Europe's decade of economic reform draws to a close

By: Wolfgang Münchau

Gerhard Schröder lost his job as German chancellor in 2005 largely because of unpopular and badly implemented welfare reforms. Now Kurt Beck, his successor as chairman of the Social Democratic party, has proposed to undo one critical element of those reforms. He wants to exempt older workers from the full force of the welfare cuts.

 

Mr Beck’s proposals have caused outrage among pro-reformers in Germany. Yet they are extremely popular: 82 per cent of the public supports him, according to a poll. It looks as though he is going to prevail within the grand coalition.

 

Mr Beck’s U-turn is an important milestone. It probably marks an end to Europe’s decade of reform. In Germany, the welfare reforms have turned out to be so unpopular that the SPD’s poll ratings have dropped to between 25 and 27 per cent.

 

Is this really just a case of a victory of political expedience over economic necessity, as it is portrayed by the pro-reformers? The answer is no: from an economic perspective, these reforms were marginal. Politically, they were a disaster.

 

The first of these judgments stands in contrast to frequent claims that these reforms have contributed to the strong economic recovery. That is nonsense. But it would have been a nice story. You reform the economy and, bang, the next upswing is going to be stronger and longer.

 

What really led to an acceleration of exports and domestic investment was a combination of strong growth in Germany’s export markets and wage moderation at home. The latter was the result mostly of external competitive pressures. Of course, it may also have been caused by a rise in the domestic labour supply, and that could be attributed to the reforms. In fact, that argument is not entirely wrong. We know that some discouraged workers have re-entered the labour market. But crucially, long-term unemployment still accounts for about 40 per cent of all unemployment. The proportion may still fall in the future, which is why the economic effect of these reforms cannot be fully judged at this point. But it would be folly to claim that Germany is already a reformed economy as a result.

 

A British political consultant once made an astute observation to me about the differences between the SPD and New Labour. He compared the German pro-reformers with what he called “Labour brutalists” of the 1970s, such as Denis, now Lord, Healey. The German pro-reform Social Democrats are old-fashioned cost-cutters. They are not creative reformers.

 

It is often said that New Labour had the advantage that someone else had done the dirty work for it, while the SPD had to do it all by itself. But that is not entirely true. When the SPD returned to power in 1998, the government undid the few labour market reforms of the previous administration, instead of building on them. New Labour, by contrast, had a well laid-out reform agenda in 1997.

 

Mr Schröder wasted the upswing, and was bounced into his reform agenda only when the economy went into recession. When it finally came, the programme lacked strategic direction. The welfare reforms were not reinforced by reforms in other areas, such as an opening of the markets for services. It could have included the privatisation of state-owned banks, the creation of a more effective capital market or the liberalisation of corporate governance.

 

The timing of the welfare reforms was wrong too. That should have come at the end of a reform cycle so that the economy would have been in a position to create new jobs, as welfare participants re-enter the labour market.

 

As a strategic exercise, economic reform is akin to planning a war. The works of Carl von Clausewitz, the Prussian military theorist, would be more useful to a pro-reform politician than the latest finger-wagging report from the Organisation for Economic Co-operation and Development. You need to plan for different political and economic scenarios. You need to know when you can retreat and when to stand firm. You need solid public support, not only at the beginning but throughout the process. And you need a viable exit strategy. The public needs to know when you are finished. Permanent reform is as nonsensical as permanent war.

 

The failure of economic reforms in Germany has mirror images in other large European countries. In France, the last government tried, and failed, to liberalise labour contracts, and it remains to be seen whether the new administration is better at providing a more strategic focus. In Italy, successive governments have been reforming different parts of the economy, but nobody has dared tackle the inefficient public sector. The European Union’s reform programme, the Lisbon agenda, is also too diffuse.

 

In all these years, I have yet to meet a single politician in a large continental country with a plausible economic reform strategy. I suspect most European voters have not met one either. The electorates have regrettably, but logically, concluded that parties advocating economic reforms cannot be trusted. Do not blame the voters. The idea that voters are incapable of grasping what is good for them is plainly absurd.

 

The small countries have fared better, but their successes hold few lessons as their political economy is so different from that of large countries. It is now time for a new approach, something strategic, and something that does not call itself “agenda” or “reform”. Both words, and the politicians who use them, are associated with failure.
 

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© The Financial Times Limited 2007

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