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

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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,
Merkel, as head of the coalition government 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 health care 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.

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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

4. (SBU) With an expected budget deficit of more than 2
percent this year and 4 percent in 2010 -- just as mid-

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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.


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.


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

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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.


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
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.


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.


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

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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

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.


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 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.


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.

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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).


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