Schroeder's economic challenge

Smiles now but battles with unions and employers loom

Analysis
By Tim Weber BBC News Online

As the champagne goes flat after the victory parties of Germany's governing parties, the hangover is rapidly setting in.

Sparring with the United States over policy towards Iraq aside, Chancellor Schroeder will have to occupy himself with just one big issue, the economy.

The German economy is held back by a 'Reformstau', a logjam of much-needed reforms

On the morning after the vote, Germany's main stock market index dropped sharply - yet again. Investors don't like narrow government majorities, but the decline of the Dax - down 40% from its peak - is also a reflection of the country's stagnant economy.

Annual growth weighs in at a mere 0.1% - the slowest in Europe. And there is little sign of a lasting recovery.

	:	Key election graphs
Click here to see German election statistics

For two years, until 2001, German exporters experienced a brief boom, driven by the weakness of the euro.

But since the US economy is in recession, demand for goods made in Germany is falling sharply, and euro interest rates are too high for the liking of the country's industry.

Costly floods

The German economy is held back by a "Reformstau", a logjam of much-needed reforms that have a habit of not materialising.

It's not so much Mr Schroeder who is to blame for this. His right-of-centre predecessors talked for 16 years about reforms, but delivered none.

Mr Schroeder will be fought every inch of the way by both trade unions and employers, each fearing they will lose out

The chancellor has made a few bold steps, reforming the system of capital gains taxes, for example. German industry, entangled in a system of crossholdings, can now get leaner, meaner and more competitive.

A sweeping reform of the income tax system is set to revitalise the economy as well.

But here the problems begin. Cleaning up after this year's devastating floods has proved so costly that the chancellor was forced to postpone the start of tax reforms by a year.

And the biggest piece of reform - making the labour market more flexible - has been much talked about but made little progress.

Failure to deliver

Unemployment is the scourge of the German economy. The jobless rate stands at 8.3% - or more than four million people - the fourth-highest in the EU and three times worse than in neighbouring country the Netherlands.

And it was Mr Schroeder's failure to deliver on his promise to push unemployment below 3.5 million that nearly cost him his job.

In the run-up to the election, a commission headed by an SPD-friendly industrialist, Peter Hartz, drew up a list of labour market reforms, which ranged from a root-and-branch reform of the system of job centres to new rules for part-time, temporary and low-paid workers.

Add the much-needed reform of Germany's school system to the list of 'must-dos'

Mr Schroeder has promised to implement the plan, or at least parts of it, but he will be fought every inch of the way by both trade unions and employers, each fearing they will lose out in the process.

And the bitter election campaign of the past nine months has deeply hurt Germany's consensus model of labour relations.

Bosses and union leaders engaged in brinkmanship not seen since the eighties, resulting in that rare thing in German labour relations, widespread strikes.

Rein in healthcare

In this poisoned atmosphere it will require all the chancellor's charm and diplomatic ability to restart the much-vaunted but hardly effective "alliance for jobs" between employers and employees.

To round off the list of problems, Mr Schroeder is under pressure to keep to tight spending limits, imposed by the eurozone's stability pact, cut back on bureaucracy and rein in escalating healthcare costs.

All this requires tough decisions... Long-established entitlements will have to disappear

Perhaps most important of all, he also has to find a solution to Germany's pensions crisis, caused by an ageing population.

Oh - and add the much-needed reform of Germany's school system to the list of "must-dos". Superior education and vocational training, after all, underpins the high productivity of Germany's workers - and in turn their high wages.

Partisan upper house

All this requires tough decisions on spending, benefits and subsidies. Long-established prerogatives and entitlements will have to disappear, and both workers and bosses will be smarting.

So can the chancellor and his partners in the Green Party come up with the ideas - and the resolve to implement them?

Even if they do, there is one big stumbling block. Germany's upper house, the Bundesrat, is controlled by the country's conservatives, and if past form is any guide, they will show little willingness to forgo partisanship for the country's greater good.

"Reformstau" is a word that will dominate Germany's headlines for a few more years to come.