German Economy Slides Amid Fears of Recession

Although German economists are reluctant to call it a recession yet, many are lowering expectations as costs to rebuild east Germany soar

FOR the second time since unification two years ago, German Chancellor Helmut Kohl is breaking his promise of no new taxes.

There is simply no alternative, the chancellor and his supporters argue. East Germany is costing far more than Bonn first reckoned, and the west German economy is in a downturn and unable to shoulder the mounting bills of the east.

At the conference of the Christian Democratic Union in Dusseldorf Oct. 26, Chancellor Kohl called for a tax increase by 1995. He did not reveal any further details, but warned that if necessary spending cuts were not carried out, a tax hike could come even earlier.

Some German industrial leaders, as well as Kohl's own finance minister, Theo Waigel, have reacted negatively to the idea. They worry that the prospect of new taxes will remove the incentive to cut government spending. They also argue that even if the tax increase is a few years off, consumers and businesses will anticipate increased costs and begin tightening their belts now. This will only push the sluggish economy deeper into the mud. Growth expectations down

German economists have begun frantically revising their economic forecasts downward. The Economics Ministry ratcheted down its already conservative estimate of west German economic growth for next year to 1-1.5 percent, from 2.5 percent. The country's five leading economic institutes adjusted their 1993 west German growth forecast even lower, to 0.5 percent.

"The fall in business confidence over the last three months is the worst I've seen in 15 years," says Siegfried Utzig, economist for BDI, the federal association of German industries. "A tax increase is the worst alternative."

But Kohl sees things differently for several reasons:

* The east German economy is not rebounding as quickly as had been hoped, and is therefore still unable to make a serious financial contribution to its own recovery. Economics Minister Jurgen Mollemann admitted last week that the economy in the east will probably grow by only 2 to 5 percent this year, compared to original government expectations of 10 percent or more.

* Additionally, new and unexpected bills for rebuilding east Germany keep pouring in. Kohl's biggest financial worry is 400 billion deutsche marks ($266 billion) of accumulated east German debt and the annual costs to service that debt. It is this mountain of debt that he wants to bulldoze with his tax increase.

* The means first envisioned to pay for east Germany - the booming west German economy - has run out of steam.

"This is the hour of truth," he said Oct. 26.

Although economists here will not call it a recession yet, the dreaded "R" word is beginning to pop up in the media. Except for the first quarter of this year, the last five quarters have seen zero or slightly negative growth in west Germany's gross national product. Key industries, such as machine tools, autos, steel, and electronics have announced major layoffs. Exports, Germany's bread and butter, dropped significantly over the summer, hampered by the international recession and the high mark. Focus on the mark

Even the stubborn Bundesbank, single-mindedly following a policy of anti-inflationary high interest rates (and thus a strong mark), appears to have acknowledged the seriousness of the economic downturn.

The Bundesbank slightly lowered money market interest rates on Oct. 21, though it left its key rates untouched and does not appear ready to lower them in the near future.

Critics such as BDI economist Utzig say Kohl should increase government borrowing in the short-term and do some serious budget cutting in the mid-term to pay for east Germany. Social services are generously funded here, as are industry subsidies.

But the chancellor is apparently unwilling to add to Germany's soaring debt by substantially increasing borrowing. As far as spending cuts go, Kohl says this is his chosen course for the next two years. Bonn's plan

The government wants to hold the 1993 budget to a 2.5 percent increase and accommodate greater demands from the east through cuts in other parts of the budget and elimination of red tape. The chancellor is trying to work out a "solidarity pact" between industry and federal and state government to keep costs - especially wages - under control.

Financially, Bonn will be helped by a previously agreed on increase in Germany's value-added tax, which will rise from 14 to 15 percent on Jan. 1, 1993.

Kohl says that, unless forced to, he does not want to institute a major tax increase before 1995. Given the less-than-robust economy, a tax hike next year would be "absolute poison," says Minister of the Chancellory Friedrich Bohl.

Commerzbank economist Peter Pietsch calls the west German economic downturn a cyclical one, and predicts a very modest recovery to begin in the second half of next year. A supporter of Kohl's tax proposal, Mr. Pietsch, however, thinks the economy could stand a tax hike as early as 1994 - though he says this is unlikely because that is a national election year.

In any case, Pietsch is in line with those among Kohl's advisers who have been urging a tax increase for months. The unification bill is simply too big to be paid for solely through budget cuts, he says, for which there is not enough political will.

"In this case, [a tax increase] is fair and probably the better alternative," Pietsch argues. "It's quite obvious that the economic situation is different than it was two years ago, and the government is having to say, `We made a mistake.' "

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