German opposition reformers in retreat, waiting for a new beginning

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1 EZA Briefing Note: EZA 640/27Oct04: Germany/Politics German opposition reformers in retreat, waiting for a new beginning Rivalry between the leaders of the CDU/CSU opposition, Angela Merkel and Edmund Stoiber, reflects a general debate on the political direction of the opposition camp. While reform-minded Merkel wants to present the CDU as a market-oriented alternative to the government, Stoiber wants to continue the CSU centrist traditions. The current fight on health care reform serves both party leaders as an ideal battleground, given the stark differences of the reform alternatives. Merkel lost ground in recent months due to the CDU decline in the opinion polls, the resignation of chief reformist Friedrich Merz and the resignation of Baden-Wuerttemberg state premier Erwin Teufel in Apr05 and the ensuing local leadership contest. Although the debate dented the CDU/CSU as an opinion leader on economic reforms, its result may help re-establish its reform credentials. The announcement of Baden-Wuerttemberg state premier, Erwin Teufel, to resign in Apr05, made 25Oct and the ensuing leadership contest can be seen as continued bad news for Angela Merkel s ambition to unseat chancellor Gerhard Schröder on a reformist platform. Although potentially clearing the ground in that state it adds to the problems faced by Merkel in recent months through the demise of chief financial reformer Friedrich Merz (06Oct) and the disloyalties of CSU head Edmund Stoiber and his health care spokesman Horst Seehofer. Merkel vs. Stoiber internecine strife between reformists and centrists It is not just the economy which is in disarray but also the German political scene. The rise of unemployment to a post-war record, threats of mass redundancies (as at the retailer Karstadt and the car producer Opel) plus growing labour unrest at VW should be an ideal battleground for any opposition party. However, the main opposition parties, the CDU/CSU, have seen their lead over the SPD in the leading national opinion poll Politibarometer slide steadily since Feb04 from 22% to 14% in Oct04. According to the poll Infratest the CDU had dropped to 38% (SPD: 31%), falling below its 2002 election result. The main reasons for the decline in voter support are the lack of unity between the CDU and its Bavarian counterpart CSU on the one hand and the perceived lack of leadership on the part of CDU head Merkel on the other. While Merkel s position seemed unassailable until spring after a string of successful local elections the conflict between the CDU and the CSU on key reform projects has significantly dented her popularity. According to opinion polls on 21Oct, 57 percent of respondents doubt Merkel s capacity to lead her party. Although most of this had been attributed to personal differences between Merkel and Stoiber, the conflict goes beyond the personal ambitions of the two rivals. At the 02Dec03 party congress Merkel made the CDU sign up to a radical reform agenda on taxes, health care and labour markets, presenting the program as a clear market-oriented alternative to the government s timid reform agenda However, since then her plans have been thwarted by Stoiber s CSU, who feared that the radical overhaul of the tax system and of the social system would disturb the balance of German society, and reduce the party s appeal to conservative middle ground voters (see also EZA rpt. 633).

2 This position has a long tradition for the CDU/CSU going back to its roots in the pre-war Catholic Centre Party, and was maintained by post-war chancellor Konrad Adenauer and later Helmut Kohl. It was based on the lines of the catholic social ethics of the beginning 20 th century as well as constraints imposed by the allied forces after the war, aimed at restricting the economic power of the corporate dynasties. Post-war CDU/CSU governments fostered a system of strong union representation in companies, centralised wage negotiations and industrial regulation, called Rhenish capitalism. The position of Merkel s refor mists, by contrast, goes back to the liberal traditions around the economist Walter Eucken and the second German chancellor Ludwig Erhardt the father of the German economic miracle. Within Adenauer s general policy framework he had secured a supply-side policy, based on clear rules, independent economic institutions and (a fair amount of) deregulation. It was not by chance that in 2002 Merkel tried to create the phrase new social market economy referring back to Erhardt s model, while Stoiber in a recent remark allegedly labelled Merkel the Protestant from the East. Taxation, labour market and health care the opposition s battleground Since Mar04 the CSU has managed to dilute the key elements of Merkel s reform agenda, taxes, labour market and health-care. Taxation The CDU proposal for a simple three band tax system and a phasing out of tax allowances failed to get approval by the CSU in the meeting of the two party boards 07Mar04. The resulting Merz-Falthauser paper (named after the financial experts of the two parties) preserved the current sliding scale tax system, but imparted a lowering of key tax rates and a general tax allowance. A more radical simplification on the lines of tax reformer Merz was only vaguely envisaged by 2008 at the earliest. This compromise which deprived the party of its visionary edge among middleground voters (see EZA rpt. 588) may have fostered Merz decision to resign as a fiscal spokesman 06Oct. His successor on taxes, Michael Meister, is highly regarded as a fiscal expert but seems to lack the political cloud, needed to enforce the radical simplification of the tax system against vested interests. Labour Market At the same meeting the CSU also diluted the CDU s proposal for more decisive labour market deregulation. The only tangible result concerned dismissal protection, where - along the CSU s own position there was a rise in the threshold number of employees for companies, for which full protection will be granted. But further reaching CDU proposals for general opt out clauses in sector-wide wage agreements were dismissed, paying homage to the CSU s centrist tradition. Stoiber confirmed this line also in the field of corporate governance; in a TV interview 24Oct seeing only limited leverage in curtailing workers powers on supervisory boards. Health care The fiercest battleground has been health care-reform. Similar to other economies Germany s public health care has been suffering from spiralling costs due to population ageing and technological progress in medicine. These problems have been aggravated in Germany by burgeoning unemployment and the particularly high pace of ageing but a parallel system of private/public health care and high regulation of the pharmaceutical sector prevents competition in medical procurement, driving costs up further. Since 2002 there has been a

3 growing acceptance of the need for a grassroot overhaul of the health care system on the part of the both the government and CDU, but much less so by the CSU and its health care spokesman Seehofer. The government favours an NHS style system labelled citizen insurance which would spread costs to capital incomes and entrepreneurial incomes, thus lowering the contributions for wage earners. In stark contrast the CDU proposal on the lines of wise man (and SPD member) Bert Rürup suggests a per-capita income-independent health contribution of 180 euros per month with a compensation for low wage earners, hence guaranteeing a maximum payment of 12.5% of incomes. Funding this compensation the cost estimates range from eur 18 bn to eur 40 bn as well as the principle of a flat premium are the most contentious issues for the CSU, going against its social and centrist instincts. To test the CDU resolve to support Merkel as opposition leader the CSU is likely to drag out inter-party negotiations in the coming weeks until the CDU party congress 04/05Dec in Düsseldorf. Two scenarios for an opposition leadership contest In our recent assessment (EZA632/13Sep04) we suggested two alternative scenarios for reforms, a go-slow scenario and an accelerating reform scenario. We made this contingent on the relative showing of the government and the opposition parties and their respective chances to win in North-Rhine Westphalia state elections, while regarding the CSU as a bystander. The government parties having deferred further reforms seem to have become bystanders, while the CDU chances to topple a stronghold of the SPD have become rather remote. While the 02Dec03 party congress was perceived as a high point in Merkel s career the coming one might mark the low point and potentially the beginning of the end of her ambitions for the chancellorship, as indicated in recent opinion polls. Together with the demise of Friedrich Merz, this would deprive the party of figureheads committed to market-oriented reforms, reducing its credibility as an alternative to the piecemeal reform strategy of the current government. Even under this scenario it would be unlikely that Stoiber would get a second chance to challenge Schröder although Schröder sees this the most likely scenario. Under the alternative scenario the current bickering provides the chance for a new beginning, given strong support among CDU heavyweights like state premiers Roland Koch, Christian Wulff and Ole von Beust for Merkel s health care reform. Even the resignation of Baden - Wuerttemberg state premier Erwin Teufel, announced 25Oct can be seen as a sign of deliberate party management, with a new candidate likely to boost the party s local election chances. Both candidates for local leadership, Günther Oettinger and Annette Schavan seem committed to a reform agenda. Other local leadership contests may be seen as a liability for Merkel as regards her leadership qualities, but even a defeat in next year s state ele ctions might be taken as a voters wake -up call to rally behind, not against reforms. Under this scenario it remains an open question, how to satisfy Stoiber s political ambitions, but Merkel might offer him a position with great international visibility. Ideally this would be the foreign ministry, or as a second-best if the FDP manages to rebound in the elections a super -ministry in the field of economics/international relations.

4 Key political events Date Reform outlook Remarks Tax estimate 2004/II 9-11 Nov 2004 negative Tax shortfall reduces chances for lower rates CDU party congress Dec 2004 positive Rallying behind reforms in CDU election interest SPD party congress Jan 2005 e neutral SPD ailing from Hartz IV debate State elections Schleswig-Holstein 20 Feb 2005 contingent on result Unpopular local SPD government, but CDU in decline North-Rhine- Westphalia 22 Feb 2005 contingent on result, more likely negative Both SPD and CDU on centrist platforms Baden-Wuerttemberg Spring 2006 positive CDU win on reformist platform likely Rhineland Palatinate Spring 2006 positive SPD-FDP coalition Federal elections Sep 2006 e contingent on result CDU win better to legislate reforms, SPD win better for winning support For further information on this topic please contact Dr Michael Clauss Discussion Partners: Dr Michael Clauss: Germany Pol / Economy John Arrowsmith: ECB / Regulatory Tel: Tel: clauss@ezadvisors.com arrowsmith@ezadvisors.com Jacques Lafitte: France Politics / Brussels Allan Saunderson: ECB Tel: Tel: lafitte@ezadvisors.com saunderson@ezadvisors.com Associate Partners Robin Marshall: UK marshall@ezadvisors.com Dieter Wermuth: Euro Area Economy wermuth@ezadvisors.com Eric Barande: France Economy barande@ezadvisors.com Graham Bishop: Brussels / Regulatory bishop@ezadvisors.com Marc de Scitivaux: Asset allocation strategy descitivaux@ezadvisors.com Miranda Xafa: Greek economy xafa@ezadvisors.com

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