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Making Germany fit for the future

By: Roland Berger
Financial Times, July 7, 2002

Germany's election campaign is paralysing the country. While the candidates manoeuvre for the contest this autumn, action on economic reform has almost come to a halt. Europe's largest economy cannot afford to let this state of lethargy continue.

Gerhard Schrýder, the social democrat chancellor, and Edmund Stoiber, the rightwing governor of the state of Bavaria, both have a fair chance of winning on September 22. Both are capable of tackling the complex problems that Germany faces today but there is an urgent need for action.

Germany is in last place among European economies, with growth in gross domestic product of only 0.6 per cent last year and expected growth of 0.8 per cent this year. The unemployment rate is 9.4 per cent: 4m people are jobless. We have lost our competitive edge: Germany's share of world trade has declined from 12.2 per cent in 1990 to 9.6 per cent today and the US and others are outperforming us in terms of innovation.

The main reason for Germany's poor performance is that we have been misallocating our resources. We have focused on subsidising the status quo and not on innovation, growth, new jobs and prosperity. To put it another way, we are not living for tomorrow but in the past. In order to move forward, we need a more competitive and entrepreneurial approach and we must reallocate our capital and human resources.

First of all, Germany needs to increase its investment in education, the foundation of its future strength, from today's 4.4 per cent of GDP to 7 per cent. We need pre-school education in primary skills such as reading, arithmetic and languages. We need more emphasis on communication and leadership skills, greater inter- national focus and the introduction of courses in our universities to prepare students for the technology of the future. The US, France and Britain have shown us how to promote elites and improve standards by creating competition between educational institutions and education providers.

Second, we have to raise the level of investment in industrial innovation to 3 per cent of GDP and focus on high-technology research and knowledge-based services. Only superior performance in innovation can safeguard our wealth in the face of global competition. Our wealth is an economic rent derived from our capacity to innovate. Other countries will pay the prices we charge only if we produce goods and services that they need but cannot produce themselves.

Third, we have to accelerate the pace of the economy's structural change away from manufacturing and towards high technology and services. We must support our service sector and those who produce innovative technology, by means of suitable training programmes, financial support and tax breaks.

Last, we must encourage the development of industry- and technology-based clusters. This will inject dynamism into our economy by creating links between the scientific and research community, companies, venture capital providers and other professional and business service providers.

All this will cost money: a sum equivalent to about 6 per cent of GDP will have to be saved elsewhere. Mr Schrýder and Mr Stoiber have promised the German public good deeds and they agree with me on these long-term priorities. Yet neither will specify how they should be financed - at least not during the campaign. I believe the money should be raised from the following sources: Privatisation, deregulation and liberalisation. Germany needs more of the market and less of the state in order to unleash its entrepreneurial forces. We still have largely state-dominated financial services, energy and transport industries. About 100,000 other companies are owned by local, regional and national governments.

The priority is to make the labour market more flexible. This would involve opening up the system of national wage agreements and making legal agreements at company level, especially in eastern Germany. Employment protection laws must also be eased and low-wage jobs released from bureaucratic restrictions. Only then can our entrepreneurs create new jobs. A good first step towards introducing flexibility and reducing high un- employment would be to adopt the ideas of the task force led by Peter Hartz, a director of Volkswagen. Reforms of the social security and healthcare systems to reduce ballooning costs. Germany must remain within the framework of a social market economy on the continental European model. But the country now has to concentrate on providing basic social insurance coverage, while leaving additional coverage to the discretion of the individual. Allowing the private sector to finance and operate more infrastructure, such as transport and communications. This shift could ease the strain on public budgets. The key would be to ensure that the public continued to have non-discriminatory access to services. Regulation would be needed to ensure that the private sector provided services of guaranteed quality at a fair price.

Such changes would allow the country to save the 6 per cent of GDP needed to invest in the future. There would be other advantages as well. Increased private sector provision would mean that capital markets gained a boost to liquidity from private investment that would make them more effective, more efficient and more competitive.

We have no time to lose: all these reforms must be initiated within the first 100 days following elections. The winner of this election will have to prove that he deserves the trust placed in him by the German people by pursuing economic policies for the future.

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