Hamish McRae: The first task of Angela Merkel must be to make the Germans less financially prudent

If Germany fails to speed itself up, that changes the prospects for the whole European economy
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For us in the UK, the election of Angela Merkel as Germany's first female Chancellor carries the inevitable resonance of Margaret Thatcher. But both the politics and the economics are very different. Germany has had a functioning government, in a way that the Callaghan government of the late 1970s was not; and the economic pressures on Germany are less extreme. Besides, Dr Merkel has no majority and has ceded one of the two ministries concerned with the economy to the Social Democrats.

Whether the Grand Coalition lasts, whether indeed Angela Merkel lasts, is of great interest to the political pundits but it has little direct interest to the rest of us. But the economics do matter. If German growth remains below 1 per cent, the entire continental economy cannot prosper. Germany is too big a part of it.

The basic point is very simple. What are the conditions that might increase Germany's prospective growth rate from around 1 per cent to, say, 2 per cent - and how might a government achieve them?

That may not sound an ambitious goal, for here we would be pretty depressed were the economy to grow at only 2 per cent. But for Germany, 2 per cent would be great. Were the country able to achieve it, it could contain its budget deficit, start to squeeze down its high unemployment rate and, with luck, allow a little over to increase living standards - something that has not happened for five years.

So, what are those conditions? The first thing to be clear about is that Germany is great at making things but not so good at developing services. The second is that export demand is fine but home demand is terrible.

Thus Germany wins the gold medal for visible exports: it has more than 10 per cent of the world export market of tangible things, more than any other country. But it only gets the bronze for invisible earnings, services and other receipts, with just over 7 per cent of the world market. (The UK, incidently, gets the silver for invisibles, with nearly 11 per cent of the world market, but is not in the medals at all for visible exports, with only a bit over 4 per cent.)

This export performance means that when world trade is growing strongly, as it has been recently, parts of the German economy do very well. German companies are also very profitable, though partly because they increasingly do their actual manufacturing outside Germany, mostly in Eastern Europe.

But you cannot live by exports alone, any more than you can rely on investment or government spending. Today's developed economies typically rely on home consumption for between about 60 and 70 per cent of total demand - with Germany towards the bottom end and the UK towards the top.

All this talk about the need for labour market reforms, structural reforms and the like is absolutely justified. But these are secondary objectives. They are only a means to an end. Or rather two ends: improving the service industries and boosting domestic consumption.

What can the new government do? The German system is different from ours not only in terms of its politics but also its economic administration. We have one economics ministry, the Treasury, which does the lot. In Germany there are two. There is a finance ministry that is responsible for the budget and hence has the disagreeable task of trying to get the deficit back below 3 per cent to comply with the Maastricht provisions. And there is an economics ministry that is responsible for all other economic functions. Angela Merkel's Christian Democrats will run this second ministry, while the Social Democrats will run finance.

You may think this a recipe for disaster, and that may be the case. But the problem is not so much the splitting of responsibility for policy - the Germans have run the system for years - but rather whether the government can sustain difficult decisions, given that the two ministries are being run by different parties.

On the first matter - improving the service industries - there are not many levers the government can pull. This is really something that only the private sector can do. The interesting question is why it has not done better already.

There are wonderful German success stories in services. For example the software house, SAP, is the only really serious European-based software creator - the only one than can give the Americans a run for their money. Deutsche Telekom, the equivalent to our BT, has become the only global telecommunications group that has a big foothold in both fixed-line and mobile telephony. The German Post Office, which has, unlike our own, been privatised, is one of the few global groups in logistics.

What is missing is the middle band of service industries and an innovative, driven financial services sector. I don't quite know why. It may be partly that manufacturing has sucked up too much good talent.

It may be partly the rigid German education system. I worry that the bright kids leave university too late. On average they are in the late 20s, whereas in the UK our best and brightest will have had five years in the job market. The bright, driven, young are not driving the economy, as they are here. If young Germans want to make money, they come to London or go to the United States. That seems to be partly a matter of taxation and salaries, but it is also a question of trust. We trust youth, not credentials.

All this is very hard to change because it is cultural.

There are practical things that the authorities can do to relieve companies of the onerous regulation that inhibits them from taking on more people. But a government cannot tell companies to trust the young or the young to go and start a business.

So the best thing that the new coalition can do is to try and create an atmosphere of greater economic freedom, by reducing unnecessary regulation, and see what bubbles up. But neither we, nor they, should expect early results.

As for boosting domestic demand, well, all the evidence is that human beings like spending money. The English-speaking world does this rather to excess. Given more confidence, and a few tweaks to the financial system to make it easier to borrow, there is no reason that the German-speaking peoples should not loosen up a bit too.

So the second task for the new government is to make Germans less responsible, at least financially. You would imagine that would be rather a fun job. Whether a somewhat plonking coalition can swing that one is another matter.

But make no mistake, if Germany fails to speed itself up, that changes the prospects for the whole European economy. Europe, or at least core Europe, remains a slow-growth zone for the foreseeable future.

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