Europe's Giant in a Squeeze

The world doesn't need another Japan - an economic body-builder gone weak in the knees because it refuses to shape up.

But Germany, world economic power No. 3, is being nearly as stubborn as No. 2 Japan when it comes to necessary structural change.

Expecting annual growth of less than 0.5 percent - its seventh year as the European Union's slowpoke - the country is weighing down the continent. The US, meanwhile, remains the sole engine to rev up global growth.

Before he was narrowly elected to a second term as chancellor in September, Gerhard Schröder seemed committed to at least some degree of economic reform. In a country where unions rule, first-term Schröder - a Social Democrat - showed courage by backing far-reaching recommendations toward greater labor flexibility.

The proposals, put forward by an ideologically balanced commission, promised to nearly halve Germany's growing unemployment - now 10 percent. To get there, Germany would have to reduce the amount and duration of unemployment benefits, remove barriers to part-time work, and prod single young people to move to where the jobs are.

But while second-term Schröder still talks about reform, his actions indicate wavering commitment. For instance, the government's labor proposal, which passed the lower house of parliament, grants new part-time jobs the same pay and benefits as full-time slots. So much for flexibility.

The chancellor, who pledged to reduce the tax burden on Germany when he first took office, has also just proposed new taxes on investments and real estate. He is also trying to increase required contributions that employers and their workers make to the national pension system.

The reason for these steps, he says, is to plug a growing government budget deficit - one that has now jumped the limit allowed under the agreement that set up the common European currency. But while tax increases may raise revenue, they discourage investment and consumer spending and are the wrong tool to use in a troubled economy. Germany's central bank agrees. So do German consumers, who have made a new pop song ridiculing the proposed tax hikes a No. 1 hit, and sent Schröder's ratings into a tailspin.

On a Europe-wide scale, the chancellor regrettably caved in to France on reform of the EU's generous agricultural subsidies. French President, Jacques Chirac, who fears the wrath of farmers as much as Schröder fears that of labor unions, persuaded him to reverse course on overhauling subsidies soon and instead keep them about the same until 2013.

Ironically, it is the EU single-currency policy that makes it tougher for Germany to fix its economy. It can't lower interest rates, nor devalue its currency. Such steps are now up to the European Central Bank.

That leaves no way around an honest reappraisal of its welfare state. That's been done successfully before: by Europe's welfare queen, Sweden, in the '90s and by Britain in the '80s. A decade ago, public spending amounted to nearly 70 percent of Sweden's GDP. Now it's down to just over 50 percent.

Still, it would be better for Schröder if he were not forced into reform but simply rediscovered his first-term self - and tapped into the Germany of the postwar era that was willing to sacrifice for the economic miracle. Two-thirds of Germans, for instance, believe the recommendations of the special labor commission tip the country in the right direction.

Even the leftist Greens, Schröder's coalition partner, seem open to structural change. In exchange for going along with the increase in pension contributions, it pushed for a commission to reexamine the welfare state. The commission leader has called for radical reform, including raising Germany's retirement age (the average is a low 60.5 years).

Inaction on the reform front could have broader implications. A cash-strapped Germany could, for instance, have trouble paying for peacekeeping or assisting Eastern Europe and Russia. Let's hope that, for the sake of German citizens and the rest of the world, Schröder takes his new commission's reform ideas more seriously than those of the last one.