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12/31/2010 11:21 AM

Germany's New Wirtschaftswunder

Does Euro Crisis Threaten Berlin's Economic Miracle?

By and

There seems to be a lot of unanimity in Germany about the country's economic prospects for 2011. But while a chorus of optimists in business and government circles make rosy predictions of continued growth, some worry that the euro crisis could put an end to Germany's post-crisis euphoria.

German President Christian Wulff and his wife Bettina recently threw a minor wrench into his country's economic upswing.

It was mid-December, and the presidential couple was touring the manufacturing facilities of Sick, a sensor producer in the small southwestern German city of Waldkirch. The honored guests had a hard time making their way past the assembly tables and conveyor belts and an even harder time holding a conversation with any of the workers. In this instance, the production halls loudspeakers were not to blame. Instead, the engineers and technicians simply had no time to chat. They were under a lot of pressure; they had orders to fill.

"Given the state of our order books, we simply can't stop the machinery," says company head Robert Bauer, adding that Wulff got a taste of "the actual situation on the ground." Indeed, Wulff may be president, but the customer is still king.

For Sick, the reality of the economic boom has been a 25 percent year-on-year increase in orders in 2010 as well as 200 new employees in its German plant. Indeed, in recent months, the demand for light barriers and sensor technology has risen so rapidly that there are now shortages in materials. "We're working at full capacity," Bauer says.

Not Just about Exports

Things aren't just buzzing in Waldkirch. Indeed, the economy is gaining steam all over Germany. The automotive industry has added additional, special shifts. The machine-building industry has made up for any drops in production resulting from the crisis. Even the trade and service sectors are hiring. There's no denying it: Germany has overcome the worst postwar recession in record time.

In 2010, Germany's economy grew by almost 4 percent, or faster than it had at any time in the last 20 years. Over 40 million Germans are currently working, more than ever before. There has also been a corresponding drop in unemployment, with the figure even dipping below the much-touted 3 million target a few months back. The success has even led some politicians to become somewhat overconfident. For example, Economics Minister Rainer Brüderle has proclaimed that: "We are on the expressway to full employment."

Whatever the case may be, the government, employers and labor unions are all certain about one thing: Unlike the booms in recent years, this one isn't solely based on exports. Indeed, even private consumption has noticeably picked up, and companies are increasing their investments.

Taken together, these last two factors basically determine domestic demand, which has shown clear signs of weakness in Germany for years. But those days appear to be over. A recent report on the economy from Germany's Federal Ministry of Economics and Technology states that, "The upswing has solidified and broadened."

Let the Good Times Roll

To get a view of just how unscathed German industry has emerged from the crisis, it's enough to take a look at the work floor of a factory in eastern Munich. Here, HAWE Hydraulik manufactures valves and pumps for tunnel-drilling machines and wind turbines. After orders nosedived two years ago, demand first picked up in Asia, before spreading all the way back to clients in Germany. "We are very happy with the growth we are seeing here, too," says Karl Haeusgen, the company's owner and CEO. "It's hard to believe, but the order level is already even higher than it was in our record year of 2008."

The company ended its short-time work program -- a special scheme in Germany that saw the federal government partially subsidizing wages and benefits in order to prevent mass layoffs during the crisis -- in March and is now even planning to start adding to its almost 1,800-strong workforce. In 2010, Haeusgen had 70 percent more orders on his books than he did the previous year. "That is massive," he says.

The revival hasn't been limited to increased demand for capital goods, either. Germans have also rediscovered the joy of consumption. Take, for example, the scene in the runup to Christmas in Dussmann, a massive book, music and video retailer that bills itself as the "cultural department store" just a block from Berlin's main downtown intersection. The place was at overcapacity, and the check-out lines stretched all the way to the front door. "Christmas sales were super," says Julia Claren, Dussman's business manager. Her euphoric mood was also shared by Stefan Genth, the head of the German Retail Federation (HDE). "The mood among retailers is better than it's been in a decade," Genth says. And even Karstadt, the massive department store chain, has emerged from hard times with newfound confidence. "We can tell very clearly that there has been a pickup in consumption," one Karstadt spokesman says.

And, if the predictions are correct, things will stay this way for a while. Economic experts predict that domestic demand will prop up the boom. In 2011, they add, consumption and investments will account for the largest share of growth, which will remain strong by German standards. The most recent predictions from Germany's economic-research institutes put the figure somewhere between 2.3 percent and 3.2 percent.

Even Germany's federal government can't avoid having to amend its cautious forecast of 1.8 percent growth for the coming year. The government's annual economic report, which is currently being prepared under the auspices of the Economics Ministry for publication in late January, includes a still-undetermined prediction of over 2.3 percent or 2.4 percent.

The Reasons Behind the Boom

These remarkable growth rates are proof of how Germany has overcome the crisis better than any other developed country. Indeed, while the United States, France and Great Britain continue to suffer from the aftereffects of the deep recession, it seems like nothing can slow down the German economy. For a long time now, Germany has been the engine of growth in the euro zone, and even the current turbulence surrounding the common currency has yet to have any really noticeable effect. What's more, several indicators of business sentiment -- ranging from the business climate index of the Munich-base Ifo Economic Research Institute to the barometer of sentiment in small and medium-sized German companies compiled by the KfW state development bank -- presage a continuation of the upswing and reflect expectations of rising incomes, profits, capacity utilization and consumption.

'Radiant Prospects'

The reasons for Germany's new economic miracle are many. The country is only now enjoying the fruit of its reform efforts over the past decade. Before the crisis hit, national finances had been half-way rehabilitated, and the federal government had been in the black. The country's Hartz reforms (the name is inspired by Peter Hartz, a former Volkswagen executive who advised Schröder on the original labor market and welfare reforms) in benefits for the long-term unemployed had injected some flexibility into the labor market. And since German salaries have hardly seen any increase in years, the competitiveness of German companies has increased.

Furthermore, Germany has also steered clear of undesirable developments seen in Anglo-Saxon countries and states on the edges of the euro zone. For example, it isn't paying the price of bursted real-estate bubbles, and it doesn't have to slim down a bloated finance sector. Experience has shown that both of these result in years of difficulty for the affected countries.

A Economics Ministry paper attributes the surprisingly quick development of the current upswing to "growth in the world economy (which) provided impetus to German exports and strengthened the buoyancy effect of the domestic economy." What's more, there has been a pickup in investments and consumer spending since the spring, which the Economics Ministry experts credit with "determining the pace of expansion along with sustained impetus from exports."

Germany's economy has also benefited from the low interest rates set by the European Central Bank (ECB). Still, considering developments in the German economy, the rates remain too low. If Germany's central bank were still responsible for setting the country's monetary policy, key interest rates would have been raised a long time ago. But, as things stand, the ECB set rates after weighing the average situation in the euro zone's 16 member countries, most of which are far from being able to boast about strong economic upswings.

"The situation is the mirror opposite of what it was 10 years back," says Joachim Scheide, a leading economist at the Kiel Institute for the World Economy (ifw). "At that time, while the countries surrounding the Mediterranean were booming, Germany was suffering from the effects of high interest rates. Today, it's the other way around."

The Optimists and Their 'Fat Years' Predictions

Economic researchers are unanimous in their belief that pursuing a policy of low interest rates will continue to fuel growth in the German economy. But the one thing they do not agree on is how things will develop going forward. The optimistic camp, led by Ifo chief Hans-Werner Sinn, predicts that the boom will be long-lasting. Indeed, Sinn has described Germany's economic situation as a "winter fairy tale" and says its economy has "radiant prospects." And Kiel Economics, a private research center and spin-off of the prestigious ifw, has auspiciously labeled what it believes to be the likeliest scenario as "the fat years."

Both of the institutes predict that the growth -- and all of its beneficial effects -- will last for some time. For example, they predict that matters will ease in the labor market. Indeed, Kiel Economics even goes so far as to predict that the number of unemployed in Germany will drop below the 2-million mark. That would translate into an unemployment rate of under 5 percent, the point that economics equate with full employment.

The institutes' economists are also expecting to see rapid improvements in government finances. As Kiel Economics sees it, by 2015, finance ministers at both the federal and state levels, as well as municipal financial departments, will be able to enjoy surpluses totaling over €80 billion ($105 billion). What's more, it believes they would actually have enough in surplus funds to both pay off their debts and lower taxes.

Today, it's already possible to see the positive effects that higher growth and employment are having on state coffers. For example, in 2010, German Finance Minister Wolfgang Schäuble will probably only generate less than €50 billion in new debts rather than the €80 billion initially forecasted.

Shortfalls at the federal, state and municipal levels will also be much lower in 2010 than had been previously estimated. Finance Ministry experts currently calculate that the deficit will run at around 3.5 percent of gross domestic product. Furthermore, they believe that the acceleration in growth will lift next year's deficit considerably below the 3 percent ceiling.

Euro Crisis Casts Shadow on Optimism

Still, there are also more pessimistic voices. For example, Gustav Adolf Horn, the head of the union-affiliated Macroeconomic Policy Institute (IMK), sees three potential sources of danger to continued economic growth. First, the global economy might once again weaken if emerging economies -- and China, in particular -- put the brakes on growth. Second, there is a potential danger coming from Germany's immediate neighbors, since many of their governments have managed to pass harsh auserity measures. And, finally, there is the yet-to-be-resolved euro crisis, which could potentially lead to a serious reversal. "For 2012," Horn warns, "you can't completely discount the possibility of an economic downturn or even a recession."

And Horn isn't alone. Scheide, the ifw expert, even believes that 2011 could witness a contraction if one of the euro-zone countries were to slide into insolvency. "That would have consequences even more painful that those from the Lehman bankruptcy," Scheide says. If that were to happen, Scheide predicts that 2011 economic growth in Germany would plummet to below 1 percent. And he puts the odds that this scenario will play out at 20 percent.

In her annual New Year's address, German Chancellor Angela Merkel, also struck reserved notes and avoided any traces of triumphalism, stating that "Europe is currently in the midst of a major test." The chancellor expressed her pleasure over the fact that the crisis appears to have been overcome and that there are once again increases in growth, employment and prosperity. But she is still a long way from declaring any golden age.

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