Germany needs cuts after losing US engine

Ian Campbell

Wolfgang Schäuble has got the right idea. It may sound mad for Germany’s prospective finance minister to be talking about tax cuts when the country’s budgetary position is in bad shape. But Germany’s problem is that its old friend the US consumer has had a financial mishap and won’t recover for a while. Germany needs its own consumers to spend more.

It is easier to analyse Germany’s problems than to solve them. The country thrived in recent years on high-quality manufacturing and exports. That success was built on both engineering strengths of old and a wave of more recent, and painful, private-sector reforms including reduced wages and benefits which made German companies more competitive.

But the buyers of Germany’s manufactured goods were mostly foreigners. Eastern Europe bought German exports as capitalist development took over from communist stagnation. Americans fuelled by fishy finance drove BMWs to the mall. The US housing bubble, the collapse of communism, a booming Britain and an emerging China: all were friendly to Germany.

Now Germany must adapt. US consumers have cut spending. With the euro at $1.50, BMWs are not going to be high on their shopping list. Eastern Europe has been shored up by the IMF but it faces a difficult period. German unemployment, at record lows in 2007, is up to 8.2 percent of the workforce in spite of government measures to keep workers in jobs. The strain on German government finances will worsen.

But Schäuble is right to plan tax cuts. The reforms of recent years reduced German job security and wages and have made the country’s consumers still more cautious. Germans must be encouraged to spend; German growth must be stimulated.

How to make the cuts affordable worries both Schäuble and Angela Merkel, the re-elected Chancellor. But the way to do that is to bring some reforming zeal to a public sector that needs to be trimmed. Merkel is a consensus politician. But Merkel II may need an Iron Lady edge. It will be some time before US, UK and eastern European friends are doing Germany big favours again.

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