Germany's Winter of Discontent Looms Large

Germany could drift into a recession this winter. That’s the opinion of a number of economists at leading German financial institutions surveyed this week by the German-language edition of the "Financial Times."

"We’ll go into recession at the end of the year," Holger Schmiedling, chief European economist for Bank of America, told the "Financial Times Deutschland." Other financial institutions, including Deutsche Bank, also expect economic growth in Germany to drop in the current and the coming quarters.

HSBC Trinkaus und Burkhardt’s Lothar Hessler is even less optimistic. “A double dip is a realistic scenario,” he says, referring to the situation where two recessive phases quickly follow one another.

Until recently, most economists were talking about negligible growth, or even stagnation, but not a full-blown recession. However, the new forecasts support what business climate indicators such as that put out by the Munich-based economic research institute Ifo have been saying for months. The forecasts are compounded by a report this week from the Organization for Economic Cooperation and Development predicting disappointing growth of 1.5 percent in Germany next year.

Businesses Put Blame on Government

The head of the Confederation of German Employers' Associations, Dieter Hundt (photo), believes the country is in its worst economic state of the past two decades. “For two years running, economic growth has had a zero before the decimal point,” he said in Berlin on Wednesday.

Hundt rejects the government’s attempts to deal with the situation as “inconsistent and contradictory” and lays the blame for the downturn squarely at the Social Democrat-Greens coalition’s door. This view is supported by many economic experts.

Both HSBC’s Lothar Hessler and Gerd Hassel from the ING BHF-Bank single out the latest tax and welfare hikes, high unemployment and even the threat of a war against Iraq as undermining consumer confidence. An increase in consumer spending is seen as vital to economic recovery.

They now expect the Federal Audit office to revise its figures for the first half of 2002 downwards when it presents its third quarter figures next week. Given the statistical importance of the first two quarters in drawing up the figures for the whole year, that would put total growth for the year well under the government’s forecast of 0.5 percent.

So what happened?

The present mood of doom and gloom is in stark contrast to the government’s optimism at the beginning of 2002. The inflationary effect of the euro, the Federal Labor Office scandal, the floods in eastern and southern Germany, September’s narrow election result, and the news that the country’s budget deficit would violate European Union regulations all signalled a bad year for German business. It was made worse by the economy’s stubborn refusal to pick up again in compliance with the Finance Minister Hans Eichel’s predictions.

Eichel’s declared intention of doing away with new government debt by 2005 was played up in the news as the EU was preparing to issue a warning to Berlin that it was in danger of exceeding the permissable budget deficit of 3 percent of gross domestic product (GDP) by the end of the year. Although Germany managed to avoid the infamous “Blue Letter,” in the end the warnings turned out to be well-founded.

Consumers: euro = higher prices

Whereas the experts were trying to raise the alarm about the German economy, German consumers were getting in a lather over rising prices. Even government surveys were unable to allay the public’s suspicion that retailers and services were using the conversion from the deutsche mark to the euro to fill their own tills.

Retailers began to worry about falling sales. “The consumer is pessimistic, anxious and despondent,” German Retailers Association Chairman Hermann Franzen said in the summer. “He’s worried about his future and unhappily frightened into intertia by negative reports in the press. He only buys what he needs, not what he likes or wants.” But Franzen also pointed out that Germans had earned more than ever in the first half of 2002; they just weren’t spending it.

The insolvable problem of the labor market

Unemployment was another major issue over the last 11 months. The discovery that the Federal Labor Office was cooking its own books to give the impression it was getting more people back to work than was actually the case forced the government to take hasty action.

The first thing the government did was increase the proportion of Labor Office employees involved in finding people work. Until that point, only ten percent of the roughly 90,000 public servants working there were actually doing that.

A commission to devise ways of reforming the labor markets was then set up under the direction of Volkswagen Chairman Peter Hartz. It set itself the goal of halving unemployment in Germany by 2005. But the opposition Christian Democrats’ parliamentary leader, Friedrich Merz, seemed to sum up the public’s dissatisfaction when he said, "There’s never... been so much hot air about economic policy as under your government. But it hasn’t resulted in any movement or new jobs. No, just in a new commission.”

A close-run thing

The opposition made unemployment one of the pillars of its election platform. But the disastrous floods which struck the eastern states particularly badly during the summer gave the chancellor the chance to seize the initiative.

Wading through stricken villages in rubber boots, Schröder seemed to be the epitome of the mover and shaker who gets things done. But the cost of repairing the damage meant that tax reforms intended to ease the burden on both employees and businesses had to be postponed.

Nevertheless, the floods, together with the chancellor’s persistent opposition to military action against Iraq, gave the red-green coalition the edge it needed to squeeze back into power on Sept. 22. But, at the subsequent coalition negotiations, the uncomfortable truth started to come to light: the 2003 budget was full of holes.

New government gets off to a bad start

The coalition negotiations were acrimonious. Eventually the Greens agreed to increases in taxes and surcharges and cuts in allowances to try to drum up the missing money. Contributions to the state pension fund were also increased.

“We hadn’t expected things to be so bad,” said Martin Wansleben, chief executive of the Association of German Chambers of Industry and Commerce. “It signals a certain confusion and, at the moment, also a bit of desperation. The coalition agreement is economic madness and is focussed only on the year 2003. Germany will lose its growth potential if that’s all the government’s got to offer in the way of signals for more employment and more growth.”

No light at the end of the tunnel so far

But it wasn’t the end of Eichel’s torment. On Nov. 13, tax estimates were drastically revised downwards: the state would collect 31 billion euros less than planned. Then the government’s panel of economic experts said Germany would most probably violate the EU’s deficit limit next year too, and Brussels agreed and announced the start of formal disciplinary procedures. To cap it all off, the opposition, still smarting from its narrow defeat in the elections, accused the government of lying to voters.

The slide from optimism to bleak pessimism has been extraordinarily rapid, and prospects seem to deteriorate by the day. It’s probably no wonder that German businesses and financial institutions are taking a bleak view of the coming year.