'Sick man' is picture of health The 'sick man of Europe' is now a picture of health (FT)

'Sick man' is picture of health The 'sick man of Europe' is now a picture of healthBy Bertrand Benoit

Published: December 11 2006 02:00 | Last updated: December 11 2006 02:00

Germany has the slowest growth of all 25 European Union member states. Our debt is higher than it has ever been before. Poverty is increasing at a dramatic pace. People fear for their pensions. And above all this hovers the devastating figure of 5m unemployed."

This was the sobering picture painted by Angela Merkel of Europe's largest economy in June last year, in a leaflet distributed by her Christian Democratic Union.

Since then, Ms Merkel has become Germany's chancellor, and the words already ring as though they had been plucked from a dusty history book.

When the Financial Times published its last special report on Germany, almost exactly a year ago, there were as many hints that the country's economy was turning the corner as there were doubts about the rebound's sustainability. A year on, even hardened sceptics agree, the "sick man of Europe" has become a picture of health.

After outpacing the US for most of this year, Germany's gross domestic product growth should reach 2.5 per cent this year, the fastest since 2000. Even the Organisation for Economic Co-operation and Development shed its long-held caution about Germany's prospects last month when it pronounced the recovery genuine and durable.

"Germany is experiencing a very strong rebound that will last well into 2008," said Jean-Philippe Cotis, the organisation's chief economist.

The latest instalment of the Munich-based Ifo Institute's business sentiment survey was the most sanguine in 15 years and there is now little doubt among experts that the economy will easily withstand next month's three-point value-added tax rise.

Despite the apocalyptic predictions being heard across Europe about the economic threat from China and India, the German Mittelstand, the small and mid-sized manufacturers that make up the backbone of the country's economy, have emerged as some of the biggest European winners from globalisation.

For the third year running, Germany is on course to be the world's largest exporter of goods this year, and its companies still generate the third highest number of patents every year.

The German disease of mass unemployment is also on the retreat. Companies have created about 500,000 jobs since January, bringing the unemployment rate below the 10 per cent mark in October for the first time in four years. Many businesses are struggling to fill their vacancies.

The rebound is reaching areas, such as construction, that have not seen signs of life in years. In the depressed former Communist east, Dresden, the capital of Saxony, is expecting growth of 3.5 per cent this year and its jobless rate has dropped below that of Cologne in the Rhineland.

Public finances, to take another item in Ms Merkel's bleak diagnosis, have improved beyond all expectations. Boosted by rising tax revenues, the government will this year bring the public sector deficit back in line with the EU's fiscal rules, one year ahead of schedule. Peer Steinbrück, finance minister, hopes to balance the budget by 2010. More surprising still, Germany's lavish social security system generated an €8.5bn profit in the first half of the year after a €7.1bn deficit a year earlier.

The vibrant economy is not the sole reason why Germany today seems a different country from a year ago. Ms Merkel's election ended 57 years of male political leadership. The first female chancellor is also the first from eastern Germany, the youngest in the history of the Federal Republic, and the first to head a "grand coalition" of Christian and Social Democrats since 1969.

Perhaps because she succeeded Gerhard Schröder, whose European and foreign policies, in particular his friendly rapport with Russia's Vladimir Putin, alienated long-standing allies, Ms Merkel was welcomed like a breath of fresh air on the international stage.

By mending Germany's frayed relationship with the US, adopting a cooler tone towards Moscow and a more constructive approach to Berlin's European partners, Ms Merkel has recouped some of the country's lost goodwill. She may have yet to alter the fundamentals of Mr Schröder's foreign policy, but in tone she is more reminiscent of the Atlanticist Helmut Kohl, her political mentor.

Ms Merkel will dominate the diplomatic stage again next year, when Germany takes up the six-month rotating presidency of the European Union and chairs the G8 group of industrial nations.

This uplifting "tour d'horizon" would be incomplete without a mention of football. When the world gathered in Germany last summer for the World Cup finals, many could not believe their eyes.

The welcoming fans, the good-natured patriotism of black-red-gold bikini tops and funny hats, the beach bars and street parties, all bathed in four weeks of bone-dry tropical weather, converged to smash the oldest and least flattering stereotypes about a country few would have considered a tourist destination. Even German commentators were taken aback.

This year has been a good one for Germany, better than any since the beginning of the decade. Yet there are patches of darkness on this idyllic tableau, and most lie in the political area.

Initially, it seemed the "grand coalition" would use its parliamentary majority to force through unpopular reforms. Ms Merkel's decision, within weeks of entering office, to raise the retirement age from 65 to 67 drew cheers from economists.

So did a long-anticipated reform of Germany's federal institutions. By trimming the powers of parliament's upper house, Ms Merkel promised to speed up lawmaking. Her actions also paved the way for the abolition, last month, of the country's notorious "shop-closing" law, giving it one of the most liberal shopping-hours legislations in Europe.

After this encouraging start, however, work ground to a virtual halt. Deeply at odds on core economic policy issues, the coalition partners have struggled to build on Mr Schröder's tough structural reforms. A draft overhaul of the healthcare system agreed after laborious negotiations over the summer was unanimously dismissed by experts as a typical example of sub-optimal compromise.

"This is not to say that there is a complete standstill on reform policies, but the momentum is disappointing," says Michael Heise, economist at Dresdner Bank. "With no major election and a strong tailwind from the economy, much more could be done."

The much-needed liberalisation of Germany's over-regulated labour, service, and product markets has been adjourned. Yielding to populist siren calls and a mounting anti-business mood, CDU and SPD have talked of increasing unemployment benefits and introducing a minimum wage.

Business is growing impatient at the coalition's cautious approach to reform - Ms Merkel describes it as taking "many little steps in the right direction". The government's decision to cut corporate tax from 38.7 to less than 30 per cent has met with widespread indifference because of an ancillary provision that would considerably expand the tax base.

A recent poll by the Allensbach research group showed 84 per cent of the country's top managers were disappointed in the chancellor.

Supporters of Ms Merkel argue that her convictions are unchanged but that it would be senseless to push for reforms that will never find favour with the SPD. For critics, however, she has become so absorbed in holding together her fractious alliance and keeping the peace between left-wingers and pro-market reformists in her party that she is neglecting to rule.

"Merkel has turned out the way I expected," says Gerd Langguth, a former CDU MP and Merkel biographer. "She has no Christian Democratic compass. She lacks decisiveness and a strong sense of political direction."

Among the public, morale is no better. A recent survey by the Forsa polling group showed 78 per cent of respondents were dissatisfied with the government. The flash of euphoria that greeted Ms Merkel's election has given way to "one of the worst moods pretty much since the second world war," says Manfred Güllner, head of Forsa.

In fact, support for Germany's two biggest parties has fallen so low that fresh elections today would almost certainly lead to a repeat of last year's draw, leaving neither in a position to form a government other than by allying with the other. "If CDU and SPD do not recover, we could even have another four years of 'grand coalition' after the 2009 election," says Mr Langguth.

One lesson of the German recovery, however, is that politics is only a factor, perhaps not the most decisive, in shaping a nation's economic fortunes. As Dirk Schumacher, economist at Goldman Sachs, puts it, "the very severe restructuring" of German companies, and their ensuing increase in competitiveness, did more than any structural reform to prime Germany's growth engine.

So while Ms Merkel may deserve less credit for Germany's recovery than her supporters claim, neither is she alone to blame for the popular discontent. The steady erosion in disposable income throughout a lean decade marked by mass lay-offs and stagnant wages is a more likely culprit.

With the restructuring now paying off and record profits translating into fresh job creation, both purchasing power and public mood could take a turn for the better next year. This is an optimistic scenario but one that would make Germany's renaissance finally complete.

Copyright The Financial Times Limited 2006