Welfare Costs Threaten German Reform Agenda?

My feeling is that the honeymoon days of Angela Merkel's government are not too far from over. What we have seen is an excess of euphoria, based on the idea that the German economy is now, at last, about to finally take off, and a lack of any real appetite to get down to the serious agenda of reform which is, more urgent than ever. Some measure of the magnitude of the what might be referred to as the submerged part of the iceberg can be seen in this article in the FT today detailing how welfare speding continues to accelerate:

Spiralling welfare costs could add €4bn to Germany’s 2006 budget deficit and undermine Chancellor Angela Merkel’s efforts to bring her country’s finances under control, members of her coalition have warned.

Confidential government statistics show that a faster-than-expected rise in the number of households claiming long-term unemployment benefits could bring this year’s deficit from a planned €38.3bn to well above €40bn ($49bn, £27.7bn).

This would dash consensus expectations among economists that the deficit will fall below 3 per cent of gross domestic product – or back in line with European fiscal rules – this year for the first time since 2002.

While Ms Merkel could still meet her cautious pledge to abide by the rules by next year, the spending explosion could lift the 2007 deficit above planned public investments, putting the budget in breach of the constitution.

“The cost explosion is threatening to blow a hole in the budget,” said a coalition insider who asked not to be named, adding that Franz Müntefering, the labour minister, “must come up with an answer”.

Figures published by the Federal Labour Agency show the number of households claiming “unemployment benefit II”, the most basic form of welfare support, comparable to the UK’s income support, has risen from 2.9m to 3.9m since its introduction 15 months ago.

According to a labour ministry document obtained by the FT, the actual number is even higher. The document shows the agency’s monthly reports, based on samples, had underestimated the number of claimants by 200,000 a month throughout last year, suggesting today’s figure was around 4.2m.

Extrapolating from the benefits paid so far this year, aides to Peer Steinbrück, the finance minister and like Mr Müntefering a Social Democrat, estimate total payments in 2006 could reach €28bn, well above the €24.4bn provided for in the budget.

Ironically, the benefit, also known as “Hartz IV” and introduced by Gerhard Schröder, Ms Merkel’s predecessor, as part of his social security and labour market reforms, was meant to cut welfare support and sparked loud protests at the time.

But, as Mr Müntefering conceded in an interview with the FT three weeks ago, loopholes have since appeared in the system that have led to a flood of claims.

Young jobseekers, for instance, have moved out of their parents’ homes and into their own flats in order to claim generous rent subsidies. Many workers whose monthly wage is lower than the basic benefit have yet to claim the top-up welfare payments they are entitled to.

“Even today, I am told, people are finding out that they have claims,” Mr Müntefering told the FT three weeks ago. “There is nothing criminal there, but it is a grey area we must look into.”

The labour ministry says benefit payments over the first quarter are a poor guide to the rest of the year because unemployment is expected to fall as economic growth accelerates in coming months.

A ministry spokeswoman said an “optimisation” bill to be drafted by the summer would cut spending on long-term jobseekers by about €1.2bn a year from 2007 onwards. Other measures already enacted should generate €500m-€600m in savings from next year.

Based on current trends, however, this would not suffice to offset the rise in claims.

“Another problem,” said a finance ministry official, “is that we doubt the labour ministry is serious about cutting spending. The guys at the lower levels are dragging their feet. Their culture is to give stuff away, not to clamp down.”

In one respect alone, news that her fiscal consolidation plan may be in jeopardy could be a blessing for Ms Merkel. It should make it easier to justify a hefty, three-point increase in value-added tax planned for next January.