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Germany on the ropes of an American recession

THINK we've got problems - our economy overheating, the Labour fox cosying up to the private sector chickens, and the Tories writhing in private-public agonies? Take a look across the Channel.

No, not so much to France; there they are embracing the hated Anglo-Saxon way of market flexibility with a Gallic curse and shrug. But to Germany: like an ageing boxing champ going to fat, Germany's economy is tottering under the blows of its latest challenger, the US manufacturing recession. Unemployment, which six months ago had fallen to 8.9pc, has now been rising steadily and has reached 9.3pc.

Worse is to come; the Munich Ifo Institute's index of business confidence has fallen back to the Asian crisis lows and industrial production is falling rapidly. Forecasts for growth this year are being revised downwards to the 1pc to 1.5pc range, with gross domestic product possibly falling (outright recession) in the second half.

So what, you may say; is not Germany entitled to the odd recessionary bad luck? Of course it is; but the last decade's pattern of German growth has looked more like a chronic sickness. Since the end of the reunification boom of 1990-91 Germany has grown by an average of 1.5pc a year. There was a recession in 1992, and near-misses in 1996 and 1999; this one would therefore be the fourth such episode.

Unemployment, after falling back to 7.3pc in 1991, rose throughout the 1990s reaching a peak of 12.7pc in 1998 before its recent short-lived dip. Nor can one say of Germany that the unemployment overstates the true rate of "non-employment"; the reverse is true.

Germany's ratio of employment to non-juvenile population is 52.3pc against the US's 64.5pc and our own 59.1pc. Nor is high unemployment confined to East Germany; the rate is indeed a massive 19.5pc in the east but still 7pc in the west.

Yes, Germany is still a rich country, doubtless - if one can believe the figures of GDP per head - richer than ours. But that is not the point; the fact that quite a few things in Germany are going well is no consolation to the average citizen who wants to be assured they will get better and not worse; and high unemployment is a socially corrosive thing, as we well learnt in the 1980s.

As they see unemployment hitting bottom at 8.9pc, they wonder and despair. What on earth is going on? Has the champion just got a headache or is it more like chronic arthritis? Or both?

Germany's main problem is with its industrial structure. It is highly dependent on manufacturing for its international living. As a share of GDP it is 23pc; that means about half of its tradeable sector. The equivalent figures for the US are 16pc and a third.

Furthermore, within that manufacturing total, the vast bulk of German production is in "medium tech" consumer goods - cars, refrigerators and other consumer white goods - and in capital goods. These sectors are now under heavy challenge from emerging market producers with very low labour costs, especially in the Far East, largely managed by Japanese companies exiting from a Japan similarly challenged on cost.

Hence the strong parallels between Germany and Japan. Neither can make good money out of these products in the face of such new competition which in any case has also had chronic excess capacity since the 1997-98 Asian crisis. The world is awash with low-cost processed metal.

By contrast the US has not merely used its fabled flexibility to shift resources into traded services but it has also refused to prop up the dinosaurs and seen sharp changes within manufacturing towards high tech like aerospace, telecoms, pharmaceuticals and software.

This is Germany's key problem. But it has two further ones. The first is East Germany. This should have been a source of strength as an old developed economy acquired a dynamic emerging market component - a Hungary or a Poland.

But East Germany was smothered at the start by the decision to exchange Ostmarks for Deutschemarks at parity, probably eight times their true value; and then to yield to west German union demands that eastern wages be set at parity too. This double blow condemned the east to decline and mass unemployment, and the taxpayer to large and mainly wasted transfers running at around 4pc of West German GDP.

The second problem is the loss of the Bundesbank and the best independent currency in Europe. The Bundesbank today would be cutting interest rates sharply and pragmatically to contain the threat of German recession. That is something the European Central Bank cannot do - already it has upset the Spanish, the Dutch and other small countries where inflation is stronger and risks becoming entrenched.

Last time something like this happened was 1998 and then the Buba was still in charge; German interest rates were cut and the Deutschemark was allowed to drop. From January 1999 the European Central Bank was able to allow further huge euro devaluation to help Germany recover while interest rates were first lowered gently below 3pc and then gradually pushed up.

Today both further euro devaluation and rapid interest rate cuts would risk inflation in ECB eyes. Germany will just have to suffer - it has a monetary headache allied to chronic arthritis in its industrial and eastern limbs.

This means a weak and unstable euro, a poor market for our trade and still more bizarre EU-nifying initiatives like the savings withholding tax - traditional foreign adventures distracting attention from domestic ills.

So what's new? Europe will remain at the heart of UK policy - an ever-running sore.

Patrick Minford is professor of economics at Cardiff Business School  

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