BERLIN/FRANKFURT (Reuters) - With tax cuts now off the table and state spending set for a rollback, don’t count on Germany redressing its part of euro zone imbalances anytime soon.
For now, Berlin has little capital -- financial or political -- to invest in diversifying its sources of growth as recommended by economists and by other members of Europe’s monetary union.
Ideally, Europe’s largest economy could simultaneously increase its own growth potential and help some of its trading partners if it reduced its reliance on exports by boosting domestic demand.
But Berlin has veered far from that path after Chancellor Angela Merkel took a beating in a key state election this month, prompting her to rule out any tax cuts before 2013 as had been planned earlier.
Instead, the focus is now clearly set on budget consolidation. And some of the potential targets for trimming that have come into the crosshairs -- like subsidized child care -- would likely have the opposite effect on consumer spending.
“There’s just no room for boosting domestic demand,” said Joerg Lueschow from West LB. “Consolidation can only weigh on private consumption, especially as expenses for individuals, like health care costs, rise.”
Germany’s large trade surplus has become more than just the envy of some of its neighbors, who have pressed Berlin to boost consumer spending with the aim of increasing imports from other European countries.
French Economy Minister Christine Lagarde triggered outrage in Berlin in March with an article in the Financial Times saying the surplus threatened the competitiveness of other euro zone countries.
Germany does not have a national minimum wage, and while years of wage restraint and welfare reform have given it the most competitive workforce in the European Union, it is one that is also less likely to spend.
A quarterly Reuters poll of economists last month forecast private consumption to fall over the first nine months of the year and post a 0.6 percent contraction for 2010.
But that was compiled before planned tax cuts were taken off the table, and coming revisions to consumption forecasts will likely head in one direction only -- downwards.
The Organization for Economic Cooperation and Development, a Paris-based club of wealthy free-market economies, has recommended its usual cocktail of structural reforms -- saying they will promote innovation and attract more investment.
Some of those changes could be relatively cost-neutral -- like easing product regulation or opening up the service sector to more competition -- and thus theoretically possible to enact even while reining in the budget deficit.
But given the current climate in Germany, the largest national contributor to a $1 trillion plan to stabilize the euro, the time is hardly opportune to ask the public to swallow unsettling changes to business rules and the labor market.
“Such suggestions are generally right,” said Joerg Kraemer, economist at Commerzbank. “But at the moment there is just not enough political support for such reforms.”
More upbeat economists hope domestic consumption can avoid a decline this year if the government manages to pass measures to at least simplify the tax system.
Others say there remains little Berlin can do to boost spending other than to focus on supporting the recovery and the labor market, and hope inflation remains low.
“Would it make sense to boost investment when there’s already overcapacity? I don’t think so, not for the next two years,” West LB’s Lueschow said.
Even if the government could lean on companies to push for a wage increase -- which officially it cannot and unofficially would not do since low wages have helped ensure Germany’s role as a champion exporter -- consumption is an unlikely candidate for growth in the near future.
Germans’ spending patterns are particular -- they avoid credit and often pay in cash, and are extra-wary of inflation for historical reasons. With the European Central Bank currently buying sovereign debt of EU member states, the specter of the money press has re-emerged in the collective subconscious.
“In the current environment, people will be saving more no matter what,” Lueschow said.
Editing by Stephen Nisbet