Over the weekend in Germany, an alliance between the conservative Christian Democratic Union and the pro-business Free Democratic Party claimed a majority in Germany’s lower house of Parliament that could set the stage for slashes to government spending and income taxes. German Chancellor Angela Merkel now has a partner who supports implementing tax cuts, not massive government spending, to spur economic growth. The FDP also shares Merkel’s desire to ease back on laws protecting workers from dismissal and establish a national minimum wage.
The new government is expected to replace an uneasy alliance between the right-leaning CDU and the left-leaning Social Democratic Party. The FDP is expected to contribute to improved relations with major allies, including the U.S. through its support of a continued German presence in Afghanistan.
But the biggest impact of the elections is expected to be felt in the business world. “Germany’s general election has delivered a clear mandate for economic reforms: neo-liberal but socially conservative, in favour of free markets and less regulation, hoping to boost the economy by lowering taxes,” writes Tim Weber.
Businesses Applaud, Germany ETF Surges
As investors and businesses applauded the new government, the iShares MSCI Germany Index Fund (EWG) surged on Monday, jumping more than 2%. It wasn’t quite the 25% gain that Indian ETFs posted after the Indian national Congress was elected in May, but a nice boost for an economy that has lagged behind its European peers for much of the year.
EWG tracks an index comprised of 50 German equities, with the financials (20%), utilities (16%), and industrials (15%) sectors accounting for about half the fund’s holdings. EWG has gained about 16% in 2009, putting it dead last among European equity ETFs. Many country-specific ETFs, including those focusing on Belgium (EWK), Sweden (EWD), and Austria (EWO) have gained more than 40% so far in 2009.
Germany, the world’s biggest exporter, was hit hard as demand for its products slumped around the world. As many European markets rebounded, Germany’s has been held in check as uncertainties surrounding the country’s labor situation swirl. The German government has kept unemployment artificially low, spending tens of billions of euro to put some 1.4 million workers on the “Kurzarbeit” program, under which workers work fewer hours and the government subsidizes lost salaries. If taxes are slashed as expected, unemployment could skyrocket in coming quarters as these programs become unsustainable.
Despite their political principles, some believe that the new alliance will have limited room to maneuver given the country’s massive debt burdens, meaning that pro-business tweaks to existing policies may be the extent of changes introduced. In her address on Sunday night, Merkel proclaimed her goal to be “a chancellor for all Germans,” an indication to some that any pro-business reforms will be moderate in nature. Merkel pledged to govern for “the workers as well as the entrepreneurs.”
Others argue that the VAT tax is long overdue. “The VAT increase not only damaged the German economy by postponing the arrival of a centre-right government by 4 years, but also by increasing Germany’s export dependence,” writes Stefan Karlsson. Germany’s long history of maintaining a highly regulated “social market economy” may be in jeopardy, as the new government looks to push market-oriented policies beginning with tax cuts and deregulation.
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Disclosure: No positions at time of writing.