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