It was just the sort of photo-op German Chancellor Angela Merkel urgently needs. Peter Löscher, the CEO of electronics giant Siemens, was sitting on a throne-like chair in the governor's palace in the central Russian city of Yekaterinburg. Contracts were being handed to him in brown leather folders, and every time Löscher signed one of the documents with his malachite green pen, the chancellor clapped with delight. The procedure took place four times, and by the time the round of contract signing ended, Siemens had secured Russian orders worth about €4 billion ($5.2 billion).
The real purpose of Merkel's five-day visit to Russia and China last week was to hold political talks with the two countries' leaders, but the most important message of the trip was meant for the German people. Look, Merkel seemed to indicating to German citizens, German industry is in demand worldwide, even if the government at home is divided and lacking direction.
The German economy has indeed come roaring back to life this summer. Two years after the outbreak of the financial crisis, the auto industry is adding extra shifts once again. The machine building, electronics and chemical industries are all reporting a rapidly growing number of orders. Total unemployment is expected to drop below the 2.8 million mark this fall, the lowest level since 1991.
For the first time in decades, the former "sick man of Europe" is back to being an engine for economic growth. According to an internal government assessment, the country's gross domestic product increased by more than 1.5 percent in the second quarter of this year. In their last prognosis, completed in April, government officials had predicted only 0.9 percent GDP growth. Production in the manufacturing industry increased by 5 percent over the previous quarter. The government assessment also shows that exports grew by more than 9 percent in May.
'Number One in Europe'
If the trend continues, say the experts, the German economy will grow by well over 2 percent this year, or almost twice as much as in most neighboring countries. Economists are already proclaiming a second economic miracle, while a former French foreign minister is complaining that Germany is "number one in Europe" once again.
The unexpected comeback is the result of an unprecedented large-scale economic experiment. After last year's dramatic economic slump, Chancellor Merkel, after some initial hesitation, decided to support a bailout program modeled on the theories of British economist John Maynard Keynes. When the economy is in decline, the professor concluded based on the experiences of the Great Depression, the government must quickly counteract the trend with massive government spending programs.
In keeping with Keynes' theory, the former grand coalition government of the center-right Christian Democrats (CDU) and the center-left Social Democrats (SPD) launched an extensive package of stimulus and bailout measures, which included €480 billion for ailing banks, €115 billion for financially weakened companies and €80 billion for two programs to stimulate the domestic economy. As then-Finance Minister Peer Steinbrück said, the goal was to "fight fire with fire."
It did not proceed entirely without collateral damage. The government kept moribund banks alive and rescued companies that didn't need rescuing. It spent money to allow companies to scale back production and paid consumers premiums to destroy assets with intrinsic value. Streets were repaved only to be torn up again soon afterwards, and schools were renovated and later shut down.
Although a gigantic waste of money was put into motion, it did prove to be extremely beneficial during last year's historic economic slump. Government debt skyrocketed, but in return companies received new orders, consumers had more money to spend and banks, no longer fearing that their borrowers could soon go out of business, started lending again.
Kept the Economy Afloat
The government bailout programs reestablished the basic confidence in economic development that had been lost in the financial crisis. "Public spending, in the form of economic stimulus programs, kept the economy afloat," says economist Peter Bofinger, a member of the German Council of Economic Experts.
This is true, for example, of the scrapping premium -- a program similar to "cash for clunkers" in the US. The name alone suggests that it has little to do with conventional ideas of economic prudence. Under the program, consumers buying new cars received €2,500 for their old cars, which were then scrapped.
This was nothing but a government incentive to destroy billions in national wealth, and quite a few observers were surprised by the enthusiasm with which Germans took the government up on its offer. Hundreds of thousands of perfectly functional cars were taken out of circulation, while new car ownership grew by an impressive 23 percent.
The incentive program cost the government €5 billion, while primarily benefiting foreign makers of small cars. The biggest beneficiaries were companies like Dacia, Fiat, Suzuki and Kia. Opel, VW and Ford also profited from the scrapping premium program, while German luxury carmakers Audi, BMW, Mercedes-Benz and Porsche got nothing. "We are the only country," Daimler CEO Dieter Zetsche scoffed, "that has created a program worth billions to subsidize foreign industry."
Experts called it a "flash in the pan," while forgetting that even small sparks can be helpful in a severe crisis. The premium to encourage small car purchases did more than support the economy in the Asian and Eastern European countries where the cars were produced. It also helped Germany's substantial auto supplies industry to offset the sharp decline of the previous year with shipments to those foreign automakers benefiting directly from the scrapping premium. This helped companies survive that are now urgently needed by German automakers in the current recovery. Nevertheless, it was a success that came at the high cost of €5 billion in government bailout funds.
Only a Slight Increase in Unemployment
The second large-scale program that the government devised to assist companies, the so-called short-time working program, also helped bridge the economic slump. The legal framework for the program has existed in German social legislation for decades. When companies experience sharp declines in sales, they are permitted to reduce their employees' working hours, and the government offsets a portion of the costs. The goal is to avoid layoffs and retain employees until the recession is over.
In the most recent crisis, Berlin repeatedly enhanced the rule, thereby triggering an economic miracle that attracted worldwide attention. While the jobless count grew by seven million in the United States, Germany experienced only a slight increase. In return, however, the number of short-time workers rose sharply, until it reached a record 1.5 million last May.
Now that the economy is picking up steam once again, Germany industry already has a large reserve of well-trained employees at its disposal to handle the growth in orders, and at minimal cost. At Munich-based Siemens, for example, the number of short-time employees has declined from 19,000 last summer to 600 today. Human resources executive Walter Huber says that the situation has eased, and that the federal government deserves the credit: "The extension of short-time working benefits was the right decision at the right time."
The measure is expected to cost at least €6 billion this year alone. But even the Organization for Economic Cooperation and Development (OECD) believes that it is money well invested. According to an OECD report, the labor market in Germany "has survived the global economic crisis much more effectively than in most other member nations."
In addition to benefiting the labor market, the German economic stimulus program also boosted consumer spending. Short-time workers have more disposable income than the unemployed, and as a result, German consumers were hardly forced to cut back during the crisis.
Throwing Cash at the Populace
Foreign countries also benefited. US economists are still critical of Germany for saving money at the expense of its trading partners during the crisis. But precisely the opposite is true. Last year, Germany saw a significantly sharper decline in exports than imports. On balance, German imports boosted demand in the global economy by about €42 billion.
The two economic stimulus programs launched by the cabinet were partly responsible for the boost. They were designed to stimulate domestic demand, and as part of the program, the government spent more than €20 billion in additional funds for new construction and the renovation of existing buildings. Sidewalks and streets were paved, universities were renovated and windows were sealed.
The package was of truly Keynesian proportions. For the British economist, whether government spending programs provided practical benefits was secondary. He argued that the most important thing was to distribute as much money to the population as quickly as possible, even if it meant that the government "were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again."
Seen in this light, the most recent stimulus programs completely satisfied Keynes' requirements. Millions were spent on swimming pools that had seen declining numbers of visitors for years, or on schools that had to be closed soon afterwards, because there weren't enough children to fill the classrooms.
Questionable at Best
By law, recipients of public investments under the second economic stimulus program must be permanent. But according to a previously unpublished report by the German Federal Audit Office, this requirement is often not met. The auditors at the Bonn-based agency identified many measures for which long-term use is questionable at best.
For instance, they wonder whether it truly makes sense to spend €222,000 on the renovation of a cultural center in a neighborhood with only 300 residents. And they question whether it is reasonable to invest in firehouses in regions that have seen population decline for years.
In some cases, local governments are spending stimulus funds to fulfill costly wishes. A government-owned stud farm in the southwestern town of Marbach, which includes a breeding facility for Arabians, is being renovated to the tune of €7.5 million. Schöningen, a town in the northern state of Lower Saxony, has plans to build a €15 million interactive museum for old hunting weapons. The Hamburg zoo is using €7.5 million in government subsidies to build an Arctic Sea habitat that will initially house polar bears, common murres and other animals.
According to the Federal Audit Office report, in 9 percent of projects "the subsidization criteria were not adhered to" or "it was not possible to achieve the goals associated with them." The auditors are particularly troubled by the fact that the money from Berlin is being used to fund so many small projects. They report that about a third of all projects cost less than €50,000, and that about 2 percent come in at less than €5,000. Projects like a wall-mounted diaper table for a kindergarten, historical wall charts and the construction of a sandbox are not suited "to achieving the economic goals of the Future Investments Act," the Bonn auditors conclude. In addition, they argue, such "very small projects" are "consumptive in nature."
Perhaps they are right, but during the crisis, it was more important to provide companies with orders. No one is more aware of this than Jörg Meseck, who owns an engineering firm in the eastern state of Brandenburg. When the economy declined, Meseck lost about €13 million in orders. Just as he was contemplating having to let some of his employees go, he started receiving new orders funded by the government's second stimulus program.
'Pick Up the Pace'
Most of the projects Meseck accepted were small, including a school renovation and replacing the windows at a high school. But without the orders, he would hardly have been able to retain all of his employees.
Now the crisis is over and Meseck's business is going so well that he even plans to hire another engineer soon. He says that customers have been calling him for the last two months and saying: "Things are looking up for us, so you're going to have to pick up the pace."
The same story is now unfolding across the entire German economy, even in the long-ailing construction industry. To the surprise of many experts, private demand is growing again in the wake of the artificial boom triggered by the economic stimulus program. In the fourth quarter of 2009, the number of building permits issued for new multi-family dwellings was up by 25 percent over the previous year, and since then statisticians have seen a rise of 5.5 percent. If there had been no government stimulus programs, many companies would no longer be around to benefit from the current boom.
Companies that still ran into difficulties despite the measures could fall back on another government assistance program. The German Economic Fund kept €115 billion available for companies that could no longer qualify for loans from their banks because of the crisis.
The package designed to head off a feared credit crunch proved to be grotesquely oversized. By early July, about 15,000 applications had been approved for loans or loan guarantees, for a total value of just over €13 billion -- far less than expected.
Financial Boost from Berlin
Many businesses had exhausted their credit lines with banks. Often, they could only receive fresh funds by providing more collateral or by paying higher interest-rate premiums than before the crisis. Some companies were simply unable to meet these conditions, even when business was going relatively well again.
A subsidiary of Düsseldorf steelmaker Schmolz + Bickenbach needed about €500 million, most of which came from the federal government and the state of North Rhine-Westphalia. The money served "as the basis for the successful completion of a new financing framework by the end of 2010," says Marcel Imhof, the company's chief executive. The company received a loan for €200 million and loan guarantees worth €300 million. If the company had not received the funds, "the rug would have been pulled out from under us," says Imhof, referring to the banks with which his company normally does business.
ZF Friedrichshafen, an auto parts supplier based in southern Germany, also received €250 million from the Germany Fund. The company didn't need the money to stay afloat, but to keep its banks happy. ZF, which specializes in transmissions, set the money aside as a safety cushion, "in case the crisis had lasted longer," according to the company's official statement. ZF still hasn't actually used the financial boost from Berlin.
It's a completely different story in the northeastern state of Mecklenburg-Western Pomerania. Last year, shipyards in two coastal towns, the former People's Shipyard in Stralsund and the Peene Shipyard in Wolgast, which have since merged to formed P + S Werften, were hit with nine cancellations of orders for new ships worth a total of €300 million. The group slipped into the red and layoffs began.
The new shipyard was able to acquire new orders, but now it needed additional loans to pre-finance the labor. The banks hesitated, and the Germany Fund eventually approved a guarantee for a €326 million loan. "Without this assistance," says P + S Werften CEO Dieter Brammertz, the continued existence of the company "would certainly not have been possible to this extent, and presumably not at all."
Not as Positive
Cases like this lead many economists to conclude that the impact of the bailout programs on the real economy has generally been positive. A lot of money was wasted and many pointless projects were subsidized. Nevertheless, the government stimulus programs helped pull the economy out of the recession.
The verdict on the oldest of the crisis programs, the Soffin bank bailout fund, is not as positive. Only a few weeks after the Lehman bankruptcy, the German government, in what was an historically unprecedented move at the time, made €480 billion available to rescue the country's crisis-shaken banks.
Since then, the banks have received about €150 billion in guarantees and about €30 billion in capital assistance. Some banks went under and others were nationalized.
Today, conditions have somewhat returned to normal in the German money and credit markets. But the financial sector, unlike industry, is still a long way from recovery. On the contrary, a large share of the country's state-owned banks still lack a sustainable business model, and it remains to be seen whether government-supported lenders like Munich-based Hypo Real Estate can survive in the long term.
The unsolved problems of the German financial industry show that although the economic recovery is clearly visible, it is still far from certain. Banks around the world still have large numbers of toxic securities and treasury bonds from highly-indebted countries on their balance sheets. The bankruptcy of a major bank or an EU member state would be enough to trigger the next global downturn.
Besides, Germany, for better or for worse, is tied to the global economy. The fortunes of German industry are still dependent on the economic health of trading partners. If the United States were to plunge into another recession or if growth weakened significantly in China, Germany's recovery would end very quickly.
As such, Germany's greatest strength is also its biggest weakness. "We have a world-class industry," says Deutsche Bank chief economist Thomas Mayer, but adds that the key sectors of the domestic economy are "quite underdeveloped."
By Markus Dettmer, Dietmar Hawranek, Guido Kleinhubbert, Alexander Neubacher, Christian Reiermann, Friederike Schröter and Janko Tietz