View From Frankfurt: German optimism faces crucial test on the wages front: Workers seek share of the fruits of recovery, but the Bundesbank is taking fright

It is a pretty safe bet that the near-euphoric tones heard from business in Germany will soon change dramatically.

Not that the steadily recovering economy is about to hit the skids again, but rather that the somewhat forced optimism felt necessary today will be perilously out of place in six weeks' time. Right now most of the German business community is raucously rooting for Chancellor Helmut Kohl and his centre-right coalition in the final straight before the general election next month.

Nothing has done the Chancellor's prospects more good than the timely appearance of the recovery and the optimistic strains from the corporate backing vocals. But once the election is over, and regardless of who wins, the lyrics will switch rapidly to 'Maybe things are not so great after all.' It will be a time for caution, laced here and there with a good shot of despondency.

The closing months of this year see the beginning of the 1995 wage round in western Germany. The unions have been quick to pounce on the new optimism and the evidence of rapidly rising corporate earnings. Klaus Zwickel, leader of IG Metall, the powerful engineering union that sets the pace in bargaining, said workers now expected their share of the fruits of recovery. After two years of declining purchasing power, this means deals above inflation with an extra measure for productivity gains.

The stakes this time are enormously high. The moderate wage deals of the past two years have done much to make up for the excesses of the unification boom, which drove labour costs to grossly uncompetitive heights.

Whether this process, begun in recession, can be sustained through recovery will provide an important indicator of Germany's ability, not just to improve competitiveness, but to tackle its number one problem, unemployment.

The decisiveness of this wage round has drawn an anxious Bundesbank early into the fray. Its message mixes hope with threat. If the moderation is not continued - meaning deals around the expected inflation mark of 2.5 per cent - interest rates will be turning upwards more rapidly to catch the cost-push.

The hopeful part is that there is nothing inevitable about the high unemployment to which European countries have become accustomed. It can be broken down, but in Germany's case this will require, in addition to wage moderation, radical changes to labour market culture. A similar lecture has just been given by the OECD.

In the 1960s the average unemployment rate in West Germany was 1 per cent. In the 1970s it rose to 2.5 per cent, by the 1980s it was around 7 per cent and today it is 8.5 per cent. With each recession it has risen significantly while the ensuing recovery failed to make good the jobs lost.

The Bundesbank has no doubt about the main reason behind this evolution. 'A cardinal structural problem' of the German economy is that labour has become too expensive, said Hans Tietmeyer, president of the central bank, at the end of last month.

While attention has focused on the effects of the profligate pay deals during the early 1990s, which accelerated Germany's plunge into recession and exacerbated the heavy loss of jobs, the problem goes back much further.

It started in the 1970s with the policy of raising the lower-paid by means of lump-sum-plus-percentage deals. This socially inspired policy ended up having anti-social consequences, increasing unemployment by making unskilled labour too expensive.

Moreover, the German system lacks the flexibility to modify such developments. In the 1980s, even with a string of moderate wage rounds, the expensiveness of unskilled labour was maintained by a mechanism that in effect sets a minimum wage.

In the 1990s the wage deals exploded, just when a vast pool of cheap labour competition suddenly opened up in eastern Europe. The result is that unskilled labour forms a far greater proportion of Germany's unemployed than of the working population.

In theory, the German bargaining system is decentralised, with its regional focus. But the reality is highly centralised and inflexible. One union, usually IG Metall, begins in a specific region. The result is then taken on nationally throughout that sector, and subsequently other sectors follow this 'pilot settlement' in convoy.

This not only holds up a minimum wage but makes for little differentiation, either between poor and successful firms in the same sector or between sectors such as textiles and computers.

Loosening the rigidity of this system is the key to tackling Germany's largely structural unemployment problem, argue both the OECD and the Bundesbank. Germany must accept an Americanisation of its job market.

The big question is whether such a cultural revolution is possible in a country that places such an emphasis on regulated bargaining and consensus-building. Since the 1970s, the very idea of a low- wage culture has become increasingly anathema to Germans, determined to hold on to their prosperity in a society that does not show the massive gap between the haves and have-nots common in Britain and the US.

But the lack of flexibility and differentiation this has engendered is a big reason why Germany's service sector remains underdeveloped. This is where most of the new jobs will have to be created.

German industry has done amazing things over the past two years to recoup lost competitiveness, but at the cost of massive job cuts that are not about to be easily reversed. The floor at the bottom of the wage ladder must be removed and the over-protective welfare system curbed, say the Bundesbank and the OECD, to allow lower-paid jobs to flourish.

The wage round last spring provided the first signs of a new flexibility. In the chemical sector long-time unemployed people could be taken on for less than the contractual wage, while engineering firms could reduce working times from the statutory 36 to 30 hours without compensation.

The government has proposed limiting unemployment benefits to two years and has just broken the state monopoly on employment agencies to allow private competition. These are small beginnings, but, as Mr Tietmeyer noted, taken together the moderation and flexibility amount to a 'nearly historic turning point'.

The coming wage round, and the election, will decide whether this change is to continue.

(Photographs omitted)