Schröder gets his way by losing

Jul 5th 2005
From The Economist Global Agenda

At Chancellor Gerhard Schröder's urging, the German parliament has rejected his government in a confidence vote, making it likely that elections will be held a year early, in September. Whoever wins will have to get a grip on Germany's dismal public finances

WHAT sort of leader would engineer his own defeat in a vote of confidence, in order to bring forward national elections that he will almost certainly lose? An odd tactic it may be, but Germany’s chancellor, Gerhard Schröder, seems sure that it offers his only hope of securing a mandate strong enough to push through reforms that would revive Germany’s run-down economy.

After losing a key regional election in May, in North Rhine-Westphalia, Mr Schröder shocked the nation by announcing that he would seek to hold a general election this autumn, instead of next year as planned. But this is not easy to do in Germany. Those who crafted its post-war constitution sought to avoid a return to the weak, unstable governments of the Weimar Republic that had ushered in the Nazis, by making the early dissolution of parliament difficult. Thus the only way to do this is to “lose” a confidence vote. On Friday July 1st, Mr Schröder managed to achieve just that. He addressed the lower house of parliament, the Bundestag, urging it in effect to reject his administration and thus open the way to elections that would bring “clarity” and “legitimacy”. After a lively debate the chamber obliged, thanks to a large number of abstentions by members of the chancellor’s left-leaning Social Democratic Party (SPD).

The most likely date for the election is September 18th, but there are still two hurdles to negotiate. The dissolution of parliament has to be approved by the country’s president, Horst Köhler, who must weigh the support the plan enjoys among a majority of Germans, as well as the main parties and the financial markets, against the fact that it may be unconstitutional. Which leads on to the second obstacle: several members of parliament have said they will launch legal challenges at the Federal Constitutional Court.

If either the president or the court refuses to accept the confidence vote as adequate grounds for an early election, Mr Schröder, chancellor since 1998, would probably have to resign to make way for a successor from his own party until next year’s elections—most likely Franz Müntefering, the SPD’s chairman. However, lawyers from both the SPD and the main opposition Christian Democrats (CDU) are said to be confident that they will get their way. There is even a precedent: in 1982, Helmut Kohl engineered a confidence-vote defeat and the Constitutional Court backed the move, albeit with some reservations.

Mr Schröder may be on the same legal ground as Mr Kohl, but he is in a very different electoral position. Mr Kohl strengthened his hold on government in the subsequent election, whereas the current incumbent needs a miracle just to stay in power. He may be personally more popular than the CDU’s candidate for chancellor, Angela Merkel, but opinion polls give her party (and its sister party in Bavaria, the CSU) a big lead over the SPD—perhaps even enough to gain a majority without the support of their prospective coalition partner, the Free Democrats.

It does not help Mr Schröder that his party has been tearing itself apart. A new far-left alliance, co-led by his former finance minister, Oskar Lafontaine, could win more than 10% of the vote, according to pollsters. This challenge has led the SPD to shift leftwards in an effort to hold on to its core supporters. The party's election manifesto, released on Monday July 4th, contains barely any of the reforms that economists say are needed. Instead, it seeks to leave the overly generous health-insurance system intact, promises no cut in public-sector spending, and would slap a 3% income-tax surcharge on anyone earning more than €250,000 a year.

Fiscal follies

Whatever the complexion of the next government, its priority will be clear: giving the economy a jolt. Growth is too low, unemployment too high. Last year the economy expanded by a less than racy 1.6%; this year it will grow by even less, perhaps 1%. Domestic demand has been weak for years, sparking occasional fear of deflation (core inflation—excluding volatile food and energy prices—will be close to zero in 2005, according to the DIW economic institute). Strongly growing exports have helped to keep the economy in positive territory, but they are set to slow this year as the world economy cools.

The labour market continues to be a worry too. Despite the “Hartz IV” reforms enacted under Mr Schröder, the working environment is still much more rigid than Britain’s or America’s. Figures released last week showed that the seasonally adjusted unemployment rate fell slightly in June, but only to 11.7%. Awkwardly, the kind of reforms needed to solve these problems do not go down well with German voters, who seem to want the impossible: an economy that is more vibrant but also retains the basic features of the post-war “social market” model, including its generous welfare net.

The most pressing problem—and a key factor in Mr Schröder’s decision to advance the election—is the dismal state of Germany’s public finances. The federal government will borrow €22 billion ($27 billion) next year, pushing the overall budget deficit well above 3% of GDP, the ceiling supposedly set by the euro area’s stability pact. Public debt will hit €1.5 trillion by the end of 2005, or 68% of GDP. If nothing is done, some projections have debt rising to an Italian-style 111% by 2050. Adding implicit debt, such as pension liabilities, pushes the ratio to three times as high. All of which suggests that a government led by Ms Merkel may have to raise taxes.

During the miracle years, politicians found it too easy to distribute subsidies, riddle the tax code with exceptions and ignore such structural problems as a rigid labour market. But the fiscal consequences of slow growth have been dire. Last year, interest payments, labour-market programmes, pensions and other social spending soaked up almost two-thirds of federal spending. Germany’s federal system, which gives the states veto power, makes things worse by letting the government cut tax rates, but not subsidies, which consumed almost €60 billion in 2003. Add the costs of unification, mostly financed by debt, and it is easy to see why recent budgets violated the constitutional rule that deficits should be incurred only to finance investment.

Would a CDU-led government do any better? It will do what it takes to avoid the looming “state bankruptcy”, promises Steffen Kampeter, the party’s budget expert. Once in power, it will declare a spending freeze. Then it plans special laws, including wide-ranging cuts in subsidies, to get the budget back on a sustainable track. Because the CDU controls the upper chamber, the Bundesrat, these painful measures have a better chance than usual of passing.

Yet a CDU-led government will want to do a lot more than just get the state’s books in order. At first, it might launch reforms that cost nothing, such as more deregulation. But unless the economy unexpectedly bounces back, a clash is inevitable between sound public finances and hoped-for (but costly) reforms to health-care financing or the byzantine tax system. The CDU apparently plans to raise value-added tax to pay for these.

This would also avoid too much stress on belt-tightening, which risks further weakening of domestic demand and consumer confidence. Indeed, it is quite likely that the fiscal situation will get worse before it gets better. It would not be the first time that a new conservative government ended up spending and borrowing more than its centre-left predecessor.

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