The German Problem

"We don't know what Germany stands for anymore." --Senior British diplomat

"We Germans still aren't sure of our place in the world, or where we'll end up." --Editor Georg Gafron of the Berlin tabloid BZ

Remember the German question, a.k.a. the German Problem? It's back.

Once upon a time the specter was of German militarism. During the cold war, with West Germany tied to NATO, it evolved into a fear of excessive pacifism--the possibility that Germans might forge a separate peace with the Soviet Union in exchange for unification. Recent years have brought concerns that the country might grow too muscular, becoming a European uber-power that would bully its neighbors and abandon the politics of Europeanness in favor of Germanness.

Berlin's independent demarche over Iraq has raised the old bogey anew. "We will go our special German way," Chancellor Gerhard Schroder told cheering crowds at his campaign rallies in the run-up to Sunday's election. His flat rejection of German support for military action against Iraq, even under a U.N. mandate, has angered America and left Germany isolated in Europe. A "reckless" adventure in "German unilateralism," reads the summary of reactions from across the continent--epithets usually reserved for George W. Bush.

You wouldn't have known from the headlines. But in fact the real German Problem has little to do with foreign policy. To borrow a phrase from Bill Clinton, it's the economy, Dummkopf. Whoever emerges as Germany's next chancellor (and as news-week went to press, it was nip and tuck between Schroder and his challenger, Edmund Stoiber), he will have to do much more than dig his new government out of a diplomatic hole over Iraq. The country is an economic mess. And unless it musters up the will to change and work another "economic miracle," the prospect is for a prolonged decline that could drag down Germany and the rest of Europe with it.

What a change. For decades Germany has been Europe's locomotive, a well-honed machine that exported not only fine products but prosperity to the world. Yet today it's a laggard--"the sick man of Europe," as the European Central Bank's chief economist, Otmar Issing, puts it. Where Germany once was the very embodiment of fiscal prudence, pushing its EU partners toward monetary stability and sound budgets within a single euro currency zone, it's now Europe's biggest delinquent, whose free-spending ways and out-of-control deficits threaten the entire European financial framework it worked so hard to create.

The litany of hard times is by now familiar. Unemployment stands at 4 million, or 9 percent of the work force. Germany trails all of Europe in economic growth and job creation. Consumer spending is down for the second year; business bankruptcies are at an eight-year high. Some economists fear that Germany will slide into what David Barker, chief economist for Moore Capital in London, calls a Japanese-like spiral of deflation and economic stagnation.

Indeed, Germany seems bent on an almost willful path of economic self-destruction. Every other nation in Europe has cast its lot with market-based reforms as they retool their economies and work forces for the 21st century. The Netherlands and Sweden long ago began revamping their famous welfare states. France passed a radical tax cut. Italy is trying to reconfigure its labor market. Portugal has slashed social services to get its unruly budget deficit within EU guidelines. But Germany has chosen the opposite road. It's spending more, not less, on welfare. New laws have even more tightly regulated its labor market; unions have been given more rather than less power in hiring, firing and corporate management.

Eight years ago NEWSWEEK examined this "German Disease": a paralyzing, dysfunctional mix of coddled workers, notoriously meddlesome bureaucrats, powerful labor unions and entrenched industrial lobbies. Since then, for all the reforms elsewhere, little has changed in Germany. Its workers are still the world's costliest. Yet they're so heavily taxed that their standard of living is substantially lower than their American or Japanese counterparts'. They still work the fewest hours and enjoy the longest vacations. Yet working so little seems to make them ill: in all the industrialized world, few call in sick more often. Yes, they enjoy unrivaled benefits and job security--but those who haven't priced themselves out of the market can't get new jobs because companies are loath to risk hiring someone they're stuck with when business gets bad. A study by the government Labor Bureau reveals that as many as 2 million unemployed aren't even looking for work, mostly because they're better off on benefits. All told, Germany now ranks 47 out of 49 industrialized countries in "adaptability and flexibility," according to the 2002 World Competitiveness Report --by the International Institute of Management Development.

More and more, Germany resembles a society stuck in another age. It has one of the lowest shares of females in the work force. (Alone in Europe, its schools send their pupils home at noon; the tax code penalizes two-income families.) The country's service sector is woefully undeveloped, from the understaffed restaurants that tourists complain about to chronic shortages of child care, nurses and cleaning staff. Powerful guilds and cartel-like trade associations, many with roots in the Middle Ages, keep strict tabs on who can take up a profession--and make sure there's not too much change or competition. Unravel this absurd bureaucracy and its stifling rules and regulations, and Germany could create half a million new jobs almost overnight, according to the government's own Commission on Monopolies.

The irony is that few Germans would have it any other way. As with Iraq, Schroder called this, too, "our own German way." Nor did he get any disagreement from Edmund Stoiber, whose cri de guerre is "No American methods"--notwithstanding his promises to modernize and re-energize the country. Such attitudes owe much to history. Their turbulent 20th century left Germans with a yearning for stability, coupled with a deep fear of conflict and change. After the war, the country engineered a uniquely "German model" of political, social and economic organization that enshrined consensus and government-corporate partnership as the foundation of a generous welfare state. It worked for an impressively long time--until the inroads of international competition caught up with the costs and inefficiencies of maintaining that massive "nanny state." Today the German model for success has become the German model for decline.

Ask most economists how to break out of the trap, and you get clear answers. Roger Kubarych at Hypovereinsbank in New York ticks off a list: create incentives for small businesses--the prime source of new jobs--to set up or expand. Do the same for Germany's shriveled services sector, particularly in retailing, information technology and health care. Rewrite laws that hold back entrepreneurs. Loosen labor laws. Revamp and simplify the country's cumbersome tax code. Above all, deregulate, deregulate, deregulate. But when it comes to actually acting on such proposals? "Shifting is scary," Kubarych acknowledges. "Politicians know that, and so they temporize."

Temporize, indeed. Virtually every effort in recent years to reform Germany's economy, or change its social mind-set, has failed. Remember Helmut Kohl? One reason he lost to Schroder's Social Democrats in 1998 is that he dared to propose cutting Germany's unlimited sick leave to 90 percent of a worker's full wage. Remember, too, his efforts to level the playing field for German corporations saddled with high labor costs--by foisting Germany's labor laws on the rest of the European Union. Schroder has more recently crafted a similar strategy, bashing Brussels for trying to curb special protections that shield many German businesses from unwelcome competition: carmakers, banks, pharmacies, the national railroad. He is also locked in with the unions, Germany's most reactionary lobby. They've made him set strict legal limits on part-time and freelance work, and a new law expands their powers to co-manage companies. As for the opposition, Stoiber entered the arena preaching renewal. But his recipes (a little tax cut here, a little change in the labor law there) seemed dwarfed by the problems at hand.

Nor is there any real popular pressure to do things differently. Few Germans think their economy is truly sick. Most seem content to see what the future brings, so long as they keep their jobs and social benefits--a mind-set that has brought Japan to such grief. Already, the German government redistributes some 50 percent of GDP. Yet a recent Allensbach poll finds that 59 percent of Germans feel their society is becoming more rather than less unjust. There is too much inequality in society, they say--and too much freedom.

This, in the end, is the essence of the "German way." A preference for social security over individual freedom, for more government intervention rather than private enterprise, for more bailouts of businesses instead of letting good companies grow and bad ones fail. Almost half of Germans think it's the government's responsibility to create jobs and spur the economy. Those who say otherwise tend to be regarded as freaky extremists. Hans-Olaf Henkel, an ex-IBM manager and retired head of the Federation of German Industry, recently published a book called "The Ethics of Success," suggesting that Germany's problems can be cured only by a stiff dose of market economics. The response: vilification even in the mainstream media. At speeches, he's been pelted with eggs.

Germans simply don't want to debate the point. They seem to prefer ignoring uncomfortable demographic and economic trends that herald an economic meltdown: an aging population that will shrink from 82 million today to 64 million by 2050, for instance, even as pensions consume an ever-larger share of GDP.

Nothing speaks to this fact more eloquently than the recent election. It was exciting as a political cliffhanger. But where were the issues? Neither candidate offered a plausible plan for getting Germany going again. Neither charted a transforming vision for the future. In any case, that's not what voters wanted to hear. What whipped them up was Schroder's blasting Bush on Iraq, not to mention his fiscally openhanded promises to tide Germans through hard times, budgets be damned. After all, this is the nanny state. Slumping or not, few Germans wish to change it, even if that will ultimately threaten their survival as a global economic leader. That's the heart of the German Problem. And given Germany's place in Europe, it's a problem its neighbors will have to share.