Analysis: German reform angst sets in a decade after "Agenda 2010"

BERLIN (Reuters) - With its record low unemployment, thriving "Mittelstand" companies and consensus-seeking unions, Germany has been held up as a model of economic management at a time when many of its European partners are mired in crisis.

But as the 10th anniversary of the reforms credited with fuelling Germany's success approaches, a small but vocal group of politicians, businessmen and economists is sounding alarm bells over what they see as a dangerous policy complacency in Berlin that is putting the gains of past years at risk.

Some warn that Germany could even return to being the "sick man of Europe" within a decade unless Chancellor Angela Merkel takes bolder action to build on the "Agenda 2010" reforms her predecessor Gerhard Schroeder unveiled in a speech in parliament on March 14, 2003.

As southern European countries enact deep structural reforms of their own in response to the euro crisis, the worry is that Germany's competitive edge will be eroded by rising wages, soaring energy costs and what some see as a growing state role in the economy that is discouraging investment.

Critics also fault Merkel, in power since 2005, for failing to meaningfully tackle a looming demographic crunch that could hit the economy hard from 2020, and for not moving more aggressively to overhaul a complex tax regime and antiquated education system that is producing too few skilled workers.

"No one knows what will happen in five to ten years, but it is likely that Germany will run into trouble again if new reforms are not put in place quickly," Roland Berger, founder and honorary chairman of the business consultancy that carries his name, told Reuters.

"We are running the risk of losing competitiveness. Next to nothing has changed in the labor market over the past five years. This government and the one before it have profited from the Schroeder reforms and become complacent."

REFORM PENDULUM

No one expects Germany to turn into Greece overnight. Schroeder's reforms, which reduced taxes, merged unemployment and welfare benefits and increased the flexibility of the labor market by removing restrictions on temporary employment, will continue to pay dividends for years to come.

Germany's other strengths - a robust industrial base, network of specialized small-to-medium size businesses, dual vocational training system and "social partnership" between companies and unions - give it a distinct advantage over big European counterparts like France and Italy.

Some economists argue that Germany is so far ahead of its partners on the reform front that it can afford to relax and pay its workers higher salaries after a decade of wage stagnation.

But others point to hard data and anecdotal evidence that suggests Germany is losing competitiveness as a business location just as painful reforms and falling wages in countries like Spain are beginning to make them look more attractive.

Unit labor costs in Germany, for example, have risen 11.6 percent over the past five years - in line with those of Italy and France - while those in Spain have fallen by 0.6 percent over the same period, according to the Paris-based Organisation for Economic Cooperation and Development (OECD).

Productivity in the manufacturing sector actually fell in Germany between 2007 and 2011, the last period for which OECD data is available. In Spain it rose by 2.4 percent.

"Production could shift to countries with lower wages or be taken over by competitors that are eager and able to replicate the uniqueness of German manufacturing skills and knowledge," the Conference Board business research association said in a report in January.

Labor market reforms introduced by the Spanish government one year ago have made it much easier for companies to cut wages or shifts, especially if sales or profit are falling. They also lowered compensation for dismissals, to 20 days per year worked, from 45, when companies can prove they are in trouble.

The reforms have had a swift impact on the car manufacturing industry, where six of the 11 foreign carmakers present in Spain, including German giant Volkswagen, have announced expansion plans in recent months.

Figures released by the Bundesbank last month showed foreign direct investment (FDI) flows into Germany fell in 2012 for the first time in eight years, dipping by 2.4 billion euros, after rising by 29.1 billion in 2011 and 35.4 billion in 2010.

FDI flows can be volatile and difficult to interpret. But Michael Heise, chief economist at German insurer Allianz, believes they reflect a worsening business climate under Merkel.

Her government has encouraged strong wage rises, in part to help struggling euro zone partners by boosting German appetite for imports, and pushed energy prices higher by accelerating a shift out of nuclear power into renewables.

A series of big public infrastructure projects - from the extension of Germany's power grid to the building of a new train station in Stuttgart - have been dogged by political rows. This has discouraged private-sector investment.

"We need to be very careful that we don't end up worsening the business environment in Germany through lots of little steps that call our economic strength into question," said Heise.

"Everyone has been patting us on the back, saying we are so strong. That has led to some lethargy on economic policy. It is very dangerous. The pendulum is already swinging back."

ECONOMIC MIRACLE

In the OECD's "Going for Growth" report published last month, Germany came in 28th out of 34 countries ranked for their reform responsiveness.

The Paris-based group faults a tax system that it says penalizes employment, an education system which is rigged in favor of the elite, an over-regulated services sector and a failure to make real inroads into Germany's demographic problem, for example by luring more women into the workforce.

Instead, Merkel's government has ramped up spending on social programs like "Betreuungsgeld", a subsidy for parents who stay at home with their children. Despite a drive in her first term to boost the number of childcare spots, Germany's birthrate remains one of the lowest in Europe.

Hanns-Eberhard Schleyer, a member of the Hartz Commission that drafted Schroeder's labor market reforms, sees parallels between the current environment and the period when Germany's post-war "Wirtschaftswunder", or economic miracle, came to an end amid bumper wage gains and a rise in regulation.

"My big worry is that we row back on reforms that were important and necessary, that we lull ourselves into thinking we've done enough," said Schleyer.

The bitter irony is that Schroeder, a Social Democrat (SPD), was booted out of office in 2005 because of voter unhappiness with his shake-up of the welfare state, which initially led to a spike in unemployment.

Merkel has been the chief beneficiary ever since and is favored to win a third term in September thanks in part to the resilience of the German economy during the euro crisis.

Wolfgang Clement, who as economy minister under Schroeder played a key role in pushing through "Agenda 2010", also fears Germany is squandering the economic dividends from the reforms. He believes Germany needs a new "Agenda 2020", with investment in education and research as a top priority.

"We are at risk of unwinding what we so painstakingly pushed through at the start of the century," he told Reuters. "What is happening in southern Europe is impressive. We shouldn't try to convince ourselves we've done enough."

(Reporting by Noah Barkin; Editing by Peter Graff)

Source: http://news.yahoo.com/analysis-german-reform-angst-sets-decade-agenda-2010-063618205--sector.html

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