Hamish McRae: A worrying example for Europe

If the German model is failing, then maybe the post-war European social democratic way is also failing

So Gerhard Schröder took on Germany's economic problems - and lost. By calling for new elections in the autumn, after the Social Democrats' failure to retain their stronghold of North Rhine-Westphalia, he has, in effect, thrown in the towel.

So Gerhard Schröder took on Germany's economic problems - and lost. By calling for new elections in the autumn, after the Social Democrats' failure to retain their stronghold of North Rhine-Westphalia, he has, in effect, thrown in the towel.

The task will presumably pass to Angela Merkel, but with no more assurance that she will be able to force through reform than her predecessor. Too many of her compatriots cannot quite see why they should change things.

In a way, you have to agree with them. On one key measure, Germany is the most successful economy on the planet. It is great at producing the goods the rest of the world wants. Last year, it passed the US as the world's largest exporter. This year, this success story has continued, with exports rising at an annual rate of nearly 8 per cent in the first three months.

German companies are doing well, too. The markets reckon that profits of the large companies quoted on the Dax index will rise by 21 per cent this year, far faster than, for example, the equivalent UK companies.

On the other hand, the country struggles on with more than five million unemployed, more than 12 per cent of the working age population, and living standards have hardly risen for four years. Wages in many industries are falling in real terms, and workers are being asked to work longer hours or see their jobs go to the new EU members to the east. So Germany, for all its export success, is not bringing home the bacon for its people.

If this is miserable for the German people, it is alarming for continental Europe. There is the practical impact Germany has on its neighbours. Not only is Germany the largest EU economy and, therefore, the largest market for other eurozone countries; its problems are reflected in some measure in other large European countries, such as France, Italy and the Netherlands.

Arguably, Italy, now in recession, is in even deeper trouble than Germany, for Italian firms face stagnant demand at home without the compensation of booming demand for their exports.

But it is also alarming at another, broader, level. If the German economic model is failing to satisfy its people, then maybe the classic post-war continental European social democratic way of organising economic life is also failing. Germany runs the best example of a model that worked well for the half century after the War for much of Western Europe. Now it seems to have run out of puff.

You can argue that, to some extent, Germany may be a special case in that it has had to pay for the reconstruction of the former East Germany and that the all-German figures are distorted by this. For example, the West German unemployment level remains under 10 per cent, though not by much.

Nevertheless, Germany, like most of the large continental countries suffers a growth problem as well as an unemployment problem. And this leads to the wider issue: why is it that the eurozone economy seems unable to grow as fast as the British or American ones?

There is a fairly straightforward answer to that: that the eurozone in general and Germany in particular need to make the same sort of structural reforms that Britain and the US carried out over the previous two decades. As an Italian economics professor said to me a few weeks ago: "Why can't we simply look at what Margaret Thatcher did and then try and do it better?"

Why indeed? That is actually the path that Germany has been heading down in recent months, with the Hartz labour market reforms, named after the chairman of the commission that proposed them, Peter Hartz. These include such radical notions as the privatization of unemployment agencies. The trouble is that (a) such reforms are very unpopular, and (b) in the short term they are liable to make matters worse, or at least appear worse. One reason why the headline number of unemployed rose this spring to the highest level since 1933, was a reclassification under these reforms.

In any case, if governments get voted out when they try and push through such reforms, where is the political motivation for change? Better to try and muddle through. Even a new Merkel-led Christian Democrat government would find it hard to win solid support for unpleasant changes. It may well get into power, but would then find itself in exactly the same fix as Chancellor Schröder. For many people in Germany, life is not at all bad. The common conclusion is that things have to get worse before they can get better.

It is, if you like, the Edukators view of the world. That is a wonderful new German film, which you must see, about a group of young radicals who break into the plush houses of the Berlin rich and rearrange the furniture. Their aim is not to steal but to make the owners feel uncomfortable about their wealth. They end up, more or less by mistake, kidnapping a plutocrat, who turns out to be a former radical himself. Things head south from there on, in several senses.

One of the many points here is that a lot of Germans still feel it is enough to be comfortable: there is enough wealth around, provided it is shared more widely. It is hard not to have some sympathy with that. But if it prevails as the dominant eurozone view, then the region continues to grow at best at something between 1 and 2 per cent, not enough to do much about unemployment or set anything aside to cope with the needs of an ageing population.

Besides, such a vision does not hold much hope for Europe's skilled young, who bunk out. There are 400,000 European science and technology graduates working in the US and only about a third plan to come back. The UK benefits hugely from the exodus of European talent but it can hardly be good news for the Continent.

To this must be added a further concern. Something has clearly gone wrong with the German economy, but it may be that the reforms that are supposed to fix things, even if carried out, won't work. I don't think we fully understand what is going wrong with the continental European economy. Some bits are fine: Scandinavia is tremendously competitive. Spain has been doing well, though that may be largely catch-up.

The worry is, Germany might indeed punch through reforms, that German companies would continue to make wonderful exports, but growth would still stagnate and many of the best-educated young would still leave. If that is right, then Germany - and much of the Continent - has to think about what is wrong with their economic model. Is it personal tax rates? A lack of freedom for the young? Regulation? Is it a deeper problem of the education system? Maybe that is too alarmist. But that 400,000 figure would terrify me.