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Analysis: Europe's Japanese economy-I

By SAM VAKNIN, UPI Senior Business Correspondent

SKOPJE, Macedonia, Nov. 20 (UPI) -- On Monday, the unthinkable happened. The European Commission initiated "excessive budget deficit" procedures against the two biggest members of the European Union -- France and Germany -- for having breached the budget deficit targets prescribed by the much-reviled Stability Pact. This seems to have vindicated the voices in both countries who blame their economic woes on the stringent requirements of the compact intended to stabilize the euro.

Yet, the Stability Pact is merely a convenient scapegoat. It is because Germany brazenly -- and wisely -- ignored it that it is being cited by the commission. Still, despite an alarming budget deficit of close to 4 percent of gross domestic product this year and a transfer from Brussels of 0.25 percent of GDP as flood aid, the German economy is stagnant.

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It is set to grow by 0.5 percent this year and by 1.5 percent in 2003, says the government. Not so, counters its own council of independent economic advisors -- the "five wise men". Growth this year will be a paltry 0.2 percent and next year, fingers crossed, 1 percent.

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The IMF is more optimistic. Growth in 2003 will be 1.75 percent, it predicted last week. Even so, German GDP is growing at 3 GDP points below trend. The excess capacity translates to deflationary pressures on prices and to rising unemployment, currently at over 4 million people, or almost 10 percent. One out of every six adults in the eastern Lander is out of work.

The much-observed monthly index of business expectations, published by the ZEW Institute, predicts a nosedive in economic activity in the first half of 2003. Moody's has just downgraded the rating of yet another German household name, the Allianz insurance group.

German banks are caught in a worrisome spiral of loans gone sour, interest rates set stiflingly high by the European Central Bank, the removal of state subsidies and yet another looming recession. Business confidence is extinct, unemployment and bankruptcies soaring. More than 1,000 firms go belly up every week -- three times the rate in 1992.

The two pillars of the German economy -- the small, family-owned, businesses (Mittelstand) and the export industries -- are in dire shape. Eurostat, the European Union's statistics bureau, has just announced that industrial output in the eurozone during the third quarter actually contracted by 0.1 percent.

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In the United States, Germany's other big export destination, if one takes intermediate goods into account, the anodyne "recovery" relies entirely on the ominous profligacy of ever less solvent consumers.

Germany's problems -- like Japan's -- are structural. It is aging fast. It is inordinately expensive. It is bureaucratic. Its banks are tottering, unable to create new credits. The state is overweening and interventionary. Many of the country's industries are already uncompetitive.

Germany's labor markets are rigid, its capital markets either dissolute or ossified. The scandal-ridden, small-cap Neuer Market stock exchange was closed down this year, having lost more than 90 percent of its value since March 2000. Both the average German and decision-makers are loath to reform a virulent system of prodigal social welfare coupled with all-pervasive rent-seeking by various industries, especially in construction, banking, the media and agriculture. Germany is living off a past of miraculous wealth creation. But the signs are that it may have exhausted the principal.

Germany faces a series of painful choices between unpalatable alternatives. The Minister of Finance, Hans Eichel, must either hike taxes -- including on wages, in contravention of campaign promises only two months ago -- or lose control over the public finances.

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According to new proposals, pension contributions will go from 19.1 to 19.5 percent of salaries. Another idea is to set a minimum corporate profit tax, thus preventing businesses from using accumulated tax credits. A host of business-friendly tax loopholes and deductibles will be abolished. These measures will surely discourage hiring and investments and may cause long-suffering multinationals -- both German and foreign -- to relocate.

German household debt is higher than in America. But taxes on capital gains and interest -- about to be raised -- discourage savings. This will be further compounded by the ballooning deficits of both central and state budgets. Even if all the right ideas are implemented, including massive spending cuts, the government, according to Business Week, will have to borrow $32 billion this year -- crowding out the private sector.

Fiscal largesse is considered to be an automatic stabilizer in a recessionary economy. But whether it is depends on how much new money is included in government spending and how productively it is targeted. Japan's river of squandered supplementary budget packages, for instance, did little to revive the moribund economy.


Part 2 of this analysis will appear Thursday. Send your comments to: [email protected]

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