Why Germany has one of the strongest economies in the world.

One of the most important reasons, maybe the most important, why Angela Merkel will almost certainly remain Chancellor of Germany after the elections of 25 September is the strength of the German economy. Unemployment has halved since she took office in 2005, the country has not only managed better growth than most of the Eurozone since the financial crash but, almost alone in the developed world, is now running a budget surplus. Why risk a change?
Barring some extraordinary shift of public opinion over the next 10 days that record will take her through to her fourth term of office. If a leader has been in power for so long it is reasonable that success should be attributed to their leadership. But actually the building blocks of this run of relative success were in place when she took office, and have in the main to do with deeper strengths of Germany.

There are really three main elements to German success, elements that cannot be directly replicated, but which are relevant to the rest of us. Perhaps the most important were the labour reforms brought in at the beginning of 2003, under the previous centre-left Chancellor Gerhard Schröder. At that time German appeared to be the sick man of Europe, with unemployment well above the EU average, and sluggish economic growth. 

The changes, called the Hartz IV reforms after the chairman of the commission that devised them, the senior VW executive Peter Hartz, were introduced on a rolling basis, culminating in 2005. These cut unemployment benefits, but more important, they created a bargain: people were pushed to look actively for work to get their benefits. In addition were other changes were made to create a more flexible labour market: these included fixed-term contracts, temporary agency work and the so-called “mini-jobs” with few benefits.
For a couple of years unemployment continued to climb. It reached nearly 11 per cent in 2005, but by the time Angela Merkel was elected the tide had turned. Her Christian Democrats reaped the benefit of the unpopularity of the Social Democrats, who had brought in the reforms. It was a great lesson of the unfairness of politics, wonderfully expressed by Jean-Claude Junker:
“We all know what to do, we just don't know how to get re-elected after we've done it”.
There are two other elements to German success. One is the close relationship between education, and in particular technical training, and industry. It is too complex an issue to do justice to here, but the web of companies, middle-sized and huge, are not only very good at technical training themselves. They also work with nearby schools to preserve the flow of skilled young apprentices. In most of the rest of the world, people who build up companies want to take their profit and sell them off. In Germany, helped by the a special provision in inheritance taxation, they pass them on their children. That has enabled Germany to preserve its famed Mittelstand, the raft of middle-sized (though actually sometimes actually very big) manufacturing companies.

Angela Merkel eye-rolls at Vladimir Putin during conversation at G20 summit

The point here is this industrial structure has nothing to do with the stewardship of Chancellor Merkel. It existed long before. But she has supported it, rather than undermining it. For example last year her government managed to head off a court challenge to the favourable inheritance tax treatment of family companies, by reaching a compromise which preserves the loophole provided the family remains engaged in running the business.
The third element of her success also pre-dates her rise to power: fiscal rectitude. The government has long sought to balance its budget. Last year the surplus was the highest since 1990, since unification in fact. Germany’s constitution was changed in 2009 to require a balanced budget. From last year the federal government cannot run a structural deficit of more than 0.35 of GDP, and from 2020, the states will not be permitted to run any structural deficit at all.

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Why is this so important to German success? Well, views differ and there is a sizable camp that feels that this is all too rigid. Germany needs to invest more, particularly in infrastructure. But the culture behind fiscal orthodoxy has enabled German business to hold down its costs, and persuade the German workforce that restraint for them is the right policy. Here Angela Merkel is benefitting from social and economic attitudes that have been established since the 1950s. Germany has been outstanding at holding down its costs of production.
Until the euro was introduced German export success resulted in successive revaluations of the deutschemark. Germany adopted the euro at too high a rate, so for the early 2000s its costs were uncompetitive. That was a second reason, alongside a rigid labour market, for the high unemployment. But the country ground away, cutting costs and improving quality, and now is super-competitive again. But this time it does not have to revalue – indeed it cannot do so.
That gives the final twist to Germany’s success: the combination of financial discipline and membership of the Eurozone. It has meant that Germany has piled up huge surpluses, and those surpluses are unbalancing world trade. But for the moment the country is a great success story, and its Chancellor gets the credit for that – even if the success were not really of her making.