Germany steers steadily back on economic course

It's springtime for Schroeder and Germany. A decade after reunification sent the national debt and unemployment soaring, Germany is finally getting its economic house in order.

Social Democratic Finance Minister, Mr Hans Eichel, has proven a steady hand on the purse-strings and two leading economic institutes have given Germany a clean bill of health.

The outlook for the economy in 2001 is better than it has been for years, according to the annual study by the International Monetary Fund (IMF).

The IMF said the economy will grow by 3.1 per cent in 2001. Germany's five "economic wise men" gave a more modest prediction, expecting growth of 2.8 per cent.

While that is still behind the euro-zone average, it is higher than predicted a year ago. Despite higher oil prices, inflation is expected to remain around 2 per cent.

The main impulse behind the recovery has been the boom in exports, expected to rise by 10 per cent next year, encouraged by strong world demand and the weak euro.

But economists agree on the factor that risks dragging down Germany's successful economic performance. "Structural reforms, particularly on the labour market, will be needed to achieve a long period of strong growth," says Ms Ulla Koch wasser of IBJ Research.

The five "economic wise men" agree, saying that rigid labour market policy remains the greatest threat to growth. The IMF says failure to address the problem "will push Germany towards a premature slowdown".

Chancellor Schroeder differs with the economists on labour policy. "In my view it is the task of the government to find an appropriate balance between the labour flexibility required by business and job security for employees," he said.

Chancellor Schroeder came to power saying his success in government should be judged by his success in cutting unemployment. The number of people employed in Germany this year rose by 600,000 to 38.54 million and predictions say it will further increase in 2001 to 38.92 million, bringing unemployment down to 8.5 per cent.

The new year will see the start of Germany's new tax regime. The top rate of income tax will fall in stages from 51 per cent to 42 per cent in 2005 while the bottom rate of tax will drop from 22.9 per cent to 15 per cent. Corporation tax will fall to 25 per cent from 40 per cent.

The new tax package will allow firms like Deutsche Bank and Allianz to sell their cross-holdings in each other without incurring capital gains tax. Analysts say they expect this change to raise Germany's international competitiveness, with the entire tax reform package adding about 0.25 percentage points to Germany's annual growth rate.

The new tax package is not cheap, however, with an estimated price tag of DM57 billion (€29 billion). But Germany's coffers are overflowing with the proceeds from the auction of third generation UMTS mobile phone licences and the sell-off of a 25 per cent stake in Deutsche Post.

One of the most important events on the economic landscape in 2001 will be the pension reform. The proposed reform to address Germany's ageing population will lower annual increases in pension payments and introduce private pension schemes with government back-up of DM20 billion.

Another interesting development may emerge from ongoing talks between the German and Russian governments about exchanging Russian debts of DM3 billion for equity in Russian state companies.

Chancellor Schroeder is pleased with the "good grades" from the influential German economists. He has promised to continue reducing debt to balance the budget by 2006. If things continue the way they have been going, it should be a smooth ride.