Economists hand Schroder prized Christmas present

Berlin's millennium eve bash - a spectacular light show with lasers stretching over six kilometres - has provoked a torrent of abuse from critics who complain that its aesthetic is uncomfortably reminiscent of Nazi spectacles in the 1930s.

But the argument is unlikely to dampen the high spirits of many in German business who are facing the new century in much better shape than they could have imagined even a year ago.

The signs of prosperity are unmistakable - packed restaurants, lengthy taxi queues, gleaming new cars and airport lounges full of families taking winter holidays. And although business leaders, like farmers, can usually be relied upon to complain about their lot, their grumbling has become ever more muted in recent months.

Just in time for Christmas, the Munich-based Ifo Institute published its most upbeat assessment to date of Germany's economic prospects in 2000, predicting that the economy would grow by 2.75 per cent. As recently as August, the institute was forecasting a growth rate of just 2.4 per cent for next year.

If Ifo's prophecies come true, unemployment will fall by 200,000 to 3.9 million, inflation will rise, but only slightly, Germany's budget deficit will reduce and the euro will strengthen.

It all looked so different a year ago, as the business community squealed with outrage at the former Finance Minister, Mr Oskar Lafontaine's threats to shift more of the burden of taxation onto the shoulders of the rich. Mr Lafontaine's public rows with the President of the European Central Bank (ECB) Mr Wim Duisenberg, threatened to destabilise the launch of the euro and the new centre-left government in Bonn looked increasingly in disarray.

To cap it all, German exporters were still reeling from the crises in South East Asia, Russia and Latin America - which hit them harder than most of their competitors.

Things began to improve in the spring, shortly after Mr Lafontaine's abrupt self-destruction, as exports picked up and a cut in interest rates gave manufacturers a welcome boost. The low value of the euro, although it has damaged the reputation of the new currency, provided exporters with a market advantage - particularly in Asia, Latin America and the ever-buoyant US.

Industry warmed to Germany's new Finance Minister, the fiscally-cautious, former Latin teacher, Mr Hans Eichel, who confounded most observers by pushing a massive package of public-spending cuts through parliament. Mr Eichel crowned a successful year by unveiling a five-year tax plan that will ease the burden on businesses and wage earners alike.

Under the proposals, the standard rate of corporation tax will sink from 40 per cent to 25 per cent in 2001 and the lowest rate of income tax (now 23.9 per cent) will fall first to 19.9 per cent and, by 2005, to 15 per cent. The top rate of income tax will fall from today's 53 per cent to 45 per cent within five years and a whole range of taxes on businesses will be cut or simplified.

Economists have long claimed that Germany's complicated tax system is, along with high labour and social welfare costs, a key cause of structural unemployment.

Chancellor Gerhard Schroder's government has promised to reform the social welfare system and, given the coalition's recently strengthened political position, there is every reason to believe he will keep his promise.

Although some analysts were alarmed by Mr Schroder's dramatic intervention to save the Holzmann construction firm in November, there is little prospect of a return to the left-wing economic policies favoured by Mr Lafontaine. None the less, the government's political priority is to reduce unemployment and all economic policy initiatives are likely to serve that goal.

Germany's labour costs may be less of a problem than they immediately appear. According to a recent report by the Institute for Economic Research in Berlin, Germany's reputation for high labour costs is based on a statistical distortion because most international comparative studies only look at labour costs per hour in manufacturing industry.

Germany certainly tops the tables for manufacturing labour costs but the study claims that, while blue-collar workers represent a relatively small (and diminishing) proportion of the workforce, most other workers enjoy similar, or smaller, earnings than their equivalents in the US.

The Ifo Institute's report predicts that the euro will become firmer in 2000, a development that may please Mr Duisenberg and his colleagues in the ECB but is unlikely to have much impact on the currency's reputation in Germany. Despite popular opposition to the loss of the deutschmark, the euro's weakness against the dollar has provoked little unease among the public.

Relations between the ECB and the German government took a dip towards the end of the year when Mr Duisenberg criticised the Holzmann intervention. As the German recovery gains momentum and Mr Schroder's political stature grows, Mr Duisenberg might be better advised to avoid such public clashes over policy - not least because the central banker's public image leaves much to be desired.

But if current economic trends continue, Mr Schroder is unlikely to pick fights with anyone. Instead, he will seek to keep a steady hand on the economic tiller and hope that recovery will soon spawn much-needed jobs - especially in the east of the country - and that he will reap the political harvest when he faces the voters again in three years time.