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Germany: Euro-Zone's Economic Giant Stumbling

If the European Union ever hopes to realize its long-term dream of becoming the world's leading economic area, Germany will have to turn itself around. The German economy is stagnant and looking at a third straight year of low or no growth. RFE/RL talks to experts about what is ailing Europe's largest economy and prospects the situation may improve.

Prague, 10 January 2003 (RFE/RL) -- When the U.S. economy began sputtering three years ago after a decade of growth, European Union officials boasted at the time that the EU would not be severely affected. The European economy, they said, was relatively self-contained and more or less immune to outside shocks.

Today, with hindsight, that pronouncement looks hopelessly naive. Not only did the EU quickly follow the U.S. into recession, but growth in Europe continues to lag behind the U.S.

Much of the blame can be placed on Germany, Europe's biggest national economy and arguably now its weakest.

Instead of taking the lead in Europe, Germany's economy -- heavily dependent on exports -- faltered badly. Growth in 2001 was 0.6 percent and last year was a barely perceptible 0.1 percent. Most economic institutes predict growth of less than 1 percent this year.

Stefan Schneider, an economist at Deutsche Bank in Frankfurt, said officials underestimated how strongly exposed Germany was to the world economy -- especially to the U.S. economy. He said this can be seen in Germany's dependence on trade and investment, and also in measures of consumer and business confidence. "When German entrepreneurs are asked to assess their overall [economic] situation, they -- at least with one eye -- look at what's going on in the U.S. and their sentiment adjusts accordingly. There are various links to how Germany is exposed to the international economy."

Daragh Maher, a Europe analyst for ING Financial Markets in London, added that the drop in the U.S. stock market that began in 2000 was felt strongly on the German stock market and had a follow-on effect on consumer and business confidence. "The German equity market was very highly correlated with the performance of the U.S. As the U.S. market slipped, so did Germany's, and that obviously had a detrimental impact on wealth, confidence, and spending within Germany."

Maher said other countries, like France and Britain, weathered the downturn better because consumers there continued to spend despite poor economic prospects. Germans, by contrast, tended to put more of their money into savings as a way of protecting themselves from what may be a prolonged downturn. "Germany has never had the legacy of the strong consumer, at least in the past five years, to support growth in the way the U.S. had. So [consumer spending] hasn't provided a buffer in the way it has in [countries like] the U.S. and France."

This past week brought more bad news. The German federal labor office said the number of people out of work rose by 200,000 in December to 10.1 percent of the workforce. The total number of unemployed workers reached 4.2 million last month, after rising above the politically sensitive 4 million mark in November.

Chancellor Gerhard Schroeder, in a campaign promise last year, said he would reduce the number of jobless to 3.5 million.

The European Commission in Brussels added insult to injury when it reprimanded the German government for allowing its budget deficit to exceed 3 percent of the size of the economy -- the target limit for government spending. Germany's deficit is estimated to be 3.8 percent of GDP for 2002. It has until May to tighten the budget or face possible sanctions.

The government will have a hard time reaching that target. Schroeder originally hoped to close the spending gap by raising taxes, but that strategy backfired when it angered public-sector workers. The government this week conceded to union demands to give some 3 million public-sector employees a 3 percent pay rise. The treasury will lose much of the tax gain to the higher wages.

German Interior Minister Otto Schily, who led the government side in the wage talks this week, played down the potential damage of the settlement to Germany's federal budget. "I believe that from the employers' point of view, this compromise is acceptable and this deal goes to the limits of what is affordable."

Discontent over the tax plan has sent Schroeder's approval ratings down to 30 percent -- despite winning re-election just last year. His Social Democratic Party (SPD) is now expected to fare poorly in two state elections scheduled for next month.

To be sure, Germany is not the only country experiencing serious economic problems. The slowdown in the U.S., the 11 September terrorist attacks, which prolonged the recession, and now prospects for war in Iraq are all out of Schroeder's control.

Yet analysts say the Germans themselves bear at least some responsibility for their plight. Maher said Germany failed to take advantage of the high-growth years of the 1990s to make structural changes, such as reducing the number of public-sector employees. It is now trying to make those changes during tougher economic times. "It didn't do enough during the relatively high-growth years [of the 1990s] to get public finances back into good shape. And therefore, in the current juncture, where growth has ebbed away, they haven't got the leeway in terms of fiscal policy or government spending to be able to stimulate the economy in the way they would like."

German labor law is also faulted for being too rigid, and relatively high payroll taxes make German labor some of the most expensive in the world. "The major area where reform has to start is the labor market. We have to get down the supplementary wage costs. We have to have to get more flexibility in the pay agreements, especially in terms of the pay differential between the highly qualified and the not-so-qualified. And we have to reduce some of the very generous labor-protection laws," Deutsche Bank economist Schneider said.

Schneider said it won't be easy. The German population is aging and the number of younger people, presumably with energy and fresh ideas, is falling.

Germany in the 1950s and '60s won the world's admiration for rebuilding its economy quickly from the ruins of World War II. The German term "Wirtschaftswunder" (economic miracle) entered the international lexicon. Germans -- and the rest of the European Union -- are now hoping a second miracle is in the offing.

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    Mark Baker

    Mark Baker is a freelance journalist and travel writer based in Prague. He has written guidebooks and articles for Lonely Planet, Frommer’s, and Fodor’s, and his articles have also appeared in National Geographic Traveler and The Wall Street Journal, among other publications.