Financial Times: Merkel celebrates German model

March to the middle

By Lionel Barber, Bertrand Benoit and Hugh Williamson

Published: June 11 2008 03:00 | Last updated: June 11 2008 03:00

For most of the past decade, Germany was the sick man of Europe. No longer. In the past two years, thanks to robust growth, it has created 1.6m jobs and is approaching full employment. No other country in the world, not even China, earns more from exports.

Germany's economic performance contrasts with that of the US and the UK, both victims of a credit squeeze that has exposed flaws in the Anglo-Saxon model of laisser faire capitalism and deregulation. Once derided as outdated and inefficient, the German social market alternative is proving resilient.

Angela Merkel, the 53-year-old German chancellor, could therefore be forgiven a moment of schadenfreude as she welcomes the Financial Times for an hour-long interview in her Berlin office. Now one of the most experienced European leaders, she has acquired a gravitas that sets her apart from the mercurial President Nicolas Sarkozy in Paris and the introspective Prime Minister Gordon Brown in London.

"I see myself at any rate as someone who, together with her cabinet, has achieved a great deal," she says with a self-confident smile.

Barely three years ago, in the run-up to her election as chancellor, Ms Merkel openly admired British and American economic recipes. She has since become more assertive in defending the German way - a free market tempered by consensus-building politics and a generous welfare state. Her relaxed mood, however, belies the difficulties she will face in the final year of her term.

"I am not in charge of forecasts," says Ms Merkel, who eschews small talk and prefers to sit at a long table rather than on the white linen sofas at the end of her spacious office. "But if estimates are any guide, we will experience a slowdown in growth . . . It will be much lower than in the past few years."

The chancellor claims to be relaxed about the rise of the euro, which most economists believe will sooner or later dent German exports. The currency's strength, she says, is a boon for importers of raw materials as well as a scourge for exporters. Yet, she says, "the rising price of oil presents all economies with a formidable challenge".

It is not just the economic horizon that is darkening. The public's mood is souring amid rising prices and stagnating incomes. Ms Merkel's fractious "grand coalition" is running out of steam. The political landscape is fragmenting and moving leftward ahead of next year's general election. Once fêted as a tough-minded reformist, the chancellor faces accusations of backsliding.

Further complicating her work is Germany's great paradox. Of all the advanced economies, it is perhaps the greatest beneficiary of globalisation. Industrial giants and the Mittelstand (the small and mid-sized companies that form the backbone of the economy) have prospered in markets such as Brazil, China, India, Russia and eastern Europe. Yet the average German citizen is critical of globalisation, which is linked to economic insecurity and stagnating wages.

Ms Merkel must reconcile these conflicting forces as the credit squeeze impacts on the real economy. "We are witnessing an exponential increase in the penetration of globalisation," she says. "There is a protectionist temptation. This is not the right way to address the challenge of globalisation."

The dark side of globalisation revealed itself in the global financial crisis and it is on this issue that Ms Merkel's waning enthusiasm for Anglo-Saxon capitalism is most apparent. She has harsh words for bankers who took on unacceptable levels of risk or bought and sold exotic products with little idea of their value.

The chancellor politely refrains from endorsing President Horst Köhler's description of financial markets as "a monster". She is, after all, speaking to the FT. But, as the daughter of a Lutheran minister, she is in no doubt as to where right and wrong lie.

A trained physicist, she says people who buy lasers in Germany know what a laser is. "Financial markets are a lot more opaque." When financiers behave irresponsibly, she says, industry acts as a "lightning rod" to ground the ensuing tension. "That has to change so that a country like Germany, which still produces a lot of industrial goods, does not have to carry the economic risks."

Ms Merkel skirts over the fact that Germany's cosseted public-sector banks were happy to take on extra risk in an effort to boost thinning margins. These were among the first casualties of the subprime crisis last summer and had to be bailed out.

Josef Ackermann, chief executive of Deutsche Bank, the country's foremost financial institution, best summarised his sector's plight. Once vilified for his pay package and unsparing management style, Mr Ackermann, a Swiss national, confessed: "I no longer believe in the market's self-healing power."

Ms Merkel says such statements are tantamount to giving protectionism "an open flank" and may contribute to discrediting politicians who, like her, favour free markets.

She points out that Germany was the first country to draw attention to the opacity of financial markets when, as chair of the Group of Eight leading industrial nations last year, it called on hedge funds to improve transparency. A flicker of a smile appears as she notes that, following the Northern Rock debacle, to which she alludes without naming the nationalised bank, "our British friends" have come round to the idea of shining more light on opaque financial instruments.

The chancellor is now prepared to go one step further. It is time, she says, for Europe - in the form of the 15-member eurozone - to translate its economic power into greater influence over the rules and standards governing the world's financial markets.

"Europe has developed a certain independence thanks to the euro. But of course, in terms of the rules, the transparency guidelines and the entire standardisation of financial markets, we still have a strongly Anglo-Saxon-dominated system," she says. "The robust currency system of the euro has not yet secured sufficient influence over the rules governing financial markets."

She supports the creation of a European ratings agency to challenge the dominance of Moody's and Standard & Poor's. Alongside an improvement in the pricing of risk by the ratings agencies, she wants to beef up capital requirements in the banks.

Yet Ms Merkel is acutely aware that the crisis demands a political as well as a regulatory response.

Despite the recovery of the past two-and-a-half years, there is widespread rejection of past economic reforms, renewed hostility towards globalisation and a diffuse sense that the rebound has not benefited the "little guy".

The political outcome has been rising support for the Left party, founded formally last year by former East German communists and disaffected Social Democrats and other radicals in the west. The SPD, junior partner in Ms Merkel's coalition, has been most affected by the emergence of this new force and is now struggling with record-low poll ratings and membership. Such weakness has bred tensions within the cabinet, which are rising as next year's election approaches.

Against this backdrop of discontent, Ms Merkel projects an inclusive message - the only one that strategists in her Christian Democratic Union believe will deliver victory next year. "There were always times when people had a special yearning for security," she says. "When they ask: 'Whatever happened to security? Is there anything I can still rely on?' we politicians must answer. If we don't, then people may become radicalised."

She rejects the Left party's polarising response. "Should we forge an alliance of the weak against the strong? Or should we try to gather the weak and the strong together to harness this country's opportunities? That is the debate."

This is not a new playbook. Ms Merkel of 2008 has traces of Konrad Adenauer, Germany's first postwar chancellor, whose portrait hangs over her desk. Adenauer sought to foster stability at a time of radical change by creating the social market economy, which celebrates its 60th anniversary tomorrow. Adenauer's motto, she recalls, was "no experiments".

Such discourse is a departure from her last electoral campaign. In July 2005, she told the FT that "reforms must happen right away and come in a package. They should create a feeling among the people that something is changing." Three years on (and after a disappointing election result), Ms Merkel has matured and her economic liberalism has softened. Globalisation, she insists, needs taming.

"The social market economy was always against the division of society. It is a system that had and still has social cohesion and equality at its core. It tries to forge alliances . . . In a way, we will perhaps always insist on a higher degree of equality than in Anglo-Saxon societies."

Echoing a widespread sentiment in Germany, she insists on the social responsibility of business. Recent scandals - investigations into bribery by Siemens and corruption at Volkswagen, against tax evasion by wealthy Germans and into allegations that Deutsche Telekom spied on journalists - have made it hard, she says, for politicians to take business's side in public.

"This is a heavy burden because it shakes confidence in our institutions - and companies like Telekom and Siemens are almost institutions in Germany. Such isolated cases must be thoroughly and decisively investigated. But our criticism should not be understood as a blanket condemnation of business.

"These provide hundreds of thousands of jobs in this country. My patriotic sensitivity tells me I must stand by these companies in tough times. We must lead them on to the path of virtue, no question, but one should not condemn them en masse.

Ms Merkel's march towards the middle has prompted commentators to attack her government's record on economic reform. Her willingness to yield to the antireform camp contrasts sharply with the toughness she displays on the international stage - she obtained unconditional surrender from Mr Sarkozy on his project for a union of Mediterranean states and frustrated US President George W. Bush over Nato membership for Ukraine and Georgia.

She bristles at the criticism and lists the achievements of her cabinet - a rise in the retirement age; incentives for women and migrants to join the labour force; the abolition of coal subsidies; a flotation of the Deutsche Bahn railway operator; investments in research and development; the creation of a national academy; cuts in non-wage labour costs; and corporate tax reform.

"I think a sober look at the work of the grand coalition will show we have achieved a lot . . . You can say this comes too late, that that is too little and the other comes too early. But I mentioned a few things of which I can say: When this government's term ends, Germany will be better positioned."

She dismisses the notion that Germany is proving averse to change. The chancellor, who grew up in communist East Germany, points to the country's reunification as evidence to the contrary. "Fifteen to 20 per cent of the population who enjoyed 30 per cent of West German living standards joined the country in 1990. Within 20 years, we managed to bring these living standards to 80 per cent of western levels . . . Despite globalisation, Germany faced and mastered an extraordinary challenge."

She stands up and walks to a pile of files, extracting a note that bears the price of unity: "€1.5 trillion [$2,300bn, £1,200bn] went into German unification."

Still, she ducks the question of whether she would describe herself as a "reform chancellor", a label often applied to her predecessor, Gerhard Schröder, who pushed through unpopular labour market and social security reforms that were in part dismantled by her cabinet.

That is because her priorities have changed. Once determined to loosen the shackles binding German business, today she merely says: "We should take no measure that undermines growth" - including her coalition partner's calls for a universal minimum wage.

Her emphasis on jobs is informed by the experience of the past two years, during which a sharp fall in unemployment sent tax revenues rocketing and helped eradicate the funding deficit of Germany's lavish welfare state without the need for painful benefits cuts. "Without this development on the labour market, we would face a giant shortfall in the pension system . . . It allowed us to cut contributions to the unemployment insurance scheme . . . At current labour market trends, I see more leeway for even deeper cuts."

This, says the chancellor, is why there is no conflict between tax cuts in the future and her pledge to balance Germany's federal budget by 2011 - two goals most economists see as mutually exclusive.

Ms Merkel, whose coalition introduced a hefty 3 percentage point increase in value added tax, insists fiscal rectitude is not an end in itself. She says the goal of a balanced budget is not something "dreamt up by penny-pinching bureaucrats. It is a contribution to making an ageing society future-proof and reversing our rising reliance on credit".

The chancellor declines to be drawn on her campaign strategy for the 2009 election - the guard of honour is already waiting in the courtyard for Dmitry Medvedev, the Russian president, on his way from the airport.

There is little doubt, however, about her future electoral pitch. She will not run as "Miss World" - a sobriquet coined last year by the Bild tabloid in reference to her diplomatic successes. She will not be the candidate of business either, as she was in 2005.

She will appeal to middle Germany and, in particular, to its fearful segments. Her audience will be the same dairy farmers from the Allgäu and Schleswig-Holstein who are massing at the Brandenburg gate, near the Chancellery, in protest at falling earnings.

She fends off one last question - would she support the appointment of Tony Blair, the former British prime minister, as the first president of the European Union? "Today is not the day," she says, adding that EU leaders should first flesh out the job description. She is clearly not eyeing the position herself, though, as sometimes rumoured.

When she ran for the chancellery, she had not banked on leading an unwieldy coalition with her political rivals. Her achievements are a work in progress that can only be completed once she heads a coalition of her own choosing. Ms Merkel is far from being finished with the job of ruling Germany.
Copyright The Financial Times Limited 2008