European Affairs

Winter 2004

 

Opinion
France and Germany Must Face the Harsh Realities of Globalization
By Michael Backfisch

 

Time and again, the U.S. economy dazzles envious Europeans with its thrilling growth rates. While business and consumer confidence is picking up steam in America, the euro area is once again lagging behind. On the European side of the Atlantic, politicians too often stare blankly at the United States as the “locomotive” of the world economy Ð expecting to be pulled out of stagnation.

This is the wrong approach. Germany and France, the two powerhouses of continental Europe, have to increase their own competitiveness. That means saying farewell to the illusions of the good old times.

In the fall of 2003, about 100,000 people took to the streets of Berlin to protest against German government reforms that would trim the country’s generous welfare programs. The demonstrators chanted slogans like “poverty for all” and distributed leaflets criticizing “the most serious attacks on living standards and working conditions since World War II.” Have Germans developed some sort of revolutionary spirit? Not to worry, they are still structural conservatives. But that is exactly the problem.

Chancellor Gerhard Schroeder has begun to adapt the legendary German welfare system to the necessities of globalization. At stake are social security as well as health and unemployment insurance systems. They are all compulsory and financed equally by employers and employees. As a central part of what is called “Agenda 2010,” the government has proposed a significant reduction in unemployment benefits. A principal requirement is that those laid off must accept any job if they want to avoid cuts in benefits.

Previously, a highly–developed benefit system stifled the incentive to look for new work. The reforms of “Agenda 2010” are a deep watershed for Germans, who for decades have thought that the state provided “full coverage” against all risks of life. In addition, the government has started an overhaul of the health–care system, which entails increased co–payments for medical treatment.

There is no doubt that these reforms are painful. But they are overdue and nothing more than a first step. For too long, Germans had cherished their dream that the glorious days of the postwar economic miracle (“wirtschaftswunder”) would last forever. The truth is that a social safety net that once worked well has been confronted with new realities. Today’s birth rate in Germany amounts to an average 1.3 children per woman. That is way below the 2.1 level required to maintain the size of the population.

Just take a look at the pension system: Today, on average three members of the work force pay for one retiree. In 2040, the ratio will be less than 1.5 to one. This huge demographic shift also endangers the financial viability of health insurance. Fewer working people will have to support a growing number of pensioners Ð these are the grey facts of an ageing country.

The rest is simple mathematics. In order to maintain the system, you either have to increase the premiums or reduce the benefits. As a result, either the workers and employers or the seniors have to carry the burden. But the continuation of this logic would be absurd in a shrinking society like Germany. The working population, which already has to bear a heavy tax load, would have to pay more and more just to keep the current level of pensions.

In addition to that, companies’ budgets would also be strained, which is one reason why the unemployment rate remains at the relatively high level of approximately nine percent. There is a huge disincentive for companies to take on more workers. It also means that the state, which shoulders a portion of social security, would have to pay more, driving up the budget deficit. For this reason, the government has recently started giving tax advantages for individual retirement accounts (“Riester–Rente”). It is a good idea, but it is too little too late.

Such measures do no more than scratch the surface of a harsh reality: Germany’s whole social system is sick because the political class has been asleep for decades. Since the late 1970s, experts have warned in numerous surveys of the upcoming demographic changes. But instead of tackling the tremendous challenge, the politicians let the far–reaching studies gather dust in their drawers. As late as in the 1990s, Norbert Bluem Ð then labor minister under Chancellor Helmut Kohl Ð provided the false comfort that pensions were “secure.”

The right course would have been a partial privatization of social security as well as health–care and unemployment insurance. With regard to the pension system, the following rule of thumb could have been applied: The younger the citizens, the more flexibility they would have for individual retirement accounts. There would be a sufficient transitional period for all generations to adapt.

After 20 years or so, the system would have reached the desired balance between partial privatization (treasury bonds, mutual funds, etc.) and a basic level of traditional funding. But such a comprehensive proposal would have required leadership and courage. Instead, German politicians thought only as far as the next elections, handing out “goodies” to their respective constituencies.

Chancellor Schroeder now has to pay the enormous check for decades of missed opportunities. When the International Monetary Fund talks about Europe’s need for structural reforms, it is primarily addressing Germany. In its last World Economic Outlook, the IMF provided a bleak assessment of Europe’s largest country: “The German economy remains weak for the third year in a row, adding to the sub–par performance of the euro area as a whole and threatening to hold back the region’s recovery prospects.”

Today’s Germany not only suffers from inflexibility, it also has a mentality problem. Too many people still expect the state to fulfill their needs instead of taking action on their own. This was different in the years following World War II, when a whole generation rolled up its sleeves and developed a work ethic that became famous across the globe. But with the economic success of the 1950s and 1960s, Germans got used to their unique, luxurious social system. Over time, the sweet poison of a pervasive leisure culture spread to the most remote nooks and crannies of society. Deluded by the seductive amenities of the new vacation fetishism, people did not realize that the world had changed.

After the collapse of communism, the pace of globalization accelerated Ð economies became intertwined as never before. Low wages in India or China were no longer of simple statistical interest: they emerged as bitter realities for the work forces of advanced countries.

This does not mean that developed nations have to bow to a downward spiral of salaries and social standards. Just the contrary: They should raise their competitiveness by stressing their own strengths in the market place. This requires initiative, discipline and sacrifice. The mentality problem in Germany is largely due to the fact that neither the politicians nor the media has adequately explained the consequences of globalization to the public.

What is true for Germany applies equally to France. French economic growth is hindered by an over–indulgent welfare system, but politicians have been silent about it for decades. Although the French social security crisis is in some ways not as dramatic as in Germany, owing to higher birth rates and accelerated immigration, it is still severe. The French malaise is aggravated by the fact that about one fifth of all employees are on the payroll of the state.

With public debts already skyrocketing, this financial burden can only be lowered by reducing costs. The government in Paris has already taken some initial steps. It has announced that it will gradually increase the working period required to qualify for a full pension from 40 to 42 years by 2020. But this is only a hesitant beginning. To prevent the collapse of the system as society ages, reforms will have to be far more profound: They must include a phased-in privatization factor.

The situation is similar with public health insurance. In the years between 1997 and 2001, when economic growth in France oscillated around a sound 3.5 percent, there was a reasonable flow of premiums into the coffers of social security as well as into those of health and unemployment insurance. But with the current slow pace of the economy, the demographic burden is weighing more heavily. The government has indicated that it wants to put forward a reform package by the summer of 2004, although it is not yet clear what the content will be.

As in Germany, the public debate in France is not driven by bold initiatives. The state–oriented tradition has created deeply entrenched expectations that the government will continue to be responsible for a functioning welfare state. This is a long-standing bulwark of French conventional wisdom that will be extremely hard to crack. At least there has been an initial process of questioning some long cherished beliefs. In the summer of 2003, a book with the gloomy title of La France qui Tombe (Falling France) by Nicolas Baverez triggered some fiery discussions about the decline of the country.

But apocalyptic scenarios have so far resulted in little more than a half-hearted course of muddling through. Both France and Germany have to come to grips with the unpleasant realities of changing demographics in a globalized world. That implies that the two governments will, at the very least, have to start a frank dialogue with the public about the new necessities.

Michael Backfisch is the Washington bureau chief of Handelsblatt, Germany’s business and financial daily. He covers both politics and economics from the U.S. capital. Previously, he was a foreign policy editor for several German dailies.