Policy Regression?

In Berlin, it's been a demanding, frustrating two months of coalition negotiations since the parliamentary elections. But it appears that Germany's three principal political parties have figured it out - they announced yesterday an agreement to form a new "grand coalition" government. It will be led, for a third time, by Chancellor Angela Merkel and her Christian Democratic Union (CDU), who won 41.5% of the votes in the fall election, compared with 25.7% for the next biggest party, the Social Democrats (SPD).

So the European Union's most important economy will once again have a government, though only assuming ratification of the coalition contract by the 470,000 members of the SPD on December 14 (an uncertainty, given that much of the SPD's blue-collar base is uncomfortable with the business-centric wing of Ms. Merkel's party). But just how grand is the new contract? The 185-page document bears the clear stamp of the SPD: it establishes a minimum wage, to begin in 2015, for the first time in Germany, a move opposed by not only employer groups, but even the unions, and especially by the country's central bank, concerned with its negative impact on employment, especially in eastern Germany where labor productivity remains anemic. It also actually lowers the eligible pension age for those who have worked for 45 years (when long-term German demographic trends are hardly favorable to growth, and when most other governments in developed countries are, for the same demographic reasons, looking to raise it), and directs temporary surpluses in the pension trust fund to more social spending rather than being used to reduce contributions. Ms. Merkel's CDU did prevail in one area - there will be no tax increases, and no new debt after 2015.

But the larger question remains: will these policy compromises coming out of the coalition agreement so substantially dilute the successful reforms in Germany, particularly those of the labor market begun more than a decade ago, that the country's globally competitive position will be undermined? This will be the delicate balance Chancellor Merkel will need to strike as the new coalition government begins its work - to, on the one hand, ensure that the overall impact of any new government economic policy is the enhancement of now weakening German productivity, while, on the other hand, to placate her coalition partners on the left so as to prevent a collapse of the government and the political instability, in Germany and the EU as a whole, that would ensue.

Italian Prime Minister Enrico Letta, no stranger himself to walking the fine line of coalition government, and perhaps feeling a bit less threatened following yesterday's vote in the Italian Senate to expel Silvio Berlusconi, was quick to express his relief and pleasure that a new German government is being formed. He is well aware that the German government will remain at the center of the euro zone's strategy in tackling debt and banking issues - a sort of euro-underwriter - and, in 2014, Mr. Letta may well need such a service. Ms. Merkel's balancing act, then, could become even more complicated.