Merkel coalition faces economic test

September 28, 2009
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, FRANKFURT, Sept 28 – The new coalition of German Chancellor Angela Merkel will likely boost the biggest European economy but analysts questioned Monday how far she would go with crucial but contentious reforms.

The German Association of Chambers of Commerce and Industry called the result "a clear vote for courageous reform" and president Hans Heinrich Driftmann said corporate tax cuts should now be "high on the agenda."

But analysts questioned how far conservative Merkel would go with possibly painful reforms after she pledged "to be the chancellor of all Germans" in the wake of her victory.

During her first campaign, Merkel called for major changes to Germany\’s solid but staid economic system that provides generous social benefits. The system\’s heavy reliance on exports left it exposed during the global economic downturn.

"Over the last four years her position has become quite blurred" while she governed with the centre-left Social Democrats in a cumbersome "grand coalition," Goldman Sachs economist Dirk Schumacher told AFP.

"Where does she actually stand" now on the issue of restructuring the German social economic model, he asked.

The new government faces a mountain of serious challenges, including the probability of rising unemployment and a huge public deficit that stems from efforts to shield Germans from the worst of the global economic crisis.

At the same time, Merkel\’s new coalition partners, the business-friendly Free Democrats (FDP), have gained in strength and will push for multi-billion-euro (dollar) tax cuts and a simpler tax code.

"The new government must therefore manage a tricky balancing act between fiscal consolidation and implementing new strategies for supporting growth," UniCredit economist Alexander Koch wrote.

Other important issues will be the country\’s crumbling demographic base that could eventually force Germans to retire later, and education reform to help disadvantaged youths gain full access to the jobs market.

"Otherwise you\’ll have a growing percentage of the population who are just dependent on government transfers and who won\’t be able to get a job," Schumacher warned.

A survey for the magazine Focus found that 38 percent of those polled put cutting unemployment at the top of Merkel\’s to-do list, just ahead of improving the education system.

The jobless rate has been largely held in check by state-subsidised shorter working hours but is still expected to climb from its present level of 8.3 percent.

"The silver bullet would be a lower tax and social security burden in order to avoid another round of stagnating real income," Koch wrote.

But he agreed that "the fiscal leeway in the next few years is slim," since Berlin is set to repeatedly breach EU deficit rules.

Meanwhile, although Merkel softened 2005 campaign pledges to overhaul the economy and free up labour markets, several economists remarked that the grand coalition had in fact made progress on the latter.

"It\’s reassuring that not everything that has been done in terms of reform will be reversed," Schumacher said.

The Sueddeutsche Zeitung daily said Merkel\’s inner drive for change was not lost and quoted her as saying recently that "Germany is in a global competition and can take nothing for granted."

She warned Germans again Sunday: "We have a lot of work ahead of us."

Schumacher concluded that "if that\’s the genuine Merkel, then we\’ll see some kind of more pronounced reforms" in the next few years.

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