The Recession Isn't the Only Burden That Germany Needs to Get Rid Of

For one thing, the hardship caused by the recession did not result in a leftward political lurch. Quite the contrary: Chancellor Angela Merkel finds herself shed of her Social Democratic colleagues, their place taken by the Free Democrats, giving her a more market-oriented coalition partner than she had during the boom years. This swing right has produced what can only be described as a conservative, supply-side variant of Keynesian policies. Ms. Merkel has finally been convinced that a deficit-producing stimulus package is needed—not an easy decision for the leader of an inflation-averse nation. Score one for Keynes.

But instead of concentrating on the huge spending programs that her American and British counterparts favor, she is pushing personal and corporate tax cuts of €24 billion ($35.8 billion) to get consumers spending and businesses investing, arguing that the tax cuts will generate growth and therefore the tax revenues to pay for them. Score one for supply siders.

All of this to the consternation of her Council of Economic Advisers. Even though inflation remains tame at around 1%, the so-called "council of wise men" (actually four men and one woman), is unhappy about unfunded tax cuts that will take the nation's budget deficit from this year's 3.0% of GDP to 5.1% in 2010, and close to that in 2011. Wolfgang Franz, council chairman, says "promises of tax cuts without solid financing … are not serious." Ms. Merkel frostily responded that her government "will do all we can to ensure that your bleak prognoses do not materialize." Not quite a Thatcher-style swing of the handbag, but close.

The willingness to run deficits is not the only major policy change. Ms. Merkel has decided that the German economy is excessively dependent on exports. With reason: When world trade collapsed with the onset of the financial crisis, Germany (along with export-oriented Japan), "experienced the most severe 'peak-to-trough' declines among the G-7 nations," according to Ruth Lea, of the Arbuthnot Banking Group. Because labor costs have been kept in check, and because German high-value, high-technology goods are—at least for now—immune from Chinese competition, exports are expected to increase close to 7% next year, despite a euro that is causing pain as it continues to rise against a sinking dollar. Still, the almost-15% drop in exports expected this year is seen as a warning that in the long run Germany must increase domestic consumption, which has remained at about 55% of GDP for almost two decades—compared with about 70% in the U.S.

No matter how much progress the government makes in inducing consumers to open their wallets, the German economy will remain heavily dependent on its manufacturing sector. Industrial output accounts for almost one-quarter of GDP, twice the portion manufacturing accounts for Britain's GDP. Which is what makes all forecasts for 2010 so difficult. Shortly in the new year, when the red ink on the income statements of family-owned manufacturing businesses comes to the attention of the nation's banks, the phrase credit crunch might take on new and more serious meaning as banks refuse to rollover outstanding loans.

German engineering firms don't like to lay off skilled workers, and regulations make it difficult for them to do so even if they want to. That's why major declines in production have produced only relatively minor decreases in unemployment. To a German plant owners' eye, skilled workers are an asset, to be cherished and husbanded. To a German banker under pressure to reduce his risk exposure, they are a cost, to be cut when business drops off. If the bankers prevail, the government will be under pressure to expand the €100 billion Deutschlandfonds that provides loans to companies unable to obtain credit through normal channels. That would take the deficit to levels that even the current government might find scary.

Never mind. Meanwhile, Germany's politicians can enjoy life in what BusinessWeek calls "Germany's hippest and most affordable big city." Perhaps because of its already-high unemployment rate of around 13%, Berlin's economy experienced a smaller drop than any German region during the recent downturn, and a higher rate of job creation. Berlin's Internet and media start-ups, its arts and fashion industries, just might grow enough to help Ms. Merkel achieve her goal of an economy less dependent on exports of machinery.