Hot spots: Germany.(International Section)

The economy is finally in an upswing that promises to be durable. Real gross domestic product contracted by 0.1% in 2005, after advances of just 0.2% in 2002 and 0.8% in 2001. In other words, it has been a long time since the Federal Republic has seen anything like adequate growth. This appears to be changing now, as the result lot 2003 suggests there was an expansion of 0.3%-0.4% in the fourth quarter. The upturn is not yet much to write home about to be sure. Investment fell sharply last year. Private consumption stayed weak and consumer confidence has remained fragile. The contribution to GDP from exports, traditionally the main engine of expansion, was evidently not sufficient to put the overall performance into positive territory. The outlook for sales abroad has brightened, though, and so has that for domestic demand.

Business conditions have picked up in a number of key markets for Germany, from North America to Southeast Asia and Japan. Since capital goods make up a large portion of Germany's export palette, it is a well-established pattern that--whenever international investment trends strengthen--German sales abroad do well. Domestically, demand will be perked up by the fact that tax relief for companies and employees totaling EUR 15 billion was brought forward from 2005. Another EUR 7 billion in tax cuts will follow. The top marginal income tax rate will drop to 45% next year and the starting rate will go down to 16%.

There is still the problem that the recovery, brief and frail as it has been to date, is jobless, meaning that it has yet to make a dent in the ranks of the idle. While unemployment declined to 10.4% of the labor force in December from 10.5% in November, this was due to special government programs and regulatory changes, not to any overall increase in payrolls. In fact, the number of people employed in Germany dropped by 392,000 in 2003, the steepest fall in a decade.

The labor scene will improve as 2004 progresses, but headway will not be quick. Moreover, the contraction in activity last year, by eroding tax revenues and bloating social welfare payments, helped push the Federal budget deficit out to 4.0% of GDP, after Germany had already in 2002 breached the EU Stability Pact's ceiling of 3.0% with a shortfall of 3.5%. The government predicts that economic growth will be between 1.5% and 2.0% this year, and on current trends this certainly looks like a reasonable forecast. Even so, Berlin is certain to violate Stability Pact prescriptions again this year--and Finance Minister Eichel is already saying that it will be a "difficult task" to get below the 3% ceiling in 2005.

This will lead to new criticism from Brussels. The European Commission has already taken the issue to court. More of a concern for the policy makers in Berlin is, though, the persistent exchange market rise of the euro against the dollar (and all the currencies that are linked to the greenback), which could put a heavy damper on the export-oriented part of the economy. The unit's steep rise has not been without benefits. For instance, it has helped to hold inflation down (inter alia, by making energy imports cheaper). To date, ...