How long can Germany's commercial verve and political paralysis co-exist?

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The Independent Online
THE CONTRAST this week of two Germanys could hardly be more stark. No, not the contrast between east and west, which is still very evident, but rather that between the best German companies and the country's political self-confidence.

The glitter - and the sheer swagger - of the German motor industry has been on display this week at the Frankfurt motor show. Five years ago the big two German producers were both in some kind of difficulty: VWAudi was wrestling with high production costs and multiple platforms, while Daimler-Benz was about to replace its chief executive and sell off a series of non-core divisions that pulled down its overall performance. Only the much smaller BMW seemed self-confident and secure.

Now the big two are racing ahead, with VW launching a series of successful models and Daimler-Benz now having incorporated the US Chrysler into its operations and, of course, its name. Only BMW, struggling with Rover, is under threat. This strength carries through to the rest of German manufacturing, for the suppliers to the motor industry, like the car firms themselves, have also lifted their game dramatically over the past five years.

Contrast this with politics. Then Helmut Kohl's Christian Democrats retained their self-confidence and their sense of leadership. Now there is a new government, only a year old, but the political self-confidence is gone. The Chancellor, Gerhard Schroeder, is sniped at; the party is in the middle of a string of local elections at which it is doing very badly.

It lost its majority in the upper house after elections at the weekend. Further, the finance minister, the calm and sensible Hans Eichel, appointed after the resignation of the leftist Oskar Lafontaine, is struggling to get a new budget through parliament. Yesterday he was supported by the Chancellor, who signalled his willingness to co-operate with the opposition to cut the austerity measures through.

Governments being unpopular does not, of itself, matter. Failure to get through a series of fiscal reforms would, on a three to five-year viewpoint, be very serious. There are three key elements to the package. First there are tax cuts, particularly for business, but which also include cutting the top rate of income tax to 48.5 per cent. There would be some offsets to these cuts from higher fuel taxation, but the trend is clearly down.

Second, there are cuts in spending, designed to lead to a balanced budget in 2006. And finally there are pension cuts, intended to start a gradual curbing of pay-as-you-go state pensions, and the promotion of private- sector pensions.

The trouble with these fiscal plans is not so much that the SDP coalition might be unable to get them through the legislature - something will get through. The problem is more that even these reforms, which sound radical to German ears, are quite modest by European or North American standards. The deficit-reduction programme, for example, only delivers the goods if there is solid growth through the next six years, something that cannot be taken for granted.

There is a significant recovery taking place in German manufacturing, as you can see in the left-hand chart. But Germany has been lagging behind France in GDP growth, as the other graph shows, and next year will presumably face higher interest rates. So even if the present government's fiscal package goes through in more or less its present form, it may not be tight enough to deliver the debt-reduction profile that it is intended to do.

Mr Eichel has described the fiscal position in pretty stark terms, saying the situation was "ruinous", and pointing out that one-quarter of taxation went in repaying debt, but the overall size of German public sector debt is not out of line with that of most developed countries at a bit more than 60 per cent. Given Germany's ageing population and generous state- funded pensions the long-term outlook may indeed be ruinous, but the immediate position appears quite manageable.

Still, something will have to give, and the longer it takes for fiscal reforms to be put in place the more radical they will have to be. Meanwhile, anyone interested in Germany is faced with a puzzle, a puzzle highlighted by this week's conjunction of the Frankfurt motor show and the debate over the 2000 budget. How long can commercial verve and political paralysis (well, near-paralysis) continue to co-exist?

I don't think anyone can give more than an intuitive guess. My own guess would be that this situation can continue for quite a while - that there will have to be some discontinuity in Germany in the next five to 10 years for things to change.

The reason is that German commercial excellence will continue. More than this, it will spread from the widely-admired strength in manufacturing into strength in many services. Indeed, that is already happening. New software firms are bursting out, and capital is flooding into start-ups and small businesses. As anyone who visits the place regularly will have noticed, there is much more evidence of entrepreneurial activity than even 18 months ago.

If you have that, you can muddle through with a badly-designed tax system, excessive welfare payments, cumbersome regulations and all the structural overheads of the German system for quite a while. Gradually the place will become more shabby, but it won't happen quickly. Given the excellence of much of the private sector, decline will be slow. You can even patch a grave fiscal situation for quite a while by borrowing a bit more and trimming a little here and there, without having to accept radical reform. In that sense Germany is not in the situation of Japan. Japan too has excellent companies, but it has a larger tail of incompetent ones and is facing a fiscal chasm, not a slithery downhill slope.

But slithery slope it is. Maybe companies matter more than governments, in which case the muddling through can go on for a long time. After all, Britain, with much less competent companies and similarly weak government, muddled though for three decades after the Second World War before reality caught up. Meanwhile, admire the cars.