Copying and distributing are prohibited without permission of the publisher.


New era of change sweeps in

01 Nov 1998

Germany's recent election result has created an uncertain background for the country as it prepares to enter into the single European currency with which its former chancellor was so closely associated - and to which its people are far from committed.
Quite what effect the new coalition government led by Gerhard Schröder - and, in particular, the new finance minister Oskar Lafontaine - will have on Germany's social, economic, industrial and financial life is, at this early stage, anyone's guess.
It may be liberating. It may be disrupting. But it will be certainly be new. Economic, political social and industrial priorities are being reassessed and, in many important respects, Germany has made a significant break with the past just as it is about to enter an era of powerful change.
With the start of European monetary union promising to create a world where capital mobility and global competitiveness rule, a sea change is set to sweep Germany's industrial landscape and its financial markets.
And, in an environment where the pursuit of self interest may become increasingly prevalent (at the expense of the traditional German spirit of co-determination), everyone - industrialists, entrepreneurs, bankers, shareholders and employees - will feel the impact. Philip Moore reports.

They are an ungrateful lot, the German electorate. More specifically, the electorate in the new Bundesländer are an ungrateful lot. Today, it is easy enough to forget that when Helmut Kohl ascended to the chancellorship of the old Bundesrepublik in 1982, the east Germans living on the other side of the Berlin Wall scarcely knew what a vote was.
While Kohl himself can scarcely be credited for the dismantling of the hated wall, it was the former chancellor who insisted - against the better judgement of scores of advisers and commentators, locally as well as overseas - that east Germans' worthless Ostmarks be swapped on a one-for-one basis with Deustchmarks.
Kohl's administration also swapped east Germans' Trabants for Golfs, their Ilyushins for Boeings, and their "Krenz Xiao Ping" (as posters in Berlin in 1989 described the last leader of east Germany) for the ballot box.
Yet it was the electorate in the former east Germany who in Germany's September elections were primarily responsible for ensuring that the 67 year old Kohl would be unable to extend his political life to what would have been its natural conclusion - presiding over Germany's entry, along with 10 other European Union members, into the single European currency which by the middle of the 1990s had become virtually a raison d'être for the former chancellor.
History books will chronicle that German unification aside, Kohl's crowning achievement was to cement ties within Europe through his indefatigable pursuit of monetary union.
The irony is that with fewer than 50 days to go before the launch of the single currency, it is far from certain that Germans will thank the former chancellor for his efforts.
According to the latest survey on public opinion in the EU published in September by the European Commission, Germans remain lukewarm at best about Emu compared to other Europeans.
This found that only 41% of Germans perceive the EU itself to be fundamentally a "good thing" - compared to an EU average of 51%, with only the newcomers from Austria, Sweden and Finland showing less support for the concept of the union.
Only 36% of Germans reckon they benefit from EU membership (a lower proportion than anywhere other than Finland and Sweden), compared with an EU average of 46%.
As to the creation of Kohl's beloved euro, 51% of Germans are in favour of the new currency, which compares with 60% for the EU as a whole, but more importantly with 66% for the so-called Euro-11 countries scheduled for participation in the first round of monetary union in January.
Only Swedes, Danes and the Euro-sceptic British are, apparently, less supportive of the new currency than the Germans.
If these findings constitute an uncomfortable postscript for the Kohl administration, they are even more so in light of the fact that unlike some Europeans the German electorate can not plead ignorance as a reason for its lack of Euro-enthusiasm.
The same survey found that Germans are much better informed about Emu than the average European, with 94% of respondents in Germany correctly naming the new currency as the euro. This compared with an EU average of 78% (only Finland, with 95%, outscored Germany on this count) and with a shockingly low level of 37% in the UK.
Be that as it may, Germans did not eject Kohl from power as a protest against his preoccupation with Emu. For most of the electorate, Emu was an irrelevance in the recent election which paled into insignificance alongside their chief concern, which was unemployment.
When the former chancellor came to power in 1982, unemployment in West Germany was 6.4%.
By the end of 1997 it had risen to 9.8% (and to higher levels in the new Bundesländer), with social security contributions having risen over the course of Kohl's chancellorship from 33% to 42% of gross wages.
The result was that in spite of unification - both in Germany and across Europe - the final economic balance sheet for the Kohl administration was not a flattering one. As Merrill Lynch noted shortly after September's election in what reads like a political obituary, "stifled by these payroll taxes, an apparent model economy admired by the world - notably by the US - turned into a high-cost location berated for its structural rigidities and its apparent failure to emulate the sweeping changes which had rejuvenated the US and the UK over the course of the 1980s".
Whether or not political change in Germany should worry investors is something over which analysts seem to be deeply divided. Morgan Stanley Dean Witter, for one, seems to be relaxed about the implications for the German economy of the Schröder victory, noting at the end of September that "despite widespread scepticism among political commentators and financial market participants, we believe the Red-Green coalition can become a successful reformist government".
Morgan Stanley went on to give five reasons supporting this view, remarking in the last of these that "fears that socialist governments in Europe could now unite to form an interventionist coalition against market forces are unwarranted, in our view."
It added: "The single market, together with the abolition of currency risks, due to the single currency, greatly enhances the mobility of production sites within the union. This puts enormous pressure on governments to compete for jobs and investment. Locational competition forces governments to cut taxes on mobile labour and capital - a trend that is already under way in countries that are also governed by socialist governments."
Merrill Lynch was also unperturbed about the impact of the new government, noting in a bulletin published immediately after the election that "we expect Schröder to largely opt for a 'New Labour' approach".
The firm added: "Although he is not quite a German Tony Blair, his leanings are clearly more towards the policies of Blair and Clinton than to those of French prime minister Jospin. As a member of the board of a German car producer [Volkswagen], he has a good understanding of the needs of businesses."
Others argue that this interpretation of Germany's lurch to the left may err on the side of complacency - chiefly because it is a fundamental misreading to assume that all European left-leaning politicians are clones of Britain's Blair.
They also say that it is an error to focus too closely on the political leanings of Schröder, when the man people should really be watching is Oskar Lafontaine, chairman of the Social Democrats and Germany's new finance minister.
As Salomon Smith Barney noted shortly before the election, Lafontaine is "extremely influential" and "a more traditional Social Democrat with left-of-centre views". It added: "He thinks that domestic demand is not sufficiently strong to boost growth, and that the purchasing power of consumers has to be stimulated by higher wages."
Oliver Kamm, head of strategic research at Commerzbank's global equities department in London, says that there are two ways in which governments can influence the behaviour of local capital markets.
On the first of these, which combine monetary and fiscal policies, Kamm is relaxed, saying that irrespective of the new German government's political bias, the forces of the independent Bundesbank, the European Central Bank (ECB) and the terms of the Stability Pact will all militate against any major change in fiscal or monetary policy.
"So the monetary conditions of the German economy don't really change irrespective of the shift to the left in the political environment," he says.
Far more worrisome, as far as the outlook for the German corporate sector is concerned, are the microeconomic policies likely to be adopted by the Red-Green coalition.
"The real threat to the German stockmarket," says Kamm, "will come from policies which at the micro level would make it more difficult for costs to be cut and for operating margins to be expanded. This seems to me to be more than just a detail."
It is more than a detail not just for the stockmarket but also for the broader German economy. When the steel company, Krupp, invited representatives of its union to India recently, it was not intended as an opportunity for them to sip tea outside the Taj Mahal.
Instead, it was a gentle reminder that in the context of the global village multinational companies hampered by unhelpful microeconomic policies at home can very easily move elsewhere.
Heinz-Gerd Stein, a board member at Thyssen (which is now merging with Krupp) puts it: "As I always say to my unions, my office is going to stay in Dusseldorf whatever happens. Theirs might not."
This danger of a migration by German manufacturing companies away from their home base is something which analysts were hinting at even before the election. Salomon Smith Barney noted in a research bulletin published in September that Germany would be entering Emu with an overvalued exchange rate and high labour costs.
"The results of having an overvalued currency inside a monetary union are severe," the firm said. "The heightened price transparency and capital mobility that will stem from having a single currency across the euro area mean that firms increasingly will seek out low-cost alternatives. In addition to its cost and price disadvantage, Germany will suffer from a relatively high real cost of capital, because it will have sub-average inflation while facing a common euro-area nominal interest rate."
The threat of an exodus of manufacturing facilities from Germany is not just a theoretical one. A Euroweek poll of companies listed on the Neuer Markt, made shortly after the election, asked these representatives of future German industry whether or not they thought the ascent to power of the Red-Green coalition would lead to "an increase in German investment outside Germany and the EU".
More than 40% of the respondents to this poll said that it would, with several choosing not to answer and very few thinking it would not.
Others agree that it is a mistake to sweep the political changes in Germany under the carpet. Concerns about economic policy having a detrimental effect at a micro level seemed to surface sooner than later when in early October the coalition unveiled a tax reform programme which sent shockwaves throughout Germany's corporate sector.
Hans-Olaf Henkel, head of Germany's influential Federation of Industries (BDI), responded to the programme by telling the German daily newspaper, Handelsblatt, that "this is even worse than we feared", calculating that the new tax template could cost German businesses up to DM100bn over the next four years.
Ulrich Beckmann, head of German research at Deutsche Bank in Frankfurt, thinks that this figure is probably an exaggeration, and that something between DM50bn and DM70bn would be closer to the mark.
But irrespective of the precise costs, several analysts outside Germany responded very negatively to the coalition's tax plans. Credit Suisse First Boston, for example, reacted with a bleak bulletin subtitled "Shareholders bear the cost in Germany".
This warned that tax reforms essentially aimed at redistributing income from companies to consumers is "negative news for corporates, which will bear most of the cost. The restructuring process [in German industry] could be slowed down".
CSFB noted too that the shift in fiscal policy could scarcely have come at a more delicate time, commenting that "this is unfortunate, given the difficult economic background of activity slowdown and price deflation".
Unfortunate indeed, because even those commentators who appear to be more relaxed about political change in Germany are becoming increasingly twitchy about the outlook for the economy.
Beckmann says that Deutsche Bank has made no alterations to its forecasts for German economic growth as a result of the election outcome, but that the emerging market crisis - which he describes as the "overriding" factor in determining the short term direction of the German economy - has led the bank to trim its growth target for 1999 from 3% to 2%, chiefly because of the impact of the global downturn on Germany's exports.
If this is an accurate prognosis, it will be bad news for Germany's new government, which has built its political platform around a so-called 'Alliance for Jobs'. Deutsche Bank reckons that the minimum growth rate required if Germany is to create new jobs is 2.25%.
Without this level, Schröder may find sooner rather than later that he is unable to deliver on his single most important manifesto pledge, which instantly points to another very obvious difference between Germany's new left-leading leader and Blair in the UK.
While the leader of Britain's New Labour inherited an economy which was on the up and up, the legacy taken up by Schröder is the polar opposite.
Beckmann believes that in the absence of robust economic growth as a creator of new jobs, Germany needs to see an increase in tax relief. "There's certainly room for an increase in tax relief," says Beckmann. "We've met the Maastricht criteria comfortably and we should use that to increase our deficit by perhaps DM10bn or DM15bn."
An increase of this magnitude, says Beckmann, would not be sufficient to exert undue pressure on the German capital market in general or on government bond yields in particular.
With 10 year Bund yields having been driven down to historical lows of below 4% in the wake of the Russian devaluation crisis, Beckmann and others argue that the German government bond market had been overbought in any event.
As Deutsche Bank noted in an economic update published in September, "in these conditions and owing to the ongoing risks from emerging markets, we expect yields to fluctuate between 3.8% and 4.2% for the present".
It added: "At the end of the year they should be near the upper end of this band, and then rise slightly further in the course of 1999. We expect a rise in yields more as a normalisation than a trend reversal."
In a much broader context, the outcome of Germany's recent election mirrors a very clear trend in the capital market and the local financial services industry, which was identified in last year's Euroweek report on German capital markets but which has intensified over the last 12 months.
This is that irrespective of how firmly entrenched and immovable traditions and ideas may appear to be, the more forward-looking Germans are very ready to abandon the cherished icons of the past - even if this means upsetting an apple cart based on the co-determination (Mitbestimmung) which was the pivot of the German Wirtschaftswunder throughout the 1960s and 1970s.
In its analysis of the German election, published at the end of September, Merrill Lynch uses a very telling expression when it notes that almost for the first time since the war, Germany's new political leaders will "push Germany's perceived national interest with less historical inhibitions and thus harder than before".
The pursuit of self interest is also a feature in the capital market. Over the last year or so, three examples of the process stand out, and each have potentially explosive implications for the German capital market and its financial services industry.
The first of the three took place in the old east German city of Magdeburg, state capital of Sachsen-Anhalt, when the Land flew openly in the face of Länder tradition by launching the first publicly rated Eurobond for a German state. One Frankfurt-based banker describes this move as having reduced "Germany's big happy family of Länder to a big unhappy family".
The second took place in the lofty skyscraper of the new Commerzbank tower in Frankfurt when the bank's chairman, Martin Kohlhausen - writing as the chairman of the Association of German Private Banks - openly lashed out at the German system of Gewärträgerhaftung and Anstaltslast, which, say privately-owned banks, give the Landesbanks a grossly unfair competitive advantage over commercial banks.
The third took place much more recently in Wiesbaden where the country's largest mortgage bank, DePfa, has decided that it will withdraw from the Association of Mortgage Banks and plough its own furrow by applying for a universal banking licence.
Underpinning all three developments is the common theme that for German borrowers or financial intermediaries, it no longer makes any sense to cling on to local conventions or traditions which can only hamper them as they formulate strategies aimed at dealing with the new competitive forces which the introduction of Emu will unleash.
With the launch of the new currency now only days away, it is probable that developments such as these will represent no more than the tip of an iceberg as other German banks or borrowers unshackle themselves from the confines of historical convention in much the same way as the country's
electorate has just done. EW

01 Nov 1998