Germany's Merkel faces increasing challenges

Forget the gloomy forecasts that Angela Merkel’s likely next coalition will deadlock or fall apart -- it might just provide the shot in the arm that Europe’s biggest economy needs.

Exploratory talks resume in Berlin on Tuesday amid public warnings from the smaller parties that policy differences remain so stark fresh elections may have to be called. That drew a rebuke from Merkel, who told her caucus that progress toward forming a fourth-term government doesn’t depend on the number of interviews given or threats issued.

Two weeks of talks have produced some accords in principle and many open questions as four parties jockey, snipe and feint over policy. Yet all emphasize their duty to keep working on the big projects like lowering taxes, chipping away at fossil fuels and promoting digital modernization -- if Merkel can weave their disparate demands into a coalition pact. She insists that she wants to and will work to make it happen.

“I don’t see why this isn’t a government that can really move things forward,” Jacob Kirkegaard, a Washington-based senior fellow with the Peterson Institute for International Economics, said in an interview.

Though Merkel is one of the most experienced negotiators in Europe, her chances of making this coalition work are less predictable than in the past because it’s never been tried at the national level. Success will mean each party -- Merkel’s Christian Democrats, her CSU Bavarian allies, the Free Democratic Party and the Greens -- having prevailed with a core policy demand that it can show to its voters.

There’s “considerable hope” that a multi-party coalition could produce “intelligent compromises” for Germany and more dynamism than under Merkel’s previous alliance with the Social Democrats, said Holger Schmieding, chief economist at Berenberg.

Merkel said she aims to identify whether there is enough common ground to begin formal coalition talks by Nov. 16. It’ll surely be a long night, she told her caucus on Monday, since nothing of importance she’s ever negotiated was over by dinner. Here’s a look at the possible outline of a deal, and what it would mean for Germany.

Merkel has signaled openness to French President Emmanuel Macron’s proposals to further integrate the European Union and euro area, creating a bloc better insulated against shocks. For their part, the Greens have expressed enthusiasm for Macron’s bid. The Free Democrats have been a lot chillier, raising the specter of a “transfer union” where beleaguered member states seek “money pots,” predominantly funded by Germany. Merkel may be the driving force in forging a compromise, according to Kirkegaard, who said a Franco-German-driven EU overhaul is part of her “personal political legacy.” One scenario could see compromise if the FDP wins a domestic political battle higher on their priority list, such as tax cuts.

Ending sales of new combustion-engine cars by 2030 was a Green campaign pledge opposed by other parties in the land of Daimler AG, Bayerische Motorenwerke AG and Volkswagen AG, and which the Greens have now backed away from. A less specific agreement for more government incentives to promote alternative drive systems -- electric, hydrogen or synthetic fuels -- might be a way around the conflict while spurring German automakers still reeling from the diesel-emissions scandal to compete with the likes of Tesla Inc. and Chinese companies. FDP Chairman Christian Lindner signaled as much, telling reporters Monday that leaning on technological innovation would make a “much bigger contribution” toward climate goals than a hasty phaseout of coal power.

One key may be to combine the Green party’s focus on environmental protection with free-market policies favored by the FDP, for instance by reducing fossil-fuel subsidies. While the Green party is alone in wanting to scrap coal-fired power plants by 2030, a broader general pledge, including a reform of energy taxes and a tightening of emissions standards for utilities over time, might unlock a deal. Merkel isn’t exactly a bystander: a one-time environment minister under Helmut Kohl, she has pledged to uphold domestic and international climate targets. “It’s a matter of wording,” said Claudia Kemfert, an economist at the DIW institute in Berlin. “Put it in market-based language, don’t talk about prohibitions".

All sides agree that the country badly needs a push for fiber-optic digital networks and better mobile data coverage in rural areas. If the FDP and Greens have their way, financing could come from selling government stakes in Deutsche Telekom AG and Deutsche Post AG. Merkel’s bloc is less enthusiastic. The Free Democrats could get a new government ministry to oversee digital advances in industry, health and education. “On the issue of the digital economy, it has less to do” with the multi-party coalition, Schmieding said. “It’s just overdue that more has to be done."

All sides agree on modest middle-class tax relief, even while maintaining Germany’s balanced budget. Merkel pledged during the campaign to lower income taxes by 15 billion euros ($17 billion). A Green call for higher taxes on the rich collides with the Christian Democrats’ perennial campaign pledge never to raise taxes. After focusing on balancing the budget during her previous term, Merkel could now shift a bit toward promoting consumer spending, something that Germany’s European partners regularly demand.

Germans are so concerned that schools and universities lag global competitors that a post-World War II taboo may fall. Under Germany’s federal system, central control and funding of education is banned. If the FDP and the Greens overcome legal concerns held by the CDU and its Bavarian CSU allies, the prohibition on aid for schools from Berlin could be lifted. There’s already a consensus to raise public spending on education, research and development to 10 percent of the economy by 2025 to help Germany close the gap in academic excellence.

Merkel has already accommodated her Bavarian allies with something close to a cap on migration, a response to electoral successes by the anti-immigration Alternative for Germany party. Europe’s refugee crisis may spur the parties toward a more comprehensive immigration law, a much bigger project that’s bedeviled many countries, including the U.S. Any deal would almost certainly maintain Germany’s liberal right to asylum, while possibly laying down rules to channel and restrict the influx of economic migrants.

Germany’s position on Turkey has become a hot-button issue among negotiators, with hardliners in Merkel’s bloc especially demanding an end to EU accession talks and a reassertion of the Christian Democrats’ official rejection of Turkey as a member state. The Greens prefer a softer approach. All parties, however, have resoundingly condemned the crackdown by President Recep Tayyip Erdogan’s government on democratic institutions and journalists. That could translate into a tougher line on Turkey, whatever compromise is found.

The bad news for Prime Minister Theresa May is that none of the four parties is likely to want to make things easier for the U.K. in Brexit negotiations. In fact, in their respective campaign platforms both the FDP and Greens welcomed the openness of Scottish and Northern Irish voters who rejected Brexit in last year’s referendum and offered them the prospect of staying in the EU. What’s more, it’s simply not a priority: Brexit has yet to be discussed in the coalition talks so far.