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Germany's grand coalition

The priorities of Germany's grand coalition — the second in nearly four decades, comprising the Christian Democrat Union (CDU ) and the Social Democrat Party (SPD) and headed by the country's first woman Chancellor Angela Merkel, who was elected by Parliament on Tuesday — are driven on the one hand, by a common quest for political compromise between traditional rivals and on the other, by the need to reconcile divergent approaches to the pursuit of economic reforms. With the outgoing Chancellor Gerhardt Schroeder's chief of staff, Frank Walter Steinmeier, as her foreign minister, Ms Merkel's pursuit of normal relations with the United States, strained over the invasion of Iraq, as also the CDU's and the SPD's conflicting approaches to European integration, will be closely watched. The overarching aim under the coalition arrangement agreed last week is to plug a huge budget gap by 2007 so as to bring the fiscal deficit within the limits prescribed for member-states by the European Union (EU). The legal argument for fiscal prudence may be obvious as Germany's record — as the biggest economy among the 12 eurozone countries — of adherence to the stipulations under the EU's Growth and Stability Pact for three successive years has not been inspiring. However, the economic rationale of achieving fiscal consolidation without introducing corresponding deregulation measures to induce growth has already drawn flak from conservatives given Germany's high unemployment and sluggish growth.

Very little of Merkel's campaign promise of reform of the labour market as a strategy to create jobs remains in the grand coalition's agreement. One of the surviving elements is the plan to extend the period after which employees will be eligible for legal protection against dismissals from six months of recruitment to two years. This may hurt the Social Democrats' political base without resulting in any improvement in productivity or employment. One of the imperatives of the conservatives cohabiting with the left-of-centre party is the limit on the government's capacity to slash social spending. The CDU, the traditional votary of low taxation, has been forced to agree to hefty hikes as, for instance, in tax rates for high income groups and in the value-added tax (VAT). Revenues from the latter are to be used to offset cuts in employers' contribution to unemployment insurance and to cover the budget deficit. The increase in VAT will, however, do little to boost domestic demand. Ms Merkel's challenge will be to weather the political upheavals that are likely to visit her rule as happened in the case of the Agenda 2010 package of reforms unveiled by the previous government. It remains to be seen whether the proposed move to raise the age of retirement by two years and increase in pension contributions to ease the burden on the Federal State's pension system will anger the young unemployed or endear the new coalition to the growing population of the aged in Germany.

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