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Romaric Godin, the correspondant of La Tribune in Germany, talked with Roland Berger about Franco-German cooperation and Germany's future following the election victory by Angela Merkel and her Free Democrat partners:

sponsored by: Roland Berger

The German business community is happy with the conservatives' election victory and their coalition with the liberals. Is this elation well founded?

The coalition partners will at least be working on the basis of the social market economy and not merely the welfare state. True, the chancellor and the CDU (the center right Christian Democrats) have understood that social aspects are an important part of the reality that is Germany. Even so, the new government will undoubtedly focus greater attention than the old one on creating the conditions for more economic growth. Angela Merkel knows full well that growth is necessary to finance our social security system and consolidate the budget. And there is no question that pushing this policy through will be easier with the FDP (the liberal Free Democrats) than in a re-run of the grand coalition. In my view, three things are needed to safeguard economic growth: Investment in education and research; a clear industry policy focus; and moves to strengthen the motivation of the German economy's high performers. Regarding this last point, it is important to reform the corporate and inheritance tax systems and abolish what is known as "cold progression" (or "fiscal drag"). In percentage terms, fiscal drag places the same burden on skilled workers as on top earners. Abolition can only happen if the budget deficit is scaled back, which in turn would allow government debt to be reduced. This must be one of the top priorities for the new government. To consolidate the public budget on this scale, federal, regional and local governments must keep their spending unchanged in nominal terms or – better still – reduce it. Having said that, this will only work if the economy grows by at least 2.3% to 3% per annum.

So might tax cuts still be possible despite the budget situation in Germany?

The EUR 50 billion to EUR 100 billion tax cuts promised by the Free Democrats during the election campaign are not feasible in my view. After all, the grand coalition had already ratified a EUR 10 billion to EUR 11 billion tax break due to start on December 1, 2010. Focused tax cuts could cut the burden by a further EUR 15 billion to EUR 20 billion over the next four years, however. These reductions would be more than just an important psychological factor. They would also ease the financial burden in a practical way. The resultant positive impact on corporate investment would in turn boost growth, employment and prosperity.

Looking back, how do you think the grand coalition has done? No one wanted a grand coalition.

Within the confines and constraints imposed on them, however, the SPD (center-left Social Democrats) and CDU have worked well together. They didn't launch any major reforms. They actually tended to undo the Schröder government's reforms – with regard to the Hartz IV (social welfare benefit) laws, unemployment benefit and Agenda 2010. On the other hand, they did press on with a number of issues, in particular raising the retirement age to 67. In the foreign policy arena, the grand coalition actually went further down the road on which Gerhard Schröder's government set out. I am talking, for example, about Germany's partnership with Russia, the deployment of armed forces in Afghanistan, improvements in relations with China and the USA – despite the refusal to commit military capacity in Iraq – and, above all, European integration. All of which was very positive. Ultimately, the grand coalition deserves praise for its work and the way it has handled the financial and economic crisis. Coordinating its efforts with its European and global partners in the G20 context, it was able to take the right actions. Pushing through the plan to save the banks and plans to revive and reform the financial system – which, thanks to a concerted effort on the part of Germany and France, ultimately led to Pittsburgh – was no easy task.

Roland Berger in an interview with La Tribune "I believe that this transition must be driven by the economy itself."

Could the liberals' involvement in the new government jeopardize Germany's commitment to reforming the financial sector? The FDP is not going it alone; it is merely the coalition partner. Where concrete action is at stake, it will have to give due consideration to the CDU's social concerns. Ms. Merkel undoubtedly wants to win the elections again in 2013! Accordingly, the Free Democrats will have to curb their more radical demands, such as abolition of the minimum wages that have already been introduced and the dismantling of employment protection measures. In short, the FDP is going to have to accept compromises.

The elections underscored the Social Democrats' dramatic plunge while the left-wing Linke party gained ground.

Does this mean that the opposition to Angela Merkel's new government will take a harder line? The wind could indeed blow colder. The word is already out that the SPD wants to adopt a noticeably more left-wing stance. I don't believe we need to fear large-scale demonstrations and street fighting in Germany, though. People are more pragmatic these days. Nor do I believe that the major people's parties will meet their end. That is especially true of the Social Democrats, who are anchored strongly enough at local and regional level to get back on an even keel. Incidentally, there is no ruling out the possibility that, over the next four years the democratic wing of the Linke party – i.e. the less radical element with less leanings toward Communism – may team up with the SPD. If that happens, the Social Democrats could bounce back to a 30% or higher share of the popular vote.

Will Germany emerge stronger from the worst crisis in its post-war history?

Yes and no. Yes, because Germany's traditionally strong industries – such as chemicals, automotive engineering and capital goods – and a number of service sectors too, including banking, have continued to restructure, raise productivity and cultivate a more international focus even in the midst of crisis. Although these industries depend heavily on exports and international trade, I don't see them declining. On the contrary, I see Germany becoming more competitive. When the crisis is over, the German economy will thus be even better placed to sell innovative and competitive products. And no, because German industry places too much faith in its traditional strengths. As a result, it has gone only part of the way toward transforming itself into a high-tech industry and service sector. I am thinking in particular of the biotechnology and IT industries. We have been successful in some areas, especially medical engineering and renewable energy. Even here, however, it will be difficult to defend our current position in the face of ever fiercer competition from the USA and China. I am not sure whether we have done all we can to safeguard our technological edge. I would also say no because we can probably no longer depend so heavily on exports as in the past. The USA's gaping trade deficit is no longer tenable. One consequence is that export surpluses such as Germany's are no longer feasible. In many branches of industry, production facilities clearly have to be relocated to countries with low labor costs and to the countries where customers are based. What we need is therefore an economic structure that, while not renouncing its export position, still focuses future growth more strongly on the high tech, service and consumer sectors. In light of demographic trends, certain branches of industry – such as geriatric care and healthcare – must be exploited more fully. Education in particular must be ramped up.

Should the government intervene in the structural transition in the German economy?

I believe that this transition must be driven by the economy itself. The business community must wake up to the fact that change is necessary. German companies have proven in the past that they are capable of adapting in this way. Some, for example, have mastered the transition from hardware to software production and thus penetrated the service sector. German firms have also successfully adapted to changes in global demand, more of which now comes from emerging economies such as China, as well as to new cost conditions. Yet the government can still play its part, first and foremost by investing in high tech industry clusters or agglomerations centered around universities. This investment will promote innovation and research; the Max Planck Institute serves as an excellent example. It can also help prepare the ground for startups by providing subsidies and tax breaks and encouraging venture capital. On this score, reforming corporate income tax would be more than useful, as the current situation presents an obstacle to the launch of new businesses.

Germany's demographic development is mired in crisis.

Its population has been shrinking since 2002. Wouldn't a rather more ambitious policy to stoke up domestic demand on this front be the obvious way to go? The grand coalition has built on the family policy measures taken by the Schröder government. And, especially under the leadership of Ursula von der Leyen, Federal Minister for Family Affairs, this policy has been bearing fruit. Yet even if the birth rate suddenly exploded, that would only impact the economy in 20 to 30 years. If we want to protect ourselves against the effects of the demographic trend, we need to operate a sensible and constructive immigration policy. We must attract the best minds to Germany, reach constructive agreements with the countries from which these people migrate, and better integrate the foreign residents who already live here. In the longer term, we must target a demographic upswing of the kind we now see in France. Here too, however, immigration is the explanation behind this phenomenon. In other words, the demographic issue will always be accompanied by the issue of integrating foreign residents. And Germany has the chance to master this challenge better than France. Whatever the case, however, family and immigration policy are two of the major challenges that will confront the coming government.

Is the German labor market now flexible enough?

Even more flexibility is naturally conceivable. Deeper cuts in employment protection in particular would be one option. However, I do not believe this process can be accelerated in the context of crisis. People simply wouldn't accept such a policy. The policies underpinning Agenda 2010, which have already made the German labor market more flexible, must be continued. Introducing a nationwide minimum wage level, for example, would, in my opinion, have been a disaster that would have threatened very many jobs. On the other hand, toughening up the terms of dismissal would pose a threat to our social cohesion. The unions and the employers must therefore return to some form of consensus. We need that in Germany if we want a moderate wage policy that does not erode our competitive position. If we fail in this task, companies will find themselves forced to restructure, causing jobs to be shed or offshored. Consensus on this point is therefore an imperative. That's why I believe, despite the participation of the Free Democrats, that the new government will not adopt more radical labor market policies.

The government currently has a high-profile presence in the German economy.

Is that how things should stay? It was right for government to intervene to stabilize the banking sector and the real economy and to be able to reform the financial system. It will also definitely be right for the government to withdraw from the economy again. Having said that, I don't think that can happen before 2011.

Family-owned businesses are typical of the small and medium-sized enterprises (SMEs) that shape the German economic landscape.

After what has happened to Schaeffler and Arcandor, are SMEs experiencing a crisis of their own? By no means! As a result of the crisis, there may well have been insolvencies and mergers in traditional sectors such as the automotive supply industry and engineered products. However, these mergers will make the industries they represent stronger and more competitive. I believe that, after the crisis, Germany will still have the most rock-solid SME sector in the world. Don't forget that German SMEs still lead the world in many markets.

Won't family-owned businesses need to find other sources of finance, though?

They have already started. More and more of them are turning to private equity, investment funds and private investors. In future, SMEs will have access to modern financing tools.

Do we need to rethink the German banking sector?

Yes, I think we do. In our country too, the crisis has structural roots. Germany is trapped in its three-pillared model made up of privately-owned banks, savings banks and cooperative banks. And within this constellation, it only has two large privately-owned banks – which is far too few. Right now, only Deutsche Bank really seems capable of surviving and standing up to global competition on its own. In the crisis, the savings and cooperative banks have shown themselves to be stable. Yet not even they have what it takes to face up to international competition. To my mind, the three-pillared model must open up if it wants to survive. In this context, I see the privatization and consolidation of the Landesbanks (banks owned by the German states) and cooperative central banks as virtually unavoidable. Even so, Germany has managed to avoid an all-too protectionist stance, and that while French, British and US banks were forced to accept government aid at the expense of restrictions on their lending business. Domestic lending was thus given precedence over foreign lending activities. By contrast, Germany's public assistance for banks was a voluntary affair with no strings attached. To my way of thinking, some of the methods used in the UK, France and the USA too cannot be reconciled to the rules of market economies and the WTO.

Is it conceivable that Germany's withdrawal from nuclear energy will be postponed?

I don't believe that it is now possible to return to nuclear energy, however much the government might want to do so. The population would not accept such a move. What is conceivable, however, would be extensions to the scheduled lifespans for nuclear power plants. I would not rule out the possibility that a future government might reconsider the nuclear option following the elections in 2013. On this score, however, Germany has charted a clear course. Accordingly, nuclear power stations can only serve as a transitional technology until such time as renewable energy is sufficiently mature, reliable and inexpensive. That, however, could take 30 to 50 years. So we are going to need nuclear energy for the time being.

German companies have a competitive edge in renewable energy.

Is this lead in danger? Yes, it is. China is Germany's most serious rival for solar power, as is the USA for wind power. Their technological advances could indeed outmaneuver us. We must not underestimate this threat; and yet I fear that is precisely what parts of Germany's industrial and political communities are doing. We need more innovation to defend our lead. Moreover, a process of concentration and consolidation is needed in this sector. I'm not saying Germany is definitely going to lose its lead. But that could indeed happen if the political leaders and corporate managers concerned do not take proactive preventive measures.

Twenty years after the fall of the Berlin Wall, many eastern German citizens still don't feel integrated.

Has the process of reunification still not been completed? No, of course it hasn't. The election results in Berlin alone provide proof enough: The figures show that the left-wing Linke party won 34% of the vote in East Berlin but barely 11% in West Berlin – despite the fact that the eastern part of the city is less badly affected by unemployment. Reunification is still not completed in people's hearts and minds. After 45 years or so under a Communist régime, you can't suddenly switch to a democratic society and market economy just like that. In light of these historic, emotional and cultural factors, it will take a whole generation to complete the process of integration. Nor have we yet achieved economic equality, even though much of the necessary infrastructure is now in place.

Right now, action must be taken on three levels. First, we must do more to promote innovation and education in eastern Germany.

Second, we must encourage industrial companies to move to and start up new operations in the east. This must not be done indiscriminately, however. We must reinforce existing competence centers such as the electronics and automotive clusters in Dresden and the media cluster in Potsdam. That is the government's job. Finally, we must encourage the migration of youngsters from eastern to western Germany, so that their subsequent return ultimately makes the eastern German regions more attractive. As things stand, these migration paths are often accompanied by social tensions.

Roland Berger in an interview with La Tribune "Germany and France should do a lot more together but talk about it less."

Is the European Union's Franco-German engine still running? In every crisis, Germany and France have been able to launch initiatives and pool their strengths – be it in business, research or politics – that have injected new stimulus into Europe. All the same, I think the two countries would be wise not to overstress their joint efforts so that the smaller countries of Europe do not feel left out. Germany and France should do a lot more together but talk about it less.

Is industrial cooperation between the two countries desirable and possible?

You have to give companies the freedom to invest and develop where they see the best opportunities, be that in China, the USA or France. The most important thing is to strengthen European companies in order to encourage investment on the continent. Protectionist action by the French government, such as in the cases of Areva and Alstom, saddens me at times. Such action hinder Franco-German cooperation for political reasons. By contrast, Germany didn't say a word when Sanofi bought Aventis, because the government here tends to intervene less in the workings of the economy. When Germany does take a similar line, it tends to be in response to action taken on the French side. On a corporate level, cooperation between the two is almost always positive, by the way. Witness the example of Axa and Allianz. In recent years, however, the French government has stood in the way on several occasions. On this score, I believe France still has room to become a little more modern and a little more market-oriented. This interview was published on on October 12, 2009 Oct 22, 2009

Sponsored by: Roland Berger