Burning Out?

In Thomas Mann's epic novel "Buddenbrooks," a well-heeled family of German burghers slides into genteel decline. The first generation lays the foundations for a fortune, the second amasses it and the third squanders the family's riches on a life of leisure. Their hardworking neighbors, meanwhile, grow steadily more prosperous. In the end, the impoverished, defeated scion of the once great family meets an untimely death.

In today's Germany, the "Buddenbrooks" syndrome seems alive and well. What was once Europe's role model and richest country is now its worst economic laggard. Last quarter it became the first and only industrialized country (besides Japan) to slip officially into recession. Unemployment, after dropping during the high-tech boom, has jumped back up past the 4 million mark--or 10.4 percent--and shows no signs of stopping there. Last week the European Commission slapped the government with a first-ever formal reprimand, warning that its deficit was getting out of control. If it doesn't shape up, Germany could face billions of euros in embarrassing fines. "We're no longer the locomotive but a brake at the end of the train," says Gerhard Fels, head of the German Economics Institute in Cologne.

Surely, Germany remains an economic giant. And every slump is followed sooner or later by an upturn. As for the literary parallels, no one expects Germany to reach the end of the line, "Buddenbrooks" style. Yet all signs suggest that the health of what the European Central Bank's Ottmar Issing warns will be "the sick man of Europe" is getting worse, not better. A Reuters survey of 16 EU countries released Friday suggests the downturn has hit bottom elsewhere in Europe. Not so in Germany, where January's rise in unemployment was the sharpest monthly gain in the survey's history. While much of the continent is busy reining in the welfare state and freeing up the economy, Germany's government expenditures have begun climbing again, gobbling up nearly 50 percent of GDP. Across the Rhine, France's strong consumer economy has brought jobs and growth, while German consumers keep their wallets shut. As the rest of Europe looks to an increasingly bright future, Germany's low growth, high unemployment and expensive government are dragging it down a spiral of economic gloom.

That could cost German Chancellor Gerhard Schroder his job. "If we don't reduce unemployment... we don't deserve to be re-elected," he said when he took office in 1998. Since then, he's done nothing to reform the system that keeps so many Germans out of work. Lavish benefits and high taxes on wages mean that many of the jobless are better off staying on the dole. A study kept under wraps by Schroder's Labor Ministry for a year (but recently leaked) shows that up to 2 million benefit recipients aren't even looking for work. The Labor Office is an inflated, expensive bureaucracy with a dismal record at finding people jobs. Strict rules--tightened further by Schroder--make it hard to fire anyone, creating a powerful disincentive for businesses to hire. "It doesn't pay for the jobless to work, nor for employers to hire them," says Fels. "Our system protects people who have a job from having to compete with people who want one."

The litany of Germany's economic woes is by now familiar. Hidebound unions, meddlesome bureaucrats and powerful lobbies have nipped all reform efforts in the bud. Public health-care costs are soaring again after Schroder gave in to the pharmaceuticals industry and removed spending caps late last year. The once exemplary school system appears frozen in another age; German high-school graduates today score among the worst in Europe in key subjects such as math and science, according to a recent international study. Economists say hundreds of thousands of jobs could be created if the professional guilds that control everything from pharmacies to plumbers were curbed. These powerful, cartel-like structures make sure there's not too much change, or competition. Retail stores are held back by stringent laws that regulate everything from sales discounts to shopping hours. Despite repeated attempts to change the law, it's still illegal to buy bread on a Sunday.

What's especially alarming is Germany's somnolence in the face of these jangling wake-up calls. In true "Buddenbrooks" fashion, most Germans don't even acknowledge that they have a problem. "We're rich enough. We can afford our social protections," says Markus Wenske, a Berlin real-estate lawyer. German companies, too, have done well by the system. They enjoy extensive subsidies, generous tax write-offs and an old-boy corporate culture that protects managers from meddling shareholders. (German CEOs last year got Schroder to veto new EU rules that would have made it easier to launch hostile takeovers, anathema to German managers and unions alike.) Meanwhile, they've stayed competitive by expanding in the United States and Eastern Europe, shedding German jobs. Defenders of the German model rightly say that it's brought the country unprecedented stability, along with a spectacular economic recovery after the second world war. But that was half a century ago, and the cost of that much-trumpeted stability is rising. Today, the old Wirtschaftswunder looks increasingly like a Wirtschaftsblunder.

For salvation, some look to Edmund Stoiber, the conservative candidate for chancellor in the September election. At his first campaign rally in Frankfurt last week, he promised "less government, less spending and more money back to our citizens." So far, so good. But almost in the same breath, he railed at "American-style hiring and firing"--code for the labor-market deregulation every economist says Germany needs to get its people working again. And in Bavaria, where he is premier, Stoiber has pampered farmers and steelworkers with lavish subsidies, pressed public banks to bail out businesses and condemned even modest pension cuts as "unsocial." "On economic policy, I don't see any major differences between the parties," says Dominik Schwark, an investment-fund manager in Berlin. In Germany, it appears, even the conservatives are socialists.

That's making Germany's neighbors nervous. A stricken giant like Germany drags everybody down, even more so now that 12 countries are tied together by a common currency, the euro. In the past, flexible exchange and interest rates eased adjustment: when wages and payroll taxes got out of hand, the mark could drop and make German goods affordable again. By the same token, the Bundesbank could lower interest rates to boost German growth. Now, these adjustments are no longer possible. ECB chief Wim Duisenberg has singled out Germany's ballooning welfare state as a major reason for the euro's weakness. Some now worry that an unreformed economy like Germany's perhaps shouldn't be sharing the same currency with the euro zone's more dynamic members, like the Netherlands, Spain or Ireland.

What a comedown. For Germany, the choice is clear. It can face the reforms it has so long avoided--or accept mass unemployment, ever-higher taxes and a further drop in living standards as the price to pay for stability. And go the way of the Buddenbrooks.