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For a number of years, the German economy has enjoyed a strong competitive position relative to its Eurozone peers. Factors such as a stable political environment, high levels of innovation and research and development (R&D) spending, a well-educated and skilled labor force, attractive unit labor costs, and high productivity provided a strong environment for domestic companies. These factors also attracted foreign capital, both from within Europe and abroad. However, the most recent national election yielded a coalition government that has shown a preference for policies that could diminish Germany's competitive position. Though the impacts of such a shift in policy may not be felt in the immediate, or even intermediate term, it is most certainly a trend that investors would be well-served to monitor over a longer time horizon.

Improved Competitiveness Through Reform

A series of reforms in the early 2000s set the stage for a dramatic improvement in German competitiveness. Following a prolonged period of high unemployment, German Chancellor Gerhard Schröder's coalition government succeeded in improving the incentives for Germans to return to work, reducing welfare spending, and cutting taxes as part of the Agenda 2010 reforms. Meanwhile, Germany's Hartz reforms successfully reduced rigidities that existed in the German labor market. These reforms played a large part in helping to cement Germany's position at the top of the Eurozone economy in the decade after their implementation. Significantly, the reforms came at a time when many of Germany's regional competitors were making no similar efforts to improve the business environment. This served to augment the impact of the German reforms.

Following the European sovereign debt crisis, the Germans preached what they themselves had come to practice. German politicians repeatedly stressed the importance of increasing competitiveness and implementing austerity programs to reign in unsustainable government spending practices. Though many of the recommendations were not well received by their peers, this did not deter German officials from espousing their support for policies that were similar to those that they had endured several years earlier.

Closing the Gap

Federal Elections held during the fall of 2013 brought with them the need for German Chancellor Angela Merkel to forge a new coalition government. Though her Christian Democrat Union (CDU) party and its sister Christian Social Union (CSU) party won a stout 41.5% of the popular vote, its previous coalition partner did not win enough of the vote to maintain its representation in parliament. As a result, Merkel's government was forced to form a coalition with the left-leaning Social Democratic Party (SDP).

As a result of the formation of the new coalition government, German policy appears to be retreating from its staunchly pro-business position. For example, the introduction of a minimum wage for the first time in the history of the country will impact nearly 15% of workers nationwide, with an even larger impact in the already-less productive eastern part of the country. While its actual impact on wages will be minimal, it will put hundreds of thousands of jobs at risk. Recent government proposals to lower the retirement age also have German companies concerned and neighboring countries outraged, especially given that they have recently been swayed by Germany to raise their retirement age and eligibility criteria. Other recent German government proposals that recommend greater intervention in the energy and property markets provide even more cause for concern.

This apparent backtracking comes at a time in which economic conditions in many of the Eurozone's periphery countries are converging with those in Germany. As a result of the sovereign debt crisis, many rigid labor laws have been loosened, pension systems have been reformed, and government accountability has risen. In addition to the pro-growth reforms being implemented across the region, borrowing costs have fallen, balance sheets are improving, and unit labor costs are coming down following several years of austerity and belt tightening. None of this is to say that Germany no longer presents attractive investment opportunities. However, the wide competitive advantage that once existed in Germany relative to its Eurozone peers is now shrinking. Should this trend continue into the future, it could have a negative impact on the country's economy, the companies that operate in it, and its equity market.

Source: Germany: A Step In The Wrong Direction?