INSIDE OUT: With Schroder just muddling through and the political establishment in paralysis, the stagnant German economy will drag the eurozone down

INSIDE OUT: With Schroder just muddling through and the political establishment in paralysis, the stagnant German economy will drag the eurozone down - The outcome from the German general election this autumn was the worst possible - for Europe as well as

by ANDREW NEIL, publisher of The Business and The Scotsman
Last Updated: 31 Aug 2010

The outcome from the German general election this autumn was the worst possible - for Europe as well as Germany. A victory for the centre-right's Edmund Stoiber would have heralded some modest supply-side reforms, but nothing to reverse Germany's economic decline. The re-election of centre-left Gerhard Schroder by a convincing majority might have let him tackle the deep-seated economic problems he ignored in his first four years.

But Chancellor Schroder held on to power by the skin of his teeth - and needs the support of the left-wing Greens to stay in office. This will make him even less inclined to do anything radical, lest it rock his leaky boat. It is a recipe for rigor mortis in Europe's biggest economy.

The result has dashed hopes that Germany's problems will be confronted.

Before the election, the pro-Schroder Die Zeit newspaper called Germany a 'barricaded society ... which hinders almost any modernisation, strangles any movement'. Schroder's narrow re-election will only reinforce its resistance to change.

Germany is no longer the Wunderkind of Europe. The mighty country of the post-war economic miracle faces a future mired in economic stagnation and (thanks to Schroder's populist anti-US rhetoric) international irrelevance.

Germany's economy has been in the doldrums for more than a decade and its political elite, on the left and the right, have no idea how to breathe life into it. The IMF has yet again downgraded its economic growth prospects, this time to a mere 0.5% for this year and no more than 2% for next year.

Such anaemic growth will condemn Germany to yet more years of 4 million-plus unemployed. And Berlin will be unable to meet the 3% (of GDP) budget deficit limit it forced on the eurozone as the price for joining the single currency.

Germany feared that the profligacy of other eurozone members would undermine monetary stability. But sclerotic economic growth has made it the biggest culprit. The Schroder government pledged to balance its budget by 2004; but this year it has already soared past the 3% ceiling and will likely soon be over 4% of GDP. Brussels has been forced to delay the balanced budget target for Germany until 2006.

In this year's world competitiveness ratings, compiled by the Lausanne-based Institute for International Management Development, Germany ranked 47th out of 49 major countries in flexibility and adaptability; in terms of the business community's trust in any German government's capacity to adapt to economic developments, it was 46th.

Germany has become the most costly country in the world in which to do business. The social-insurance costs of its all-encompassing welfare state make it prohibitively expensive to hire people, and its union-designed labour laws make it well-nigh impossible to sack them - a deadly combination and the cause of the 10% jobless rate. Yet when it comes to doing anything about it, the political establishment is paralysed.

Even German firms no longer invest in Germany: they go to America and eastern Europe for cheaper, more adaptable labour and lower taxes. Schroder talked a lot during his first term about reforming all this, but little happened. Even less will happen in his second term: one Berlin commentator told me: Schroder's policy for the next four years will be to 'muddle through' in any way he can to keep his coalition in power.

This sad state of affairs will have consequences far beyond Germany's borders. The eurozone cannot prosper as long as its dominant economy is in decline, dragging everybody down with it. The IMF expects the eurozone to grow by less than 1% this year.

The advent of the euro was meant to prompt a series of supply-side reforms; it has not happened. 'There was a hope,' says Michael Deppler, the IMF's top euro-specialist, 'that the euro would foment reform. That has not been the case.'

That is true for France and Italy too, where even centre-right governments have backed away from introducing radical labour, tax and welfare reforms.

The single currency is proving a recipe for stagnation.

Germany's flat-lining economy could be boosted by a cut in interest rates.

But it no longer controls its own rates: that is the preserve of the European Central Bank, which has set them at least two percentage points higher than the German economy requires.

Why not cut taxes or increase public spending? - tested ways in which governments have escaped downturns. These are not options: the 3% budget ceiling of the eurozone's growth and stability pact stops governments from borrowing their way out of recession.

Germany's economic predicament is a headache for Tony Blair: the more Germany looks an economic basket case, the harder it is for him to convince the British people to vote to join the euro. We are more likely to conclude, as we look at the intractable, perhaps insoluble German problem, that we are better off as we are.

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