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Cablegate: Chancellor Merkel's New Coalition: What It Means For

VZCZCXRO1346
PP RUEHIK
DE RUEHRL #1240/01 2780540
ZNR UUUUU ZZH
P 050540Z OCT 09
FM AMEMBASSY BERLIN
TO RUEHC/SECSTATE WASHDC PRIORITY 5374
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUEHC/DEPT OF LABOR WASHINGTON DC
RUCNMEM/EU MEMBER STATES
RUCNFRG/FRG COLLECTIVE

UNCLAS SECTION 01 OF 04 BERLIN 001240

SENSITIVE

STATE FOR EEB (NELSON), DRL/ILCSR AND EUR/CE (HODGES, SCHROEDER)
LABOR FOR ILAB (BRUMFIELD)
TREASURY FOR ICN (KOHLER)

SIPDIS

E.O. 12356: N/A
TAGS: ECON EFIN PGOV PREL GM
SUBJECT: CHANCELLOR MERKEL'S NEW COALITION: WHAT IT MEANS FOR
GERMANY'S ECONOMIC AGENDA

REF: BERLIN 01138

BERLIN 00001240 001.2 OF 004


1. (SBU) SUMMARY: Germany's election of a center-right governing
coalition, composed of the Christian Democratic Union (CDU), its
Bavarian sister party the Christian Social Union (CSU), and the Free
Democratic Party (FDP), was supposed to herald a shift to a more
business-friendly government. The reality may be something less than
that as campaign rhetoric collides with exploding deficits and other
constraints; tax cuts, for instance, will be limited as the
government strives to rebalance budgets. On economic and social
issues, look instead for a continuation of many of the same policies
of the Grand Coalition, with a few concessions to business. The same
goes for labor and social welfare programs. Although the CDU/CSU
took pains in the election campaign to present themselves as
ideological bedfellows with the FDP, as head of the coalition
government Merkel had staked out economic positions that frequently
mirrored those of her SPD Finance and Labor Ministers. With Merkel
still at the helm, any drift to the right will be tempered by the
Chancellor's own commitment to "social market economy" principles.
Major cutbacks on aid to job-sensitive industries like autos and on
healthcare spending are therefore unlikely, as are an early
privatization of Deutsche Bahn and a shake-up of labor hiring and
firing policies. A similar dynamic may play out on the energy and
environmental agenda with Merkel, the committed environmentalist, in
a tussle with the more pro-growth FDP. The FDP is also unlikely to
win a battle with Merkel to loosen constraints on German business
with Iran. Ultimately, the makeup of Merkel's cabinet (see also
septel) may be as consequential for the Black-Yellow coalition's
economic policies as the negotiated coalition agreement. END
SUMMARY.


THE ECONOMIC AGENDA: CONTINUITY AND MODEST CHANGE
--------------------------------------------- ----

2. (SBU) As the new coalition prepares itself to take power,
initial economic challenges will be largely tactical. (NOTE:
Chancellor Merkel (CDU), Minister-President Horst Seehofer (CSU) and
presumed Vice Chancellor and Foreign Minister Guido Westerwelle
(FDP) are aiming to sign a coalition agreement by November 9 at the
latest, before the anniversary events for the fall of the wall.) The
Chancellor, accustomed to moderating demands from her SPD partner to
the left, will now find herself at the other end of the political
spectrum, as she tries to balance pro-business FDP objectives with
what some refer to as her "social democratic course." Early
statements indicate that she intends to block FDP assaults on some
policy positions taken by the previous Grand Coalition. Potential
flashpoints include financial market regulation, targeted state
intervention on behalf of troubled industries and companies, and
health care policy. CDU sources tell us consideration of these issue
areas may also guide the party as it parcels out the various
ministries. "In financial matters, working with the FDP will become
more difficult, certainly in the beginning," a Chancellery contact
told us. The party will have a "steep learning curve and will have
to modify and moderate its positions on several policy areas."

3. (SBU) A key issue to watch will be tax reform (reftel); the CDU
and FDP will have to deliver, after making this their central
economic campaign issue. The CDU envisaged decreasing the corporate
tax rate, and using tax incentives to encourage public and private
sector research and development. The FDP promised a radical overhaul
of the entire system, with lower rates at some levels but higher
rates at others; the net effect, however, would be a 35 billion euro
loss in revenues, according to independent estimates. Tax policy
could, therefore, be a point of contention, but lower rates for
small earners and for families, as well as some cuts in the
corporate tax, are likely outcomes in any event.

4. (SBU) With an expected budget deficit of more than 2 percent
this year and 4 percent in 2010 -- just as mid-term targets for
Germany's balanced budget amendment kick in, mandating structural
deficits of no more than 0.35 percent -- the new coalition will face
strong pressures on revenues. A VAT hike, at least in the near term,
is unlikely since Merkel publicly ruled it out. Tax cuts, however,
could be accompanied by a "streamlining" of the tax code: code for
phasing out subsidies. Cutbacks in pensions, health care,
unemployment support will be more difficult, since less funding for
these social systems would increase costs for companies, which the
FDP would staunchly oppose. A senior Chancellery official envisages
a net fiscal impact of around 10 billion euros at the most. Bottom
line: the scope for cuts is limited.

THE LABOR/SOCIAL AGENDA: MERKEL'S BACKYARD

BERLIN 00001240 002.2 OF 004


------------------------------------------

5. (SBU) In their initial reactions to the election result, ranking
union leaders warned the new coalition government against embarking
on a "neo-liberal policy course" and to respect worker rights. The
main reason for their concern is the FDP's election platform which,
inter alia, calls for limiting labor's role in company advisory
boards and work councils, and for measures to weaken protection
against dismissal rules and collective bargaining coverage.

6. (SBU) Disappointed with the election outcome, German Trade
Federation (DGB) President Michael Sommer warned against "an
eradication" of the social-welfare system due to the crisis. In a
televised interview the day after the election, Sommer reminded
Chancellor Merkel to keep her promise not to weaken the existing
protection against dismissal regulations. Sommer characterized FDP
demands as a "declaration of war" against the unions, and warned the
new coalition of "consequences." If necessary, unions would be able
to mobilize resistance, Sommer held.

7. (SBU) Despite the sharp public rhetoric, union leadership knows
it needs to continue on its current moderate course, including
restraint on wage increases. In order to influence policymakers,
leaders have scheduled a meeting with Merkel to discuss the economic
crisis and the new coalition agreement. Union leaders know that
Merkel is their potential ally in the coalition and will not
hesitate to woo her. In a similar vein, Hubertus Schmoldt, outgoing
chair of the Mine, Chemical and Energy Workers Union (IG BCE) noted,
"The election result is obviously not what we had wanted, but we
will look for a dialogue and cooperation."

8. (SBU) In a September 29 meeting, IG Metall's North
Rhine-Westphalia district leader Oliver Burkhard told Embassy that
the election outcome could be attributed, in part, to the SPD's
obvious lack of "compassion" for the "ordinary people" most
seriously affected by former Chancellor Schroeder's Agenda 2010.
Burkhard was cautiously optimistic that a CDU-led government might
correct some shortcomings in the labor market and pension reforms,
and did not expect major changes in labor law or worker
participation rights. "The FDP will not prevail," he said, referring
to statements by prominent CDU leaders in North Rhine Westphalia
such as Pofalla (a possible new Labor Minister), NRW Labor Minister
Laumann (chair of the CDU's labor wing, and also a potential
candidate for Labor Minister) and NRW M-P Juergen Ruettgers, who
immediately after the elections strongly warned the FDP not to
expect the new government to touch hot button issues like protection
against dismissals, co-determination or health insurance system. The
coalition leader, Merkel, is likely to agree.


STATE BAILOUTS: THE OPEL TEST CASE
----------------------------------

9. (SBU) Opel and Hypo Real Estate (HRE) may be early test cases
for the new coalition. Voices in the FDP (and CDU/CSU) bemoaned the
Grand Coalition's willingness to prop up struggling firms through
take-over, loan guarantees and other market interventions. Serious
debate, however, centered mainly on which firms were systemically
important enough to be saved, and how many jobs were at stake.

10. (SBU) During the campaign, FDP-leader Guido Westerwelle
criticized Merkel's handling of the Opel bailout, but steered clear
of dismissing a government role in saving Opel jobs, some of which
are found in his home state of North Rhine-Westphalia. The
Chancellor could use a calculated confrontation with the FDP to
demonstrate CDU compassion. Where such a strategy would leave the
CSU and, in particular, the current Economics Minister zu
Guttenberg, is an open question, since zu Guttenberg once advocated
insolvency for Opel. On the other hand, the Chancellor is also
vulnerable. As the Magna deal becomes more complicated and mired in
controversy, it could well become more draining on taxpayers. Not
facing these constraints, the FDP could argue against shoveling more
public funds into Opel.


PRIVATIZATION: NOT SO EASY
--------------------------

11. (SBU) The previous government was committed to the
privatization of the public sector German Railway (Deutsche Bahn -
DB). Evidence of mismanagement, however, forced repeated delays of
the plan to place DB stock up for sale. Analysts have concluded that
the troubled company is no longer a viable candidate for

BERLIN 00001240 003.2 OF 004


privatization. In addition, the protracted recession has hurt
railways badly, making it difficult to find investors willing to
purchase DB stock. Ever the pragmatist, Chancellor Merkel would
likely be willing to delay privatization indefinitely. The FDP, by
contrast, is committed to privatization of public sector holdings on
ideological grounds and could press for the plan to proceed, even if
this is not the right time.


NUCLEAR PHASE-OUT ON HOLD?
--------------------------

12. (SBU) During the campaign, the SPD tried to make nuclear power
into an issue, but it failed to resonate with the voters. The SPD
argued that under no circumstances would it delay the phase-out of
Germany's nuclear power plants. (NOTE: The current arrangement would
close the last reactor some time around 2020.) The FDP favored
extending the life of the reactors. Merkel refused to be pinned
down, stating only that nuclear power must serve as "bridging
energy" until renewable energy sources are fully up and running.

13. (SBU) With the SDP now in opposition, the CDU-FDP coalition is
likely to become more sympathetic toward nuclear power. The CEOs of
energy giants RWE and E.ON have offered to turn over to the
government part of the additional earnings generated by any
extension of nuclear power. As the EU's cap and trade system
becomes more widespread, nuclear power could become more attractive.
Should Germany proceed with the phase-out, it has few viable options
to replace the power generated by nuclear reactors, which currently
provide 23 percent of the country's power needs. The introduction of
more coal-fired plants with their large CO2 emissions would be
prohibitively expensive while greater use of natural gas would
increase Germany's dependence on Russia, the only viable supplier. A
CDU-FDP coalition could opt for an extension, although it would
touch off a serious battle with the opposition and a hot public
debate; Germans from across the political spectrum oppose nuclear
power.


HOW GREEN ARE YOU REALLY?
-------------------------

14. (SBU) Under the Grand Coalition, Germany embraced
environmentalism with an enthusiasm rarely seen in other countries.
Large tax-payer subsidies have fueled the creation of an enormous
renewable power industry and Germany has surpassed its Kyoto Accord
goals for curbing CO2 emissions. This has come at a heavy price and
become the cause of considerable complaint from many of those who
voted for the incoming CDU-FDP coalition. More conservative voters
argue that Germany should not take an economic hit to meet its
climate change and environmental goals, while economic rivals like
China and India ignore global warming and the environment to procure
an advantage.

15. (SBU) Originally hailed in the media as the "Climate Chancellor"
for her efforts to elevate awareness of environmental concerns,
Merkel, along with the SPD, implemented large, taxpayer-subsidized
plans that helped build a world-renowned renewable energy industry.
Merkel remains under pressure from German heavy industry concerned
about carbon leakage and resulting job losses, however, especially
in the auto, steel, chemical, aluminum, and cement industries. Last
December, Chancellor Merkel and the Economics Ministry lobbied the
EU Commission to exempt German heavy industry from the planned
auction of carbon permits in the EU Emissions Trading Scheme (ETS).
She also expressed deep opposition to EU legislation seeking to tax
emissions from large cars, which would hurt the luxury sedans
produced by German automakers. Against the backdrop of a shaky
economy, we expect to see the new coalition seek to navigate between
the Scylla of climate advocates and the Charybdis of heavy industry.
Merkel will likely seek to execute her domestic climate renewable
and energy efficiency plan, but with little further ambition,
particularly if she is tugged back by the FDP.

COMPLICATING SANCTIONS AND EXPORT CONTROLS
------------------------------------------

16. (SBU) The shift in coalition partners from the SPD to the
pro-business/pro-export FDP may also complicate Merkel's desire to
tighten sanctions against Iran should diplomacy fail. A FDP-led MFA
is likely to keep the interest of their core business constituency
in mind, particularly in times of financial crisis, and may be
reluctant to back stronger sanctions that would negatively impact
German exports. In addition, the new coalition may become more

BERLIN 00001240 004.2 OF 004


liberal on the exports of "war weapons," particularly in politically
sensitive cases that are decided by the "Bundessicherheitsrat"
(national security council) - a panel composed of Merkel and the
Ministers of Foreign Affairs, Defense, Finance, Economics, Interior,
and Justice, which will be populated exclusively by CDU/CSU and FDP
party members. On the other hand, the export control authority for
civil and dual-use goods, BAFA, is an independent agency within the
Ministry of Economics and in theory is independent from any shift in
the governing coalition. And if Merkel decides on tougher sanctions
for security considerations, that will trump the concerns of German
business in Iran.


MINISTERIAL ROULETTE
--------------------

17. (SBU) While speculation over future Black-Yellow policies is
becoming a national pastime, the direction of the new coalition's
economic, social and environmental policies is largely a question of
who will lead the various ministries (see septel for full cabinet
discussion). The Finance Ministry is seen as the big prize, with
the Economics Ministry trailing somewhat behind. Although the Labor
Ministry does not have the same cache, it is an important bellwether
of social issues. Options follow:

--Finance: CDU will like to control the purse strings, but lacks
financial expertise. Hesse Bundestag Member Roland Koch is
mentioned as a possibility, but he has shown no signs of interest.
Current Economics Minister zu Guttenberg is another, as is Hans-Otto
Solms (FDP). Bottom line: No clear front runner.

--Economics: Although the FDP may want it, it has only one viable
candidate: Rainer Bruederle. Succeeding the youthful and dynamic zu
Guttenberg will be a hard act to follow for the soft-spoken, 60
year-old Bruederle. Moreover, zu Guttenberg is rumored to want to
stay on as Economics Minister.

--Labor: The CDU wants it to emphasize its credentials on social
policies. The Chancellor may want to reward loyal stalwarts such as
CDU Secretary General Ronald Pofalla. Josef Laumann, Social Affairs
Minister in North Rhine-Westphalia is another leading contender (see
septel).

MURPHY

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