A Campaign of Rainmakers Despite Promises, Downturn Will Hit Coffers of Social Safety Net

Even as the political parties are making expensive promises to voters, the recession is digging deep holes into the Germany's social welfare coffers. The next government will face a massive challenge: It must reform the current system and introduce serious cost-cutting measures.

By , Michael Sauga and Stephanie Schnura

When it comes to attracting voters, Olaf Scholz has a number of tricks up his sleeve. Sometimes he poses as a politician concerned about the people, and sometimes he uses the prospect of financial benefits to court voters.

And sometimes, on the other hand, he takes both approaches simultaneously, as he did last Wednesday. Scholz, Germany's federal labor minister, is standing in the lobby of his ministry's headquarters, using his charisma to win over the participants in an idea contest called "Good Work for Single Parents," an important target audience for Scholz's center-left Social Democratic Party (SPD). First he poses for photos with each group of contestants. Then he lists the benefits with which he plans to improve the lives of Germany's single parents.

Scholz promises "comprehensive childcare services for infants," a "legal right to all-day daycare" and the hiring of additional teachers and daycare workers. He says that he wants to raise the children's allowance (the cash payment provided each month to families with children) for low-income earners and reduce the wage gap between men and women. He also holds out the prospect of providing special counseling services at employment agencies and announces a new service that will provide the unemployed with daycare services when they acquire a new job. "We will continually expand services for single parents," Scholz promises.

A Pot of Gold in the Cellar?

Germany is in the grip of the worst recession since World War II, and yet the parties are campaigning as if they had discovered a pot of gold in the cellar. The conservative Christian Democratic Union (CDU) and the business-friendly Free Democratic Party (FDP) are promising wage-earners and the self-employed rapid tax cuts, recipients of benefits under Germany's Hartz IV welfare reform program for the long-term jobless higher exemptions from retirement contributions and low-wage earners bigger pensions. The Social Democrats plan to prolong semi-retirement, expand prevention programs in healthcare and introduce new subsidies for advanced vocational training. "Crisis? What crisis?" the parties are asking, while offering the kinds of campaign promises that were more common in the 1960s.

The only problem is that their promises on social policy issues stand in sharp contrast to the financial developments of the foreseeable future. Even if the economy begins growing again in the autumn, as the RWI Essen institute for economic research predicts in an analysis prepared for SPIEGEL, the financial shortfall among the major social insurance agencies will balloon to almost €30 billion ($43 billion) by the end of the year, the highest figure since the beginning of the millennium.

The consequences are dramatic. "Relying on growth is not enough" to offset the deficits, says RWI analyst Heinz Gebhardt. According to Gebhard, the next administration will be forced to sharply reduce spending, raise premiums or inject taxpayer money into the social insurance system. Economist Bernd Raffelhüschen is convinced that "we need a new Agenda 2010," a reference to the comprehensive structural reforms undertaken by the cabinet of former German Chancellor Gerhard Schröder.

The experts at the finance and economics ministries are also aware of this. They predict that a rigorous cost-cutting program will be necessary by the beginning of next summer at the latest, and that the new administration will not be able to avoid taking the unpopular step of cutting deeply into the social security net.

Nevertheless, campaign strategists at the parties' headquarters believe that citizens cannot take too much of the hard truth in the run-up to the election. Instead, they are doing their best to repeat the mistakes of the notoriously deceptive 2002 campaign. Even though the New Economy bubble had just burst, then Chancellor Gerhard Schröder and Christian Social Union (CSU) candidate Edmund Stoiber entered the campaign spouting all kinds of upbeat slogans. Schröder had hardly been reelected before ordering even sharper cuts, losing much of his political credibility as a result.

Disastrous Economic Data

The same pattern could repeat itself this time. The economic data are disastrous, particularly with order volume in key industries, such as machine-building, contracting sharply in recent months. Although the recession has had little effect on social insurance funds, experts predict that this will change. One reason is that the number of unemployed will likely rise, exceeding 1 million by next spring.

Each new addition to the unemployment rolls not only leads to an additional burden on the unemployment insurance system, but it also reduces the flow of revenues that support the welfare state -- from taxes to workers' contributions to the unemployment, pension and health insurance system.

Graphic: A collapsing market

Graphic: A collapsing market

As purchasing power declines, companies are coming under growing pressure to further reduce their workforces. In its analysis, the RWI has extrapolated the effects of these changes on social insurance funds. If the economy develops as expected this year, employment agencies alone will accumulate a deficit of roughly €20 billion next year. Although the Nuremberg-based Federal Labor Office is still able to draw on reserves from previous years, it will have accumulated a record deficit of €18 billion by the end of 2010.

The situation in health insurance is hardly more encouraging. The RWI analysts predict that the compulsory government health insurance system will run up a deficit of close to €5 billion this year, and will add another €6 billion in 2010. The total projected deficit of €10.5 billion exceeds the amount all health insurance agencies combined spend on drugs and medical devices today.

The only bright spot, according to the RWI, is pension insurance, where the insurance carriers are able to offset their deficits with reserves in the double-digit billions.

A Coming Crisis of the Welfare State

This is cold comfort, though, because the German welfare state will face an unparalleled fiscal emergency in the wake of the economic crisis. If the government plans to offset the expected deficits with increased revenues, it will have to raise social security contribution rates by three percent, the RWI analysis predicts.

The last time German businesses and workers were asked to increase their contributions to that extent, it was to pay for German reunification. The CDU/CSU and the SPD would be unable to keep their promises to cap social insurance contributions at 40 percent of gross pay.

The alternative, reducing the deficits by imposing a rigorous cost-cutting regimen, is hardly any more attractive. Reductions in the range of social benefits would not only contradict the rosy promises of the current campaign. Instead, the next government would have to grapple with the legacy of the current grand coalition's reform, and in doing so admit to its own mistakes. Instead of making the social insurance funds weathertight, the CDU/CSU and the SPD have ensured that they are more susceptible to crisis than ever.

The overhaul of the statutory health insurance system comes at a particularly high cost to contributors. In the past, competition among health insurance agencies helped to keep the costs of the system somewhat in check. But then Chancellor Angela Merkel's cabinet established its central health fund with uniform contribution rates for all, thereby successfully purging from the system any pressure to cut costs. It comes as no surprise that doctors, hospitals and pharmaceutical companies have been doing so well recently.

But now the fund is running out of money, which will create a dilemma for the next administration. Either it will have to permit the health insurance agencies to impose so-called supplemental premiums on most of their customers, or it will be forced to yield to the insurance agencies' demands for higher tax subsidies.

If it chooses the second option, "future increases in healthcare spending will impose a burden on public finances," states to a report prepared for the Finance Ministry by the Berlin-based IGES Institute. Whenever the healthcare industry generates higher costs, the treasury will be asked to pay up. The federal subsidy, the experts write, would "cover the fiscal shortfalls in statutory health insurance."

Reform Efforts Abandoned

The current CDU and SPD coalition government's legacy on pension policy is no less unpleasant. When the Merkel administration came into power, the problems in the retirement funds seemed to have been resolved for the most part. After years of wrangling, the previous SPD and Green Party coalition government created a series of reforms that spread the costs of an aging population across generations in a reasonably equitable way.

To prevent the burden on younger Germans from becoming too excessive, pensions were to rise more slowly than wages in the future, and pension levels were to be reduced in the long term. The experts were confident that the approach would work, so that all the current grand coalition had to do was to implement the reform plan.

But nothing came of it. Instead, the CDU/CSU and the SPD turned the disruption of what had been touted as the reform of the century into government routine. In 2005 and 2006, the pension abatements that had come due were simply suspended. In 2008, the government diverged from the reform plans once again and, for the ensuing election year, introduced, in violation of the applicable adjustment formula, the highest pension increase in more than a decade. Finally, last April Labor Minister Scholz even gave retirees a so-called guarantee that their pensions would never be reduced, not even if wages declined.

Graphic: Swelling contributions

Graphic: Swelling contributions

The outcome is disastrous. The SPD-Green Party coalition's much-praised pension reform is little more than a shell today, while the government continues to postpone action on a mountain of unresolved pension cuts worth more than €20 billion. If it wanted to reduce these cuts, as planned, it would have to ask retirees to accept both regular reductions and reductions that were not imposed in past years.

The result would be at least 10 years of pension freezes. Hence, the government expects from its successors "greater fortitude on matters of pension policy than it has demonstrated itself," says Bert Rürup, a pension advisor to the government for many years and currently the chief economist for insurance broker AWD. The only solution, says Rürup, is to create "a new, more transparent pension formula."

Thus, the next administration faces a reform challenge that no cabinet has been asked to cope with in a long time. Regardless of whether the Chancellery is run by a Social Democrat or a Christian Democrat in the future, the next coalition government will not be able to avoid raising the contribution rates for unemployment insurance, restructuring the health fund and enacting a new pension formula. In other words, Merkel or Social Democratic candidate Frank-Walter Steinmeier will have to introduce, in concentrated form, the same social reforms that they both successfully avoided in the past legislative period.

One of the few politicians to openly address the challenges of the coming administration is CDU budget expert Steffen Kampeter. "If economic growth does not return," he says, "the social systems and the federal budget will be faced with challenges that we politicians cannot even imagine."

But the parties, including the smaller ones, are unwilling to entertain such insights until after the election. For the FDP, for example, reductions in the level of benefits provided by the German welfare state have never been substantial enough. But eight weeks before the election, FDP leader Guido Westerwelle is singing a new tune. To offset social hardships, Westerwelle said last week, the limit on the assets a long-term unemployed person can have in order to qualify for public assistance under the Hartz IV program, must be significantly raised after the election. In fact, Westerwelle called for a tripling of the exemption amount.


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