Economic engine back in gear

German recovery:The stoically stubborn German consumer is the single cloud on the recovery horizon, writes Derek Scally

Taoiseach Bertie Ahern kept a straight face in Berlin in October, but inside he must have been grinning.

After flying in for talks over dinner with chancellor Angela Merkel, she treated her guest to a little pre-dinner flattery by telling the press pack how she hoped Germany would soon be enjoying Irish-style economic growth.

A decade after drafting the Stability Pact to force fiscal discipline in Ireland, Germany was the country driven to record levels of borrowing by an economic slowdown and the soaring cost of financing dole payments for a record five million unemployed.

But as 2006 draws to a close, it appears the Germany economic engine is finally back in gear after years of simply ticking over.

Growth this year is set to top 2.5 per cent, according to most forecasts - the highest level in six years - with another 2.1 per cent likely in 2007. Unemployment will fall below 10 per cent next year, new borrowing has reached its lowest levels since German unification in 1990 and the IFO index of business outlook has hit a 15-year high. Germany continues to export more goods and services than any other country in the world and is expected to top $1 trillion in 2006 for the first time.

Even Germany's seemingly cursed construction sector, in crisis for over a decade, turned a corner in 2006. "No one predicted the average 3 or 4 per cent profit growth we're going to reach," said Heiko Stiepelmann of Germany's Construction Industry Federation.

After years of preaching a message of doom and gloom, Germany's chorus of Cassandras are now singing a different tune. "We believe that the economic recovery is robust and will certainly continue through the next year - possibly to the end of the decade," said Hans-Werner Sinn, head of the IFO institute, who two years ago wrote the bleak book Can Germany be Saved?

One reason for the recovery is that economic and social reforms of the Schröder government to cut welfare and subsidies have finally begun to kick in. "By German standards, reforms like limiting unemployment benefit to 12 months are a sensational leap," said Alfred Boss of the Institute for World Economy in Kiel.

Of all economic institutes, it gave the most pessimistic growth forecast for 2006 of just over 1 per cent and had the unusual honour earlier this month of admitting it had missed another reason for the recovery. "What many of us overlooked is the extreme wage restraint of the last three years," said Dr Boss. "It looks like businesses are reacting by finally creating more jobs."

While Germans obsessed about cost problems and agreed moderate pay deals over the last years, salaries continued to rise elsewhere. "Salary levels are still high here but relatively modest wage agreements in the last three years means overall costs have fallen," said Gernot Nerb, the IFO's chief economist. "German companies have gained competitiveness because salaries in other countries have risen so much that they have come closer to the German level."

It is a similar logic that has spurred the German property market to record levels of sales - and record prices - in 2006. German property was traditionally viewed as expensive, but after a decade of static prices now seems good value compared to elsewhere.

Irish investors have piled into the market like never before this year, joining Danes, Israelis and Swedes in snapping up shopping centres and residential blocks from Essen to Hamburg and, above all, in Berlin. More than 70 per cent of property that changed hands in the German capital this year - worth €10 billion - was sold to foreign investors.

"Investors see huge potential for rental increases and corresponding yields," said Peter Starke, head of Berlin property company Aengevelt Property, to Die Welt newspaper. "The capital city bonus factor is important to foreign investors. Compared to German investors, they have a lot more optimism and imagination about the future."

In all the talk of the Aufschwung or economic recovery, there is one cloud on the horizon: the stoically stubborn German consumer.

Germans are traditionally averse to risk and credit: banks generally give only 80 per cent mortgages and just one in five Germans owns a credit card. Added to the recent wage restraint and unemployment fears is the fact that, according to federal statistics, average German disposal income is 2 per cent lower today than it was in 1991.

The year-end optimism in the German media about a recovery isn't yet shared by the wider public: some 48 per cent don't think they will benefit from the recovery in their pay packet, according to a survey by the infratest dimap polling agency.

At the same time, economists are warning unions and politicians not to lose the run of themselves in 2007 with pay demands and budget giveaways.

So, despite the first shimmer of a feel-good factor, the reflex reaction for many here is still to look on the gloomy side.