The German way forward

Ravi Kalia examines the future of Europe's largest economy

On the surface all is well. Angela Merkel's Christian Democrat Union (CDU) party returns to government with a neo-liberal partner. The German economy has started expanding. The International Monetary Fund predicts German GDP growth in 2010. But delve deeper and there are structural issues challenging the social market economy model of Germany. A fragile employment outlook, burgeoning national debt, a heavy dependence on exports and divergence in eurozone deficits suggest that the German economy may be blessed to 'live in interesting times', the first Chinese curse.

Ms Merkel has returned to government with a smaller share of the vote for her liberal conservative CDU party, but enough to form a coalition with Guido Westerwelle's liberal Free Democratic Party (FDP). Although coalition talks are still in progress, tax and labour market reforms to encourage employment and consumption can be expected. This would mean dismantling some of the social market tenets of the German model.

The German economy is heavily dependent on exports with a high savings rate and a relatively small domestic consumption. This is the main reason why the German economy has slumped over the past two years. President Obama openly criticised Germany, along with China, at the G20 for exporting too much and not consuming enough, leading to global imbalances. Motivation enough for reform?

There is resistance to abandoning the German model, best outlined by Ms Merkel's final pre-election speech: "It's all about the defence of our ideals when we talk about globally anchoring the principles of social market economy [...] Germany has a strong voice on the world stage."

The focus of her government has to be employment, where prospects have been bleak in the recession. Substantial government work subsidies have been keeping employment levels artificially high in some sectors. The recent state intervention in the sale of the car manufacturer Opel to the Canadian car parts firm Magna showed a readiness to pursue protectionist policies. The German government provided €4.5 billion to guarantee the deal. Magna's restructuring proposals are likely to result in fewer job losses (as a proportion of the workforce) in Germany than in other countries like Belgium, Spain and the UK.

German graduates do not face the same pressures as some of their international counterparts. The usual work route for graduates in Germany is highly structured as compared with, say, the UK and US. Streaming begins from the age of 8 or 9. From here the most able students go on to attend university, usually after a gap year, which lasts anywhere from 5 to 7 years and includes work experience. German students enjoy a freedom to transfer between subjects and universities, which is unheard of in the UK. More practical initiatives with extensive workplace training and apprenticeships are provided to other students.

As a result there is not the same pressure to secure graduate jobs as in other economies. Able students can demonstrate their value through experiences and specialisation in their chosen field, often networking and interning with an employer for at least a year in advance. The education and skill level of the population is often seen as the most important asset of Germany. Because of the size of economic contraction, graduates have been choosing to spend longer in university. Some opt to go travelling abroad. There is also anecdotal evidence of German graduates moving to central and eastern Europe to secure employment.

One third of Germany's economy is dependent on export of vehicles, high-end technology, machinery and industrial chemicals. With the bursting of the credit bubble and reduced consumption in the west, this might be seen as a problem. However, the country is geographically well positioned to facilitate the rebuilding of eastern and central Europe, as well as Russia. Due to its dominance in efficient production of high quality goods, this sector should be a secure engine for growth for some time. Until BRIC countries can develop and implement a scientific edge, Germany has the advantage.

If the government cuts taxes but continues its spending policies to stimulate the economy, it will have to increase the budget deficit. This would push its deficit to GDP ratio to 6 per cent, twice what was agreed in the Maastricht Treaty. However, the new administration would still be ahead of France, Spain, Ireland, Italy, Portugal, Greece, and of course the UK. With questions being asked about some countries' abilities to repay their debt, traditional tools such as currency devaluation by printing money are not available. The consequence is that fiscally stable countries such as Germany, Finland, Austria and the Netherlands are subsidising others. Eventually people will start making the case that Germany should leave the Eurozone.

If Germany can retain its skilled workforce and maintain fiscal discipline, it will be well positioned to benefit from the growth of its surrounding neighbours. It is in the interests of those neighbours that Germany's economy continues to grow. Otherwise we could see a hole in the middle of Europe that threatens to undo the European Union itself.

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