Germany Risks Heightened Competition in Push to Remodel Europe

In trying to mold the rest of Europe into its own economic image, Germany risks restoring its biggest competitors to fighting form, which could take a heavy toll on the nation’s exports that now account for almost half of gross domestic product.

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Governments from Italy to Spain to Ireland are trying to convince German Chancellor Angela Merkel and bondholders that they can fix their balance sheets by pushing through policies designed to restore their competitiveness.

Efforts by euro-zone governments to cut labor costs may help exporters across southern Europe challenge the dominance of German competitors, risking Germany’s top spot in Europe’s economic hierarchy.

“It’s true, it’s our fate that competition will increase and we’ll have to hurry up to get better as well,” said Wolfgang Clement, a former government minister who oversaw former German Chancellor Gerhard Schroeder’s economic policy revamp. “My big concern is that we become complacent amid all this talk of Germany being strong.”

After struggling to cope with the aftermath of reunification that began in 1990, Germany turned itself into Europe’s growth engine, and was the world’s third-biggest exporter after China and the U.S. in 2010.

Germany was able to climb to the top by squeezing wages and diversifying manufacturing. German labor costs rose at half the pace of Greece’s labor costs in the ten years through 2010. Export growth averaged 5.2 percent per year in the same period, compared to 3.1 percent for Italy.

The euro region is Germany’s largest export market, but despite the possible costs to Germany, Merkel is pushing debt-strapped nations to follow her country’s lead and push through measures to promote economic growth and reduce deficits.

“I would rather focus on growing competitiveness in Europe than constantly having to worry about rescue programs,” Merkel said in March. “We’re ensuring that Europe as a whole improves.”

The European Commission said that the competitiveness of Italy and Spain, Germany’s biggest potential rivals, is well below the region’s average. To become more competitive, Italy should make labor cheaper, while Spain should improve productivity and reform its wage practices, said the commission.

Labor costs in all euro nations outpaced Germany’s over the last decade. German hourly labor costs rose an average of 1.7 percent annually, while they jumped 2.9 percent in Portugal, 3.2 percent in Italy, 3.4 percent in Greece, and 4.1 percent in Spain.

Spain’s new Prime Minister-elect Mariano Rajoy pledged yesterday that his government would overhaul the labor market in the first quarter and cut taxes for small companies. Italy, the region’s third-largest economy after Germany and France, will overhaul its employment laws. On December 4, Prime Minister Mario Monti said details would be announced “within weeks.”

However, such measures won’t be a quick fix. German Chancellor Gerhard Schroeder unveiled his package of labor, health, pension, and tax policy changes in March 2003, but it wasn’t until almost two years later that the labor market began to show results.

“It’s a very long process to become competitive,” said Andreas Scheuerle, an economist at Dekabank in Frankfurt. “It took a long time for German companies to boost their competitiveness by means of wage restraint.”

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