Tuning up the engine of Europe's economy

SINCE the Industrial Revolution, manufacturing strengths have propped up the German economic machine.

Industrial giants - names such as Daimler-Benz, Krupp, and Bayer - made Germany the economic powerhouse of present-day Europe and a crucial player in the effort to achieve lasting Continental prosperity.

But the economic rules are rapidly changing as Europe prepares for the 21st century. The service sector is coming to dominate heavy industry in the new age, and the cutting edge will involve developing computers and other information technology rather than heavy machinery.

That is prompting some economists to warn that Germany is dangerously underprepared for economic competition in the post-cold-war world.

``We need much more flexibility than we have right now,'' says Jurgen Dongas, an economist at the University of Cologne who served on the government's Deregulation Commission from 1989 to 1991.

``The future of the industrial state, that is the issue,'' says Arnulf Baring, a Berlin political scientist. ``We cannot maintain the current social-welfare state if we don't change the way industry works.''

Responsibility for guiding Germany through the transition will fall on Chancellor Helmut Kohl's coalition, which scored a narrow victory in the Oct. 16 elections. Mr. Kohl advocates deregulation, but it is unclear whether the chancellor - one of the last remaining world leaders from the cold-war era - retains the vigor and vision to implement dramatic change.

Germany's ability to adapt is critical to the success of the European Union's attempt to create a continentwide federation of states.

Forging closer EU cooperation will be difficult under any circumstances. But the experiment has virtually no prospects for success if Germany - a major force for integration - goes into a significant economic decline. And plenty of historical precedents highlight the danger to European stability when Germany is not firmly anchored in a Continental security system.

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The German economy is governed by some of the stiffest regulations in Europe. While future prosperity may hinge on the retail and service sectors, they may be the most rigid areas of the economy.

Shopping hours, for example, are strictly regulated, with stores closed nationwide on Sundays and holidays. A cash-only attitude prevails, as many smaller shops still refuse to accept credit cards.

Expansive labor laws - covering everything from hiring to discounting - have left customer-service skills underdeveloped. Meanwhile, key service-sector businesses, such as the state-run telephone company, have received government regulation and protection.

``Many companies don't feel they need to provide service,'' says Volker Gorgen, a deregulation specialist at the German Industry and Trade Council (DIHT), a Bonn think tank. ``When you operate like a monopoly, there isn't a need to attract customers.''

A short-term lift

Despite its rigidity, Germany still has the world's third- largest economy. Statistics indicate a strong economic recovery is under way after the country's worst recession since World War II. The government projects that gross domestic product for 1994 could rise more than 2.5 percent, far exceeding expectations at the start of the year.

The good economic news boosted Kohl's ratings in opinion polls leading up to the Oct. 16 vote, and was crucial to his coalition's slim win over the Social Democrats.

But if Germany wants to remain a leader in the next century, the post-October government must take quick action to rectify economic deficiencies concealed by the statistics, Mr. Dongas and others say.

Among the economic issues that require urgent attention are privatization, innovation, labor-cost reduction, and popular expectation about the welfare state.

The danger to the export-dependent German economy is perhaps best borne out by the fact that the nation's export share outside Europe has dropped steadily over the last two decades. The decline has accelerated sharply in recent years.

Germany will likely come under increased market-share pressure as the exporting ``Asian tiger'' nations, including China, Singapore, and South Korea, continue to develop.

German companies have been slow to react to the developing trends. The Paris-based Organization for Economic Cooperation and Development (OECD), in its recent economic report on Germany, described the nation's research-and-development sector as ``relatively undynamic, particularly in state-of-the-art sectors,'' such as computers and biotechnology. It also stated: ``the structural shift from manufacturing to service sectors of the economy has been markedly smaller than in other countries.''

The report praised Germany's present economic condition, but says the nation faced erosion to its competitiveness. It recommended that the German government ``assume a more forceful leadership role in the creation of a more friendly regulatory environment. Many barriers to new activities - both explicit regulations and bureaucratic inertia - have very little basis in either economic or scientific logic.''

But economists predict that deregulation in Germany will be a monumental task. Present restrictions may lack economic or scientific justification, as the OECD maintains, but they are rooted in the German psyche.

The foundation of German economic success - from the beginning of industrialization, through unification in 1871, and beyond - has rested on a unique understanding between the government and the governed.

In 1871, when Bismarck finished forging a united German state, the social compact implicitly required the nation's Prussian leaders to ensure the security of all Germans, not only from outside threats, but also from economic upheaval.

The government ensured a relatively high and uniform living standard, redistributing wealth as necessary to keep the gap between rich and poor from growing too great. In return for the high sense of social security, Germans tacitly agreed not to interfere in the formulation of government policy.

Germans' willingness to sacrifice some democratic rights in return for extensive social protection stretches back centuries, rooted in the trauma inflicted by the Thirty Years War of 1618-1648. In that conflict, Europe's major powers tore German lands asunder in a fight to settle territorial disputes. The havoc wrought by the warfare delayed Germany's development as a unified state for centuries.

The German state-citizen relationship created a stable environment conducive to fantastic economic growth, catapulting Germany into the Great Power ranks in the late 19th century. But it also allowed irresponsible and unchecked German leaders to launch two calamitous world wars in the 20th century, which consequently wiped out the unified German state.

When West Germany started rebuilding, it retained aspects of the old social contract, while introducing checks on power. The equilibrium created from the new state's adherence to social-market principles was key to West Germany's astounding economic revival in the 1950s and '60s.

But the attitude of entitlement fostered by three centuries of Germany's social-market system is now perhaps the biggest obstacle to Germany's future economic competitiveness.

Indeed, Kohl's center-right government in recent years has moved to deregulate and privatize large state-owned entities, such as the telephone monopoly and Lufthansa airlines.

The narrow Oct. 16 win could, however, weaken Kohl's ability to press for change. Every halting step to introduce workplace flexibility and stimulate innovation has met fierce resistance from vested interests, especially organized labor and state bureaucracy.

The opposition to change is understandable, Dongas, the economist, says. Germans now work fewer hours and enjoy greater benefits - including lengthy vacations - than just about anyone else in Europe.

But Germany's labor costs are among the highest in the world and must be lowered if the nation is to stay competitive. The cost to German citizens and companies of maintaining Germany's fabled social-security system is pricing German goods out of the international market.

Part of the solution appears to be in cutting back welfare benefits. Yet all attempts so far to do so have produced a popular outcry. Opposition to welfare cutbacks is intensified by a relatively high unemployment, which in east Germany is nearly 15 percent. Even though the economy is on the upswing, job creation has lagged.

``The main problems is in the heads of the people,'' says Bernd Marenbach of the DIHT. ``Liberalization of the economy is the future. But there are many people who consider liberalization to be very antisocial.''

``That's the underlying conflict, and this conflict will become sharper in the coming years,'' Mr. Marenbach adds.

Introducing flexibility is further complicated by Germans' strong ties to their native communities, says Heinz Laufer, dean of the political science department at the University of Munich. That means a large segment of society is unwilling to search for new opportunities, or to fill labor needs as new technologies develop.

``Because we're so tied to our home regions, we Germans are not so mobile,'' Professor Laufer says. ``Talking about German competitiveness, this could be a disadvantage.''

Needs of the hour

Overcoming the entrenched popularity of the status quo will require a strong government, possessing the strategic conviction to push through liberalization. A determined government will also be critical to alleviating structural unemployment, which has the potential to overburden the welfare system and stir social tension.

``The political will may be there [for deregulation], but if there's no clear governing majority it'll be difficult to achieve,'' Dongas says. The economist adds that past experience has shown that once the population has overcome its ``irrational'' fear of change, it has always quickly adapted.

``The whole issue [economic change] is better understood than it was before,'' he says. ``Three or four years ago, German politicians had difficulty even pronouncing the word deregulation. The great question is whether the current pace is fast enough.''