SCENESETTER FOR SECRETARY PAULSON'S VISIT TO BERLIN

C O N F I D E N T I A L SECTION 01 OF 03 BERLIN 003520 SIPDIS NOFORN SIPDIS TREASURY FOR SECRETARY PAULSON STATE DEPT. FOR EUR/AGS E.O. 12958: DECL: 12/15/2016 TAGS: ECON EFIN PREL GM SUBJECT: SCENESETTER FOR SECRETARY PAULSON'S VISIT TO BERLIN Classified By: DCM John Koening for reasons 1.4 (b) and (d) ¶1. (C/NF) SUMMARY. Your December 21 meetings in Berlin with Chancellor Angela Merkel and Finance Minister Peer Steinbrueck are an excellent opportunity to push economic reforms and boost German, European and global growth as Germany assumes the leadership of the G-8 and the EU. The Chancellor and Finance Minister plan to use Germany's G-8 focus on growth and responsibility to examine ways to strengthen the world economy and also to push for progress in Africa. As EU President, Germany plans to emphasize advancing the Lisbon Agenda to boost the EU's competitiveness and, in the second half of its Presidency, to re-start institutional reforms. At home, the German Government intends to encourage innovation, liberalize markets, boost financial sector transparency (particularly in relation to hedge funds),and further regulatory harmonization. Merkel and Steinbrueck will be interested in the results of your China trip, particularly your IPR discussions, as well as your thoughts on how IPR issues can be advanced in the G-8. You may also want to discuss potential sanctions against Iran and the need for Germany and the EU to keep cooperating with us to stop terrorists from misusing the international financial system. End Summary. THE CHANCELLOR, HER GRAND COALITION, AND GERMANY'S ECONOMIC CONDITIONS ¶2. (C/NF) Angela Merkel is among the strongest leaders in the EU (of a somewhat weak lot) and is bent on continuing to improve relations with the United States, wanting to keep working jointly with us on Iran and other key international problems. Her chancellorship has entered a more difficult phase in which the need for domestic economic and political restructuring and the approaching EU and G-8 leadership responsibilities are testing the cohesiveness of her grand coalition government and her effectiveness as a leader. ¶3. (C/NF) The government began to tackle its extensive domestic agenda in the spring, including a hike in the VAT, constitutional reforms to Germany's federal structures, passage of an EU-mandated anti-discrimination law, and reforms to Germany's health insurance policy. The key metrics have been unemployment levels and the size of the government deficit; the government has paid less attention to growth than we would like. Agreement at top levels in the Coalition parties on the 3 percentage point hike in the value added tax was relatively easy though a number among Merkel's Christian Democrats, as well as in the opposition Liberal (FDP) party and business groups questioned whether this was the best way to cut stubborn federal deficits. The reforms in the federal/state balance and the anti-discrimination law highlighted differences not only between the market-oriented CDU/CSU and the Social Democrats (SPD),but between Chancellor Merkel and the CDU Ministers President in several states. The health care reform proposal, with 113 changes to existing laws, was largely a product of political horse-trading and left no one satisfied. It drew complaints from Ministers-President and the business community, including pharmaceutical companies, as well as from doctors and labor unions. The Government approved a phased-in rise in the retirement age to 67 as a means to cut the deficits in pension programs, increase government revenues, and ameliorate demographic problems. The government is now working on plans to lower the corporate tax rate. ¶4. (C/NF) The business community complains the Coalition has not moved far or fast enough on structural reforms in the labor market, in improving education, and in undertaking other structural reforms -- many of which economists have called for from the late 1980's. Business leaders complain that the government fails to consult them and often note their companies may be doing well worldwide, but not necessarily at home. Meanwhile, the press snipes at every idea and highlights any politician's utterance suggesting differences among the coalition partners. The more pragmatic acknowledge that the structure of the Grand Coalition gives Merkel only limited room to maneuver on economic issues. ¶5. (C/NF) Despite the need for further reform, Germany's economy has enjoyed better than expected growth in 2006. BERLIN 00003520 002 OF 003 Rising investment in capital equipment coming on top of strong export earnings, and augmented by a slight rise in domestic consumption, are the chief factors. The country remains -- and is proud to be -- the world's largest exporter of goods. The government reports GDP will grow 2.5 percent this year, up from 1.0 percent in 2005. The German deficit is less than 3 percent of GDP, thus meeting the Maastricht criteria for the first time in 4 years. Unemployment is dropping. The number of unemployed has fallen in each of the last eight months and is about 4.0 million. Non-seasonally adjusted unemployment dropped to a four year low in November to 9.6 percent, finally below the psychologically important level of 10 percent. One result is that after years of restraint, German unions are calling for significant pay increases. Metal workers, for example, are initially demanding as much as a 8 percent raise. GERMANY'S EU AND G-8 PRIORITIES ¶6. (C/NF) Germany breaks down its 2007 G-8 Presidency into two pillars: world economy and Africa. The former includes innovation and intellectual property rights, global economic imbalances, investment conditions in developing countries, and climate change/energy efficiency. In addressing this last point, Merkel's preference is to focus on using technology to stem global warming as well as increase energy efficiency. It also provides a hook to examine global energy security issues. The Africa pillar focuses on partnering with African countries to develop conditions for growth and investment in the continent, with a particular emphasis on good governance. ¶7. (C/NF) Between January and the March 8-9 meeting of the European Council, Germany as EU President will focus on the Lisbon Agenda to increase European competitiveness and plans to present an EU action plan on energy. Increasing economic growth and creating new jobs through innovation and market liberalization are among the top priorities of the German Presidency. Merkel has said the EU must find ways to reduce bureaucracy and implement better regulation mechanisms, particularly for postal services and telecommunication. FINANCIAL SECTOR, REGULATION, AND INTELLECTUAL PROPERTY ¶8. (C/NF) Germany remains uncertain about innovations in the financial sector, a feeling that boiled over in 2005 when Franz Muentefering, then the Secretary General of the SPD and now the Vice Chancellor and Minister of Labor and Social Affairs, talked about hedge funds as "locusts." The rhetoric has cooled, but Merkel, others at top levels in her government, and some in German banks believe hedge funds need to be watched carefully. The Bundesbank echoed overall German skepticism about these firms by expressing its concern about the potential systemic risk posed by hedge funds to international financial markets. Government figures argue transparency is key to preventing instability in the global financial services industry and plan to place financial sector issues on the G-8 agenda. The Chancellor will push for transparency in hedge fund markets. Germany ranks among the few countries requiring extensive information from hedge funds while limiting their investment activities. ¶9. (C/NF) The U.S. and the EU are encouraging regulators to communicate and pursuing cooperation in an increasing number of sectors across a broad spectrum of policy approaches -- from informal information exchanges to structured sectoral dialogues to binding mutual recognition agreements. In recent years, the U.S. has dramatically expanded the scope of EU-U.S. regulatory cooperation activities to include horizontal as well as sectoral topics. The U.S. and EU have highlighted the importance of such cooperation through specific initiatives such as the Roadmap for EU-U.S. Regulatory Cooperation, which was agreed upon at the 2005 EU-U.S. Summit in Vienna. Germany has identified closer regulatory and standards cooperation as a topic for its transatlantic agenda during its EU presidency. Merkel has also publicly stated there is a need for better -- not more -- regulation in Germany and the EU. It may be useful to re-inforce her sense that the German Government and the EU Commission should learn to drop outdated or damaging regulations, not just to add new ones. BERLIN 00003520 003 OF 003 ¶10. (C/NF) Germany has become one of the EU's most outspoken members on protecting intellectual property, particularly concerning China. With an economy that relies heavily on exports and many high-tech small and medium-sized manufacturers, German business has pressed the government to take a more active role abroad in pushing governments to enforce IPR laws. Many German companies also are concerned with forced technology transfers that undercut their advantages in Chinese markets. Chancellor Merkel in her May visit to China was candid with Chinese government officials on the need to crackdown on IP violations. Germany has established exchanges between German and Chinese national patent agencies, which allow Chinese patent lawyers and experts to learn about EU and German patent regulations and how to enforcement them. The German government also helped establish a legal institution in China that focuses on intellectual property and patent law and helps to train judges to handle IPR cases. IRAN ¶11. (C/NF) Germany, along with its EU3 partners France and the United Kingdom, tried since 2004 to bring Iran's nuclear program fully under IAEA safeguards. Germany is engaged in the process of negotiating the UN Security Council resolution on Iran in New York and the German Government agrees with the need to impose sanctions on Iran for its defiance of the IAEA. Nevertheless, Germany faces internal opposition to sanctions. For instance, with German exports to Iran totaling 4.42 billion euros in 2005, many German firms have no enthusiasm for sanctions. Officials also point to Finance Ministry export credit guarantees, noting that the German government could face billions of euros worth of liability if UNSC sanctions prevent collection of debts from Iranian entities. German officials say that Germany would uphold any UNSC or EU sanctions on Iran, but at the same time worry that their input on the type or level of sanctions will be discounted in the end game, since Germany is not on the UNSC. German diplomacy, in part for these reasons, has aimed at achieving a consensus resolution among the P5 1 and accordingly Germany has tended toward a middle line between the U.S./UK and the China/Russia positions. TIMKEN JR