh, visitor and events manager at BLG.

At the car terminal, business is booming. But in the city of Bremerhaven, just a few kilometers away, there is little evidence that any of the benefits of that success are spilling over. The imposing, drab concrete structures that form part of the city's skyline are a symbol of that imbalance.

Bremerhaven has one of the highest unemployment rates in Germany at around 15 percent. The buzzing port has done little to change that. Jobs there are hard to get and the waiting lists are long, according to one Bremerhaven resident named Mandy Quelle, who works as a waitress at a local burger restaurant.

When the port switched to loading bridges and containers, many jobs in the area disappeared, according to Stefan Veith, a division head at the state statistical office in nearby Bremen. The main problem, Veith said, is that the port in Bremerhaven is mainly a transit point for products from Germany and other countries. Too few jobs are generated on site. All of the energy there goes into exporting. Investment in the region, however, is missing.

Germany's next federal government will be judged by its ability to get the country's trade surplus down to acceptable levels. But just what constitutes an "acceptable" level depends on who gets asked. The European Union prescribes a maximum of 6 percent, while the International Monetary Fund considers 5.5 percent to be suitable for Germany.

It doesn't help if the government just rests on the laurels of its laboriously balanced budget and pays for new roads with new debt in order to artificially inflate investment. Frankly, the impact that such a move would have would be negligible. Nearly 90 percent of gross fixed capital investments come from the private sector, mostly from companies. It is those very companies that must be convinced to focus more on Germany and not only abroad. If the government wants to help, it could make sure companies have a big enough pool of qualified workers to choose from, predictable energy costs, access to wide-coverage broadband networks, generous research funding, less bureaucracy and better financing conditions for entrepreneurs.

The thriving car terminal at Bremerhaven gives little boost to the run-down city of Bremerhaven.

One thing is certain: Germany is going to continue to need its exports. It will only become an attractive investment location if it is at the heart of a flourishing European single market and an intact currency union. To facilitate this, German companies need to be able to trade with the entire world. This used to be self-evident, but the Brexit vote and the recent protectionist threats from Washington have made very clear that these principles may no longer be taken for granted. In order to keep Europe united and the markets open, the German government will have to play a more active role.

If Germany doesn't take the lead, little progress will be made in the European Union. It is therefore up to the next administration in Berlin to prevent the bloc from crumbling further. In order to facilitate the acceptance and functionality of the European Union, the allocation of competencies and jurisdictions between Brussels and national capitals must be urgently reformed.

The competencies that belong at the pan-European level are fewer in number but more important in scope. E.U. members need a common foreign and defense policy to fill the gap that the United States is leaving behind. A harmonized corporate taxation law is also called for so that large corporations may no longer play the tax authorities of individual member states against one another. Europe also needs common social policies that guarantee every E.U. citizen a basic level of subsistence and thereby curbs internal poverty migration.

The greatest service that the new SPD leader, Martin Schulz, could do for his country would be to retain his unwavering belief in the European project. He must continue to stand in Berlin for the principles he stood for in Brussels. Maybe his by-the-bootstraps past will come in handy to prevent the European Union from becoming some abstract elite project.

 

Anna Gauto, Jens Münchrath, Christian Rieckens, Ulf Sommer, Klaus Stratmann are Handelsblatt correspondents. To contact them: [email protected] [email protected], [email protected], [email protected]