the US-German Economic Partnership
Thank you, Dr. Oetker, for your very kind introduction, and also for your years of support for stronger German-American relations.
I would also like to thank the co-sponsors of this event, the German Council on Foreign Relations and the American Council on Germany, especially my friends and former colleagues Garrick Utley, Bill Drozdiak, and – of course – Karen Furey.
My first interaction with these two Councils came over two decades ago at a very different time in German-American and transatlantic relations. A conference arranged jointly by these two groups during the Cold War might not have taken the time to discuss globalization in detail or to hear from the U.S. Treasury Department, because the emphasis during that period was understandably on the political and security dimensions of the relationship. Today, however, the economic and financial component is widely recognized as an essential element of the foundation of the relationship – indeed, some would say the component of the relationship that helped weather recent stormy relations on the political/military front. So it is important to look not just at where we are, but at what we can do to reinvigorate the German-American economic partnership.
When President George H.W. Bush called in Mainz in the spring of 1989 for Germany and the United States to be "Partners in Leadership," considerable attention was focused on the word leadership, a word that then and even now causes historical ripples in Germany, and not enough on partnership, which was and is the essence of our relationship and where we should focus our attention today.
Chancellor Merkel has already made history, as the first woman chancellor and the first from the East. But I believe that when we look back at her first visit to Washington as head of government, it will be seen as pivotal not because of personalities but because it launches a renewal of the German-American partnership. This is not to say our fundamental relationship was ever in doubt. But it has not fulfilled its full potential for creating benefits for our own countries and for the world.
The challenges and opportunities that face us include addressing global financial imbalances and fighting global poverty; safeguarding the environment; opening world trade; fighting the war on terror; rebuilding Iraq and Afghanistan; and addressing pressing issues in Iran, the Palestinian territories, and Lebanon. Such issues are in many ways as daunting as those confronting the world in 1989. Then the Cold War was ending at breathtaking speed, with little certainty as to what lay on the other side. Now democracy is again opening once-closed doors in some places while remaining blocked in others.
In Mainz in 1989, the first President Bush talked about "the vision, the concept of free peoples in North America and Europe working to protect their values." That vision had created NATO, helped defeat communism, and began to lay the foundation for the post-Cold War world. It is now time to renew that vision, based on the same values of democracy, collective security, and free markets to address the 21st Century's most pressing problems. The new Merkel government's coalition agreement identifies the German-U.S. partnership as a key instrument to "support peace, democracy and freedom in the world". Our task now is to convert these good intentions on both sides to effective policies and actions.
However, global engagement and leadership must be grounded on a strong economic base at home. That is true for both the United States and Germany. We in the United States strongly support the new government's focus on putting its economic house in order and do not consider a focus on domestic economic reform as being in conflict with cooperation on global issues. Quite the opposite. Reforms that lead to stronger, internally-generated growth in Germany will make it a stronger global player, including a stronger voice in the EU to push common interests and a more effective partner for the United States on issues of common concern. Likewise, maintaining strong rates of U.S. growth is what will allow us to continue to play our part in meeting global challenges while keeping our economic house in order, including significantly reducing our budget deficit over time.
Growth in Germany is important for other reasons as well. The German economy is the engine of Europe -- almost 30% of total output and the top export market for most of the rest of the EU. If Germany is not firing on all cylinders, then neither is the rest of Europe.
Together with increasing U.S. national savings and Asian currency flexibility, faster growth in Europe in turn is an essential prerequisite for redressing the problem of global financial imbalances. There has been considerable attention lately on the question of Asia, and especially China, moving toward market-determined exchange rates. This is the first vital step in the process. But Europe's role is equally important in the medium term. If the United States were to increase significantly its rate of national savings – in other words, reduce demand – in the absence of more domestic demand in Europe and Asia to take up the slack, the results for the world economy could be disruptive. We share a compelling common interest in growth and orderly adjustment in imbalances that requires us all to tackle our respective policy challenges.
For too long the German economy has been flying on only one engine – exports – while the domestic economy – investment and consumption – has been stalled. Exports have always been a catalyst for growth in Germany, and in the past have ignited a cycle whereby export revenues generate funds for investment, which in turn creates jobs and sparks consumption. But in the last few years we have all been waiting – and waiting – for the cycle to start. Analysts on both sides of the Atlantic began to speculate on whether past economic linkages were breaking down.
In the last few months, however, we have seen some hopeful signs that the virtuous cycle may finally be underway. Investment was up 7% in the most recent quarter, and business confidence is at its highest level since August 2000. Even consumption is showing signs of life with positive reports of holiday sales by retailers.
The investment numbers are particularly encouraging as they reflect a vote of confidence by German and foreign investors in Germany's investment climate. The entire international economic system is best served by policies that promote not only free trade and flexible exchange rates but also the free flow of capital across borders. Both Germany and the United States maintain and benefit from open investment regimes – just look at the current BASF bid for Engelhard or the Unicredito deal with Hypobank. But some of the rhetoric that came from Germany last year – talk of "swarms of locusts" – sent a negative signal. When Germany is trying to boost growth, it cannot afford to cut off the kind of investment that will make it stronger. Restrictions on private equity or implementing the EU Takeover Bids Directive by incorporating potentially discriminatory "reciprocity" provisions would do just that.
I find the attitude of the head of a German company recently sold to an overseas private equity group to be refreshing. He said: "We are flattered that so many private equity firms have shown interest in us. Locusts are drawn to green grass. We are clearly a juicy bite. We need their money for expansion." Germany's economy can do worse than being called "juicy."
I appreciate the tensions underlying an open investment policy. Although the United States has long advocated such a policy, recent controversy over CNOOC's proposed acquisition of Unocal has caused some to question our investment policy and how the U.S. government monitors acquisitions to protect national security interests. Given the increasing number of cross-border transactions, it is important for U.S. and international businesses that the U.S. government operate in a manner that facilitates an open investment policy that both promotes foreign direct investment in the United States and addresses national security concerns. Of course, some of the most difficult cases we face involve state-owned or -controlled companies that seek to invest or expand in the United States while restricting investment and expansion opportunities in their home markets. That is something many European countries, including Germany, need to realize, especially with regard to former state monopolies.
Another important signal to investors would be to modernize the current U.S.-German tax treaty relationship. A new agreement further reducing barriers to cross-border trade and investment, particularly with respect to cross-border dividends, would complement other investment-friendly policies. It will also ensure that investment is not diverted to other countries that have reached such a modernized agreement with the United States. We hope that we will be able to conclude such a new agreement in the reasonably near future.
And, as the new government moves forward on its economic agenda, we hope there will not be a repeat of the 2002 efforts to apply new taxes or revoke tax preferences on a retroactive basis. The predictability and reliability of taxation rules is an essential element in encouraging investors to continue to evaluate opportunities, especially in companies or sectors under stress.
The signs of renewed investment indicate a nascent upturn that is probably in part a delayed cyclical upturn. It is also likely to be the lagged effects of reforms made over the last few years. It shows that reforms matter and are essential to reverse the long slide in Germany's potential GDP, the determiner of growth over the medium term. German potential growth – another word for cyclically adjusted growth – fell from nearly 4% in the 80's to 1.25% according to the latest IMF calculation, and, without structural reform, it is forecast to fall further.
Obviously, this is not news to German policymakers who have been struggling with the politics of reform for several years. Most of the major parties now recognize that Germany needs more flexible labor and product markets, better higher education, and lower barriers to entrepreneurship and innovation if it is to regain its competitiveness in the modern, globalized economy. The "freedom agenda" laid out by Chancellor Merkel applies with equal force to economic reform.
Meanwhile, change is happening on the ground. Germany's superb export record is partially the result of firms and unions working together to maintain competitiveness through more flexible labor agreements that boost productivity. Unit labor costs have fallen faster than in other major European countries.
Germany needs to change its laws and regulatory structures to allow the reforms at the firm level to spread throughout the economy. The Government's agreed program makes concrete, if modest, steps in this direction, by reducing the tax burden on labor and labor market restrictions. More important, it is an important signal of the government's resolve to move forward. It makes clear that more reform is the solution not the problem.
An accelerated reform process in Germany would have repercussions throughout Europe. The Lisbon Agenda was designed to use peer pressure to motivate difficult but necessary reforms. What it has lacked, despite its well-grounded validation as a structural reform agenda, is real leadership by example. If Germany becomes that leader, the rest of the continent will follow.
In urging reform, I want to be clear that the United States is in no way trying to impose the U.S. economic model on Germany or any other country. Europe has plenty of successful economic growth stories, ranging from Ireland to the Nordic countries, that provide useful lessons for reform. The Nordic countries, in particular, have in recent years achieved relatively strong performance while maintaining their generous social safety net. Key factors seem to be sustainable fiscal policies, better incentives for labor participation and hiring, a better environment for technology development and entrepreneurship, and higher educational achievement.
Of course, much of the new government's economic program is focused on reducing the deficit, a priority for both of our administrations, made more urgent by the demographic imperative of aging populations. Germany invented the Stability and Growth Pact and must be the leader in reestablishing EU fiscal discipline. But fiscal tightening is coming just as a fragile recovery seems to be taking hold. Deficit reduction must be achieved in a way that does not undermine growth. In particular, potential negative effects of the VAT increase set to go into effect in 2007 must be mitigated.
Encouraging signs include the apparent strong base of public support for the new government's economic program and German investor confidence, which is at a two-year high. Other countries have been able to consolidate budgets and sustain robust economic growth because they had the confidence of the population that economic policy was on the right track and being implemented effectively. If this is to be the scenario for Germany, it must be clear that tax increases are being minimized and balanced with real expenditure cuts.
The U.S. experience highlights the importance of growth and public confidence to deficit reduction. Last year the federal deficit fell by about one-fourth, despite the costs of Hurricane Katrina, Iraq, and the war on terror. In fiscal year 2005, the deficit was 2.6 percent as a share of GDP – lower than the shares in 16 of the last 25 years and only slightly above the 2.3 percent average over the past 40 years.
This deficit reduction was spurred by an average growth rate of better than 4% in the third quarter and a strong increase in federal revenues. Federal revenues for fiscal year 2005 totaled $2.15 trillion – the highest level ever – and a 14.6% increase over fiscal year 2004. This is the largest year-over-year increase in more than 20 years. Further, this deficit reduction has occurred without any tax increases. In fact, President Bush's tax cuts in 2003 have played an important role in reviving the U.S. economy by lowering the cost of capital. Secretary Snow recently said that making these tax cuts permanent is "essential" to continuing a strong, positive trend in business investment and the U.S. economy overall.
Although revenues are up, the United States still has a federal budget deficit that is too large. President Bush has stated a goal of reducing our deficit by one-half, to below 2.3 percent of GDP by 2009, and Secretary Snow said earlier this week that further reducing the deficit is our top priority at the Treasury. To reach this goal, the U.S. government must implement tight spending restrictions. I was heavily involved in preparing the Treasury Department's budget for fiscal year 2007, and I can tell you that the President is committed to this goal of deficit reduction, even with the continued costs associated with Hurricane Katrina, fighting terrorism, and supporting democratic transition in Iraq. It is difficult work to cut spending, but cuts are necessary, and we will work with Congress to make it happen.
So both Germany and the United States will continue to place a significant priority on reducing deficits, stimulating growth, and increasing employment at home. In parallel, and not on a zero-sum, either-or basis, there are several areas of global interest where we can work together based on our shared values:
Democracy in Europe: The lure of the EU has been a powerful beacon for democracy and reform on Europe's periphery but there is much work yet to be done. Determining final status for Kosovo, sustaining the democratic gains from color revolutions in Ukraine and Georgia, and achieving change in Europe's last true dictatorship, Belarus, are all areas where the United States and Europe – with German leadership – must continue to coordinate closely. And economic progress and financial stability are key elements in the democracy equation.
WTO: As one of the world's largest exporters, Germany benefits enormously from free trade and globalization. As Chancellor Merkel said last evening, protectionism serves no one's interests. Germany has a particularly strong interest in leading EU trade policy, where protection of the farm sector seems to have eclipsed the broader interests of many EU members. The doorway to a successful round is agriculture and the key to that door is a more ambitious agriculture market access proposal from the EU. With a stronger German role, we can unlock the growth potential of trade liberalization.
We have also identified four particular priorities for strategic investments we need to consider in the Muslim and Arab worlds:
Afghanistan: As the President made clear to the Chancellor today, the United States is exceptionally grateful for the strong leadership role Germany has played both on security and in the reconstruction of Afghanistan, including hosting the landmark Bonn Conference in 2002. We are now at a critical stage in the history of Afghanistan. With the completion of the Bonn Process, even strong contributors like Germany need to redouble efforts to help ensure that Afghanistan's nascent democracy flourishes into a thriving nation and economy. The upcoming donors' conference in London at the end of this month provides an opportune moment for Germany to renew its leadership role on Afghan reconstruction. A strong German role, including through NATO, is key to enhancing domestic security and promoting economic development in Afghanistan. In that regard, I thought Chancellor Merkel's references last evening to NATO's centrality, even primacy, on both in- and out-of-area challenges were quite noteworthy.
Iraq: We look forward to cooperating with Germany as we engage with the new Iraqi authorities to help them realize their vision of a vibrant, market-based economy and to further develop democratic institutions. Iraq's leaders who emerge from December's historic elections warrant our strong support in their efforts to develop sound, credible institutions and construct the infrastructure necessary to ensure the realization of their enormous economic potential. While most of our discussion of Iraq in past years was defined by differences over "boots on the ground," discussion now must focus on the strategic significance to us and the region of success in Iraq. And that success, as in any democratic transition, must include economic progress. In that regard, not only the elections on December 15 but also the December 23 unanimous approval by the Board of the International Monetary Fund of a stand-by agreement for Iraq is a significant milestone.
Palestinian Authority: The EU continues to be a strong voice for reform in the Palestinian territories and a key player in support of the peace process. The United States looks forward to working closely with Germany in its capacity as a leader in the EU and as a bilateral actor in support of Palestinian economic revitalization. The United States and Germany share a vision of revitalized economic activity in the West Bank and Gaza, supported by strong and credible institutions.
Lebanon: Germany and other friends of Lebanon have a unique opportunity to support the efforts of the newly-elected government to implement economic and political reforms that will put Lebanon on the path toward stability and growth. International donor assistance to support these efforts should be provided in the context of a strong and credible reform program, ideally one supported by the IMF and the World Bank.
Stopping terrorist financing: Chancellor Merkel remarked last evening that fighting terrorism may be even more difficult than fighting the Cold War and that we need to consider how best to organize for that challenge. We at Treasury are engaged in that fight in many ways, notably trying to spur development in countries and regions that are fertile breeding grounds for extremists, but also by using all possible means to deny terrorists the resources to fund their evil enterprises. Germany and the United States are global leaders in the international financial system, both governmental and commercial. Both countries recognize the vital importance of a robust international financial system that can stimulate and sustain economic growth and technological development. Our countries must also be global leaders in protecting the international financial system from abuse by terrorist organizations and other criminal interests. We must continue to promote transparency across all financial sectors, and we must develop and apply financial authorities to identify, isolate, and impede terrorist and criminal threats to the international financial system. This requires national authorities with operational capabilities to attack the illicit financial support networks that enable terrorist organizations, WMD proliferation interests, transnational organized crime groups, and other threats to international peace and security. Perhaps most importantly, this requires national leadership and political will to develop and apply these authorities. Germany and the United States must work together as closely and diligently in protecting the international financial system as we do in promoting its ongoing development. And that includes our common efforts regarding Iran.
Today's meetings – both at the White House and here across Lafayette Park – will provide new impetus to the U.S.-German relationship, and it is incumbent on us to seize the opportunity of a new sense of partnership to achieve concrete results that benefit our people and the world. As Chancellor Merkel said last evening, those results will depend on more than several hours of discussion every few months, so we in the U.S. government have committed to a deeper, more direct, and sustained dialogue with Germany on our rich and varied agenda. In addition to our work together in the G-7, G-8, and, increasingly, G-20, a steady stream of American visitors will be in Berlin over the next few months, to begin to move forward on our common objectives, including economic and financial measures to enhance this most important transatlantic relationship. I look forward to being one of those visitors in the very near future. For now, thank you for your attention, and I would be pleased to field your questions.
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Diplomatic Mission to Germany
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Updated: April 2006