Germany: from Sick Man to Superpower

The euphoria that accompanied Germany’s reunification 25 years ago quickly gave way to harsh economic reality, forcing the country to confront its failings head-on. We consider the remarkable journey from “sick man” to superpower and what the difficult lessons that made it possible might mean for the rest of Europe.

On 13 August 1961, just a day after the necessary order was signed at a garden party attended by the leaders of the German Democratic Republic (GDR), the East German army set about closing the border between East and West Berlin. Fifteen years after Churchill had warned of an Iron Curtain across Europe, the ultimate symbol of the Cold War was about to become a reality.

In the GDR, reflecting the convenient claim that West Germany was still not fully de-Nazified, it was officially referred to as the Antifaschistischer Schutzwall – the “anti-fascist protection rampart”. The West Berlin city government dubbed it the Wall of Shame. To the wider world it was known simply as the Berlin Wall. It began life as a wire fence and gradually grew into a 12ft-high, trench-lined, dog-patrolled, gun-tower-dotted concrete barrier – complete with “no man’s land” and “death strip” – that divided Germany both literally and figuratively.

The move to concrete would ultimately prove to have an unforeseen metaphorical value. It meant that when the Wall finally came down, chiselled and smashed to pieces by the very people whom it had kept apart for so long, both the edifice itself and the folly it represented were reduced to smithereens.

Yet what is frequently forgotten in recalling those historic scenes is that far more than the Wall was levelled on that momentous night and during the formal reunification that followed. It was the start of a great levelling for Germany as a whole – one that dragged its economy into stagnation and obliged the country to demonstrate on the grandest scale the Protestant axiom that “suffering purifies”.

Now, 25 years later, a united Germany stands as Europe’s undisputed superpower. Moreover, the template for post-crisis stragglers across the continent is not only firmly in place but seemingly Germany’s to administer as it pleases. How has this astonishing turnaround been achieved? And has Germany genuinely earned the right to compel others not just to learn from but to live through its own harsh lessons?

The Berlin Wall fell on 9 November 1989. Within a fortnight the then Chancellor of West Germany, the conservative Christian Democratic Union’s (CDU) Helmut Kohl, announced a 10-point plan that called on East and West to move towards reunification. By March the following year the Party of Democratic Socialism had suffered a crushing defeat in East Germany’s first free elections, clearing the way for an epochal cross-border political coalition.

In tandem, having at last been laid bare, the crumbling foundations of the East’s economy and infrastructure all but collapsed. Economic, constitutional and legal mergers were swiftly arranged, and on the stroke of midnight on 3 October 1990, in a ceremony broadcast around the world, the black, red and gold flag of a united Germany was raised above the Brandenburg Gate to mark the moment when two nations officially became one.

Speaking by phone to US President George Bush the next day, Kohl enthused: “Things are going very, very well. There were one million people here last night at the very spot where the Wall used to stand. Words can’t describe the feeling.” By contrast, others had described their feelings only too clearly – albeit not in public. Behind the messages of support, amid the fireworks and the homilies and the expressions of hope, there was a growing sense of foreboding.

Mrs Thatcher assured Soviet President Mikhail Gorbachev, the man whose policies of glasnost and perestroika were pivotal to the Wall’s demise, that neither the UK nor Western Europe wanted reunification. As late as December 1989 she was warning fellow European leaders: “We defeated the Germans twice – and now they’re back!” France’s President Mitterrand was among those who privately shared the Iron Lady’s concerns over a return to German militarism and the potential economic might of a united East and West.

They were right about the latter, but whether they appreciated its realisation would take more than two decades remains a matter of conjecture. There was a price to pay for reunification, and Germany – the former West in particular – would pay dearly over the course of many challenging years.

The great levelling soon became the great lowering. In 2011 it was estimated that $2 trillion worth of public spending had been transferred from West to East, where de-industrialisation triggered what would become a dramatic increase in unemployment. The standard of living in the East rose; the standard of living in the West declined; on balance, it was not a zero-sum game. Stagnation ensued.

According to World Bank data, from 1998 to 2005 the German economy grew by an average of just 1.2% a year. Unemployment rates climbed from 9.2% to 11.1% during the same period. As if for good measure, there was a full-blown recession in 2003. Just years after serving as a beacon of sociopolitical hope, the country found itself customarily referred to as “the sick man of Europe”. It was time for some tough choices; and Germany, staggering and wounded, elected to confront them head-on.

It was unemployment that ultimately ended Kohl’s reign. As the most visible architect of reunification, he enjoyed several years of something approaching political unassailability; once the less welcome domestic corollaries of a united Germany became clear, his aura began to fade. In 1994 his party was unable to secure a majority in the federal elections; four years later the CDU was succeeded by a coalition of the Social Democratic Party (SDP) and the Greens.

The new Chancellor, SDP leader Gerhard Schröder, championed wide-ranging reform. During his first term he set about phasing out nuclear power, funding renewable energy sources and legalising same-sex civil unions. One set of reforms above all others, however, came to define his period of office.

The Agenda 2010 programme represented a determined attempt to rescue Germany’s economy. It was far-reaching and resolutely unsentimental. In the eyes of its opponents it amounted to nothing less than a wholesale dismantling of the welfare state.

The so-called Hartz reforms, the brainchild of a 2002 commission on restructuring the labour market, were central to the programme. They were named after Peter Hartz, chairman of the 15-member commission, who at the time was personnel director of Volkswagen – on whose board Schröder had served in his previous capacity as Minister-President of Lower Saxony.

“The main objective of the Hartz reforms was to reduce unnecessary generosity,” says Ralf Wilke, a Professor of Applied Econometrics at Copenhagen Business School, who has conducted extensive studies into the ramifications of the commission’s work. “It was clear that reunification had left the economy in general and the labour market in particular in a very poor condition and that a number of faults and inefficiencies needed to be addressed. The commission suggested various means by which these problems might be tackled – and, to the surprise of many people, one by one those suggestions were implemented.”

In essence, the Hartz reforms bundled unemployment and social welfare benefits into a single package. Different administrative units were given “common goals” in dealing with claimants. A “pressure to work” ideology was introduced and applied with ever-greater force.

Among the most divisive changes was a reduction in the length of time for which the older unemployed remained eligible for contribution-based benefits. This ended a system that had guaranteed a constant and considerable compensation stream – often lasting up to 32 months – for those between early retirement and old-age pension. The number of people using their entitlements as a “bridge” between leaving work and receiving their pension subsequently plummeted.

Teutonic efficiency was key to the scheme’s success. “Jobcenters”, as they were rechristened, entered into contracts with jobseekers, and sanctions – otherwise known as benefit cuts – were imposed if the latter failed to keep their side of the bargain in looking for new work. Federal and local agencies were required to cooperate much more closely and effectively. One of the targets set out in Hartz IV, the last and most controversial of the reforms, was a massive reduction in caseloads.

“There’s no question that the Hartz reforms have had a very considerable impact,” says Professor Wilke, also a Research Fellow at Mannheim’s Centre for European Economic Research and a Research Professor at Nuremberg’s Institute for Employment Research. “The measures around early retirement, the setting of shared goals, the liberalisation of the labour market and the promotion of a low-wage environment were especially effective.

“But they also proved highly unpopular. According to one study, only 18% of the population was in favour of cutting unemployment benefits. And this is the problem for policymakers everywhere: how to strike a balance between economic effectiveness and the population’s desire for social security – or, to put it another way, between saving billions of euros and losing millions of votes. 
“In that regard Schröder and the other senior members of the coalition showed enormous resilience. It’s probably fair to say they knew they wouldn’t be re-elected if they pressed ahead with these reforms, yet they carried on. It could be argued that they sacrificed their own political futures in an effort to salvage the German economy.”

Just as it brought the Kohl era to an end, so the labour market was pivotal in Schröder’s downfall. The difference was that by then the number of Germans in work was on the verge of rising rather than tumbling. Irrespective of the contempt they provoked in voters, the Hartz reforms helped Germany’s unemployment total plunge from five million in 2005 to around three million in 2008.

Even so, debate over the long-term benefits of the reforms rages on today. Critics claim most unemployed people in Germany now have little choice but to accept the next job they can find, even if it is part-time or notably low-paid, and so still find themselves to some extent dependent on state welfare. There have certainly been some unattractive consequences. A 2012 report by the Organisation for Economic Cooperation and Development commented: “Germany is the only [EU] country that has seen an increase in labour earnings inequality from the mid-1990s to the end-2000s, driven by the increasing inequality in the bottom half of the distribution.”

Other factors, too, have played their part in the resurgence. Written by academics from University College London, the University of Freiburg and the University of Berlin, an article in the latest edition of the Journal of Economic Perspectives posits that Germany’s renaissance was principally fuelled by the governance structure of the nation’s labour market institutions and their capacity to react flexibly to the “extraordinary economic circumstances” that have distinguished much of the past decade.

The authors trace this precious facility back to the seismic events of late 1989. “On the one side,” they say, “the fall of the Berlin Wall and the dramatic cost of reunification burdened the German economy in an unprecedented way, leading to a prolonged period of dismal macroeconomic performance. On the other side, it gave German employers access to neighbouring East European countries that were formerly locked away behind the Iron Curtain and were characterised by low labour costs.

“The new opportunities to move production abroad while still remaining nearby changed the power equilibrium between trade unions and employer federations and forced unions and works councils to accept deviations from industry-wide agreements, which often resulted in lower wages for workers. The decade of economic stagnation and hardship, when Germany was the ‘sick man of Europe’, prepared the population for accepting agreements for the sake of economic growth.”

It is perhaps also worth acknowledging the degree to which rehabilitation has been augmented from farther afield. In 2012 the European Council on Foreign Relations, a pan-European think-tank, published a policy briefing about the embryonic “special relationship” between Germany and China, remarking: “Germany is China’s number-one trade partner in the EU, and China is the top foreign investment destination for German companies. The Chinese are thinking about whether a ‘German Europe’ is emerging from the euro crisis. They increasingly see Berlin as the place to go to get things done.” 
“Germany hasn’t performed better simply because of the changes that have occurred domestically,” says Professor Wilke. “It obviously helps, for example, that China and other developing nations have purchased huge amounts of heavy machinery and cars. The reality is that this is a complex situation, and we shouldn’t ascribe this boom only to politicians. Ultimately, a combination of factors has been responsible for the status Germany enjoys today.”

Whatever the precise reasons for its revival, the fact is that Germany now serves as a model – or at least a touchstone – for economic recovery. It has been there and done that. Unlike most of its European neighbours – and, for that matter, the US – it survived the global financial crisis comparatively unscathed. In 2011 exports hit an all-time high of more than $1.7 trillion. By and large, the travails of the eurozone have fortified rather than undermined its pre-eminence.

Has it become too dominant? Even some Germans think so. Professor Ulrich Beck, the German sociologist credited with coining the term “risk society”, has cautioned that his homeland’s post-reunification torment and triumph are now being used as a blueprint for crisis management across the continent and that the autonomy of struggling eurozone countries is being eroded by Germany’s hegemony – most starkly illustrated by its ability to dictate the terms under which the likes of Greece and Italy can apply for further credit in the face of austerity.

And who better to embody the journey from stagnation to superpower than Angela Merkel, who was raised in the East – where her compulsory studies included a course on Marxism-Leninism – before joining the burgeoning democracy movement in 1989 and eventually rising to become leader of the CDU and, in 2005, Schröder’s successor as Chancellor? Earlier this year Forbes magazine named her the most powerful woman in the world. Many see her as the EU’s de facto leader.

Saluting her political nous, Beck calls her Merkiavelli. He also compares her to Mrs Thatcher, although he stresses: “There is one important difference. Thatcher was doing to Britain something the British electorate had voted for; what Merkel is doing to Europe has no democratic mandate.”

Mandate or not, Germany undoubtedly has the clout. It could also be forgiven for believing the privilege has been well earned. Sympathy for those countries yet to embrace and endure Hartz-style hardship is in short supply. “Strictly speaking,” concedes Professor Wilke, “this government might not occupy the moral high ground. But it has inherited it.”

The multi-billion-euro question is whether Germany can continue to go from strength to strength. The inequalities highlighted by the OECD’s report have become a subject of fierce debate. Some feel the intensity of the Hartz-inspired “pressure to work” is contrary to the state’s fundamental commitment to human dignity. The government is set to introduce a nationally legislated minimum wage, which could hamper the flexibility that served Germany so well during turbulent times.

That the future is difficult to predict is richly evidenced by the divergent fates of the chief instigators of reform. Helmut Kohl retired from politics in 2002, shortly after which it was revealed the CDU had kept illegal donations during his leadership. Gerhard Schröder’s noble sacrifice earned him a senior position with a global investment bank and the chairmanship of Nord Stream AG, a consortium for the construction and operation of a submarine pipeline between Germany and Russia – a project he initially promoted with Vladimir Putin. Peter Hartz resigned from Volkswagen in 2005 and was later given a suspended jail-term for his part in what the German media habitually referred to as a “sex-and-bribery scandal”.

For now, however, Germany is the economic powerhouse of Europe – although the eurozone is struggling to emerge from the recession that followed the 2007-2008 financial crisis. Its transformation during the past quarter-century provides perhaps the most persuasive and all-encompassing confirmation of the sentiment expressed more than 150 years ago by one of its greatest intellectuals, Arthur Schopenhauer. His words might just strike a chord with those now compelled – whether by choice, under duress or out of sheer necessity – to follow the same ethos of painful reinvention: “Punishment is directed essentially to the future, not to the past.”

Julian Chillingworth, Chief Investment Officer

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