Soul-searching over an earlier monetary union

ECONOMIC VIEW
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The Independent Online
As the European Union considers practical steps towards achieving economic and monetary union by 1999, it seems strange that so little attention has been paid to the laboratory experiment that has been going on in the very heart of Europe. In July 1990, German economic and monetary union took effect. What is the scorecard five years later?

The initial perception of reunification was that it would create an economic giant. East Germany had long been seen as the powerhouse of the Soviet bloc, a testament to the ability of Prussian economic culture to overcome the drawbacks of Communism.

As the skeletons tumbled out of the cupboard, however, revealing the dire state of the East German economy, the mood changed abruptly. Now the view was that the West German economy had shackled a ball and chain to its feet. Here was an eastern Mezzogiorno in the making, a region like the south of Italy, that would act as a permanent brake on the healthy part of the economy.

But that wasn't the only problem. With or without the new states, this was a giant going to seed. The criticisms were most ferocious inside Germany, as senior industrialists expressed their alarm about a country that was overpaying itself and under-working. Productivity might be higher in absolute levels than rival countries such as the UK, but it had been improving at a sluggish rate for many years.

Industry matched its words with deeds. A big shake-out in labour ensued, with payrolls down by some 15 per cent in the past five years. Household names like Mercedes-Benz swallowed their pride and announced far-reaching programmes of reform.

The restructuring - ferocious by the standards of a social market economy - seemed to do the trick. Germany recovered much more strongly than had been expected last year on the back of buoyant world trade. Its traditional strength - investment goods bought on quality rather than price - seemed to be paying off again. As economic activity turned up, there was a big improvement in productivity and unit labour costs fell dramatically.

Equally important, the eastern economy, which had gone into free-fall after the initial shock of reunification, began to show signs of life. In 1994, eastern Germany grew at nearly 10 per cent, a rate expected to be sustained this year.

The tables were turned, or so it seemed. The initial optimism about economic prospects for a united Germany appeared justified. The Germans might have bitten off more than they had first thought; but they were going to make a go of it.

Yet on the occasion of the fifth anniversary, the mood is once again one of soul-searching. In part this is a response to emerging signs of an unexpected slowdown in the German economy, with the IFO business conditions indicator well down on the level reached at the turn of the year. But it also reflects deeper concerns about the health of the pan-German economy.

Yes, there are signs of life in eastern Germany. But the real surprise would have been if the drip-feed of subsidies from the West had not brought about some revival to an economy in intensive care.

The scale of the transfers has been quite extraordinary. Year after year, some 5 per cent of the national income of one of the richest economies in the world has been shifted east. In 1995, they are set to fall for the first time since reunification. But at DM150bn (pounds 67bn), it is as if the entire receipts from income tax to the UK Treasury - and more - were being shipped east.

Yet most of the transfers have not gone into rebuilding the East. They have gone into bolstering the income of those unwelcome poor cousins who came knocking at the door of their rich relations in the West. Some two- thirds of the flow of money has gone into consumption.

The need for income support on so grand a scale is stark evidence of the economic collapse that occurred in former East Germany in the early 1990s. What that means is that the growth now taking place, while close to double digits, is occurring from a very low base. According to UBS, the true rate of unemployment is double the official rate of 14 per cent.

But it is the continuing signs of uncompetitiveness in the western German economy that are of most concern. Daimler-Benz's revelation two weeks ago that it would post a loss of about DM1bn this year shows the extent to which the corporate sector has been squeezed between the anvil of rising wage costs and the hammer of the appreciation of the mark this year.

Restructuring has been large by German standards. However, as Morgan Stanley has pointed out, it has been more than matched by countries that do not have to cope with a soaring currency.

Against this background of German monetary union, a split is opening up in Germany on the question of European monetary union. Industrialists increasingly regard EMU as a route to maintaining competitive advantage threatened by the mark's strength. Domestic public opinion, on the other hand, has turned more sceptical on fears that German taxpayers will end up paying for EMU.

What is clear is that even if we in this country fail to make the link between GEMU and EMU, the Germans will. It is Germany in the final resort that will decide whether the French-designed European grand projet goes ahead. The chequered course of German monetary unification suggests that they will not take that decision lightly.

Martin Wolf, the FT's chief economics leader writer, may have to wait longer than he expected to get his hands on the FT's coveted Economics Viewpoint slot. Sir Samuel Brittan, the present incumbent, dismisses as "rubbish" suggestions that he will be forced to hang up his boots when he reaches the FT's official retirement age of 62 next December.

Recently voted the world's most widely read economics columnist, Sir Samuel insists that his contract doesn't stipulate a retirement age. The FT's principal economic commentator since 1966, he is well- known to be ferociously protective of his column and was once heard to say he did not expect Economic Viewpoint to outlive him.

"Don't expect anyone to take over my column," he says. Mr Wolf and any other pretender to the throne can go jump in the lake, it seems.

JP Morgan has lost the services of Till Guldimann as head of global research based in New York. Guldimann has left to pursue a new entrepreneurial endeavour, as yet under wraps, described as "small, new and risky". He has not been replaced and his duties may be shared among existing analysts.

The London Business School has named its new head of economic forecasting as Andrew Sentance, the current deputy and a former chief economist at the Confederation of British Industry.

But the interesting question will be whether the Treasury will ask Dr Sentance to replace his predecessor, David Currie, on its panel of independent forecasters. If so, he would be the first person to have two stints as a wise man. The first was during his CBI days. There is no hint yet from the Treasury about the future of the panel of wise men, but rumour is they might borrow an idea from Gordon Brown, the shadow Chancellor, and use the departure of half the panel's existing members later this year to cast the net more widely over the economics profession.

Publication of The History of Norton Rose by Andrew St George is guaranteed to up the publicity stakes between London law firms. Norton Rose may be able to trace its history back to 1794 and also boast the conception of the first investment trust in the City of London but this does not excuse it for providing the catalyst for a slew of law firms rushing out their own potted histories in hardback.

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