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/ FT.com Home UK - Germany's chances of recovery are finely balanced Friday Mar 18 2005 . All times are London time. Roger Bove Edit Profile Take a Tour Log out Home UK Asia | Europe | US WorldBusinessMarketsMarkets & funds dataIndustriesLexComment & analysisTechnologyBusiness lifeYour moneyArts & WeekendSportJobs & classifiedsIn today's FT FT ReportsCreative BusinessFTfmFT-ITWorld reportsBusiness Reports News in depth Budget 2005 UK election build-up The new Iraq Accounting reforms News File: IPOs Arab-Israel conflict Columnists Philip Stephens Quentin Peel Lombard Martin Wolf Lucy Kellaway Amity Shlaes Featured sections FT Wealth Currencies Technology Lex column Featured Advertisers Advertiser Links 30 free trades from Ameritrade Home UKPrint article | Email article Germany's chances of recovery are finely balanced By Wolfgang Munchau Published: March 7 2005 02:00 | Last updated: March 7 2005 02:00 Friday's jobs and wage deal between General Motors and its German employees is a good example of what is happening in the German economy right now. The management of Opel, GM's European subsidiary, and worker representatives reached a deal to secure more than 30,000 jobs in the company's German car plants. In return, employees agreed to nominal wage cuts and more working time flexibility. They will also forego pay increases until 2010 in some cases. ADVERTISEMENT The deal will have two primary effects: it will make Opel more competitive and it will reduce the income of the company's workers. If you look at the German economy, you will find the same going on: a slowdown in domestic consumption and an increase in exports. Last year, Germany was the world's largest exporter in absolute terms, yet consumption growth stagnated. Falling consumption and rising exports both have the same immediate cause: wage moderation. Companies are improving their competitiveness at the expense of their employees. There are two reasons why German workers accept such deals. One is that unemployment has gone up. On a cyclically adjusted basis, the rate of unemployment now stands at 9.3 per cent of the working population, which is exactly two percentage points above the average rate in 2000, at the high point of the last economic cycle. The second reason is that the labour market reforms of Gerhard Schr der, the chancellor, are beginning to work. Unemployment has not only become more probable. Welfare reform has also made it less attractive, especially for the long-term unemployed. The critical question is: are we observing a one-off shift in real wages? Or is this going to be a drawn-out process that will depress consumption for the foreseeable future? I am an optimist on this, but only on balance. The high degree of industrial restructuring - partly a consequence of globalisation and European Union enlargement - has been quite impressive over the last few years. Job cuts in some of Germany's best-known companies grabbed last year's headlines. newspaper We are now in a consolidation phase, as the pay deal at Opel suggests. Domestic consumption, still weak in December, picked up in January. The worst may already be over. The bad news is that there are no signs that wage moderation is ending. Workers at Opel will be facing declining real incomes for the rest of this decade. The country's nominal wages are not yet falling, but last year they came close. The rise in per capita nominal wage costs - which had grown at annual rates of between 1 and 2 per cent during 1996 and 2003 - fell to zero per cent in 2004. As the Opel case suggests, there is much greater nominal wage flexibility in the German economy than is widely believed. If the Opel pay deal catches on, a deflationary spiral could develop. As employees expect to earn less money in the future in real terms, they reduce their consumption patterns accordingly. This in turn could lead to lower investment, resulting in more wage moderation, a contracting economy and so on. The appropriate policy response is for the central bank to remain open-minded. The German government should consider whether to increase public sector investment by a sum equal to 1 or 2 per cent of gross domestic product. Both education and transportation infrastructure have suffered from underinvestment in recent years. Such an investment programme should be complemented by product market reforms aimed at improving the potential growth rate of the economy. It is perhaps best to steer clear of more labour market reforms now to avoid further uncertainty. Unfortunately, the policy response is going to be different. The European Central Bank said the next interest move would be upwards. The German debate on reforms focuses again on the labour market. Furthermore, the stability pact, the fiscal rules underpinning the euro, discourages large-scale investment programmes by any eurozone country. In the absence of an appropriate policy response, it is more difficult than it should be to predict whether the German economy can escape the low-growth trap. At the same time, the chances of success are not nearly as bad as the recent string of economic forecasts suggests. wolfgang.munchau@ft.com EMAIL ARTICLEPRINT ARTICLEMOST POPULAR Search & quotes News Quotes Power search My portfolio Site services News tracking - RSS Personal office Download news ticker FT mobile FT Research Centre FT conferences Currency converter Working at the FT Research tools Analyst reports FT Research Centre Free annual reports Market research Growth companies D&B business reports = requires subscription to FT.com HomeWorld | Business | Markets news | Markets & funds data | Industries | Lex | Your money Comment & analysis | Reports | Arts & Weekend | Sport | In today s FT | Media inquiriesContact us | Help Copyright The Financial Times Ltd 2005. "FT" and "Financial Times" are trademarks of the Financial Times. Privacy policy| Terms| Advertising| Corporate

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