1

IT IS NOT often that a single country dominates the �nal of Europe’sChampions League, but on May 25th more than 360m people around theworld watched Bayern Munich score in the 89th minute to beat BorussiaDortmund by two goals to one at London’s Wembley Stadium. The sym­bolism was powerful. For the �rst time in its 58­year history, the �nal ofEurope’s most important football contest was a wholly German a�air.

From the football pitch to politics to the economy, Germany has be­come Europe’s most powerfulcountry. Described by this news­paper as the sick man of Europein 1999, Germany now appears tohave the continent’s strongest aswell as its biggest economy. It ac­counts for a �fth of the EuropeanUnion’s output and a quarter ofits exports. From Volkswagen toSAP, Germany’s big companiesare world­renowned. Manysmaller German �rms are globalchampions in niche markets suchas tunnel­boring machines andindustrial cleaners.

Germany’s jobless rate, at5.4% (using standardised OECD

statistics), is less than half Eu­rope’s average. Youth unemploy­ment, a scourge throughoutmuch of the rest of the continent,is at a 20­year low in Germany.The country’s budget is balanced,government debt is falling andlong­term bond yields are thelowest in Europe. It is the largestcreditor country in the euro zone,and as chief paymaster it has the

biggest clout in determining the single currency’s future. The weakness of other heavyweights has added to Germany’s heft.

Britain, outside the euro and distracted by a domestic debate about its EU

membership, has lost in�uence. The Franco­German tandem at the coreof post­war European integration has become lopsided. Relations be­tween Berlin and Paris are unusually poor, with some French politiciansdecrying the �sel�sh intransigence� in the euro crisis of Germany’s chan­cellor, Angela Merkel. The economic gap between Germany and Franceis wider than it has ever been. France’s economy is stagnant, statist anduncompetitive and urgently needs reform.

As a result, power within Europe has shifted sharply towards Ber­lin. Mrs Merkel is widely seen as the continent’s most important politi­cian. In Beijing or Washington, DC, the question: �Where is Europe go­ing?� has become synonymous with: �What do the Germans want?�

Bureaucrats in Brussels talk ruefully about Berlin becoming the cap­ital of Europe. �When the German position changes on an issue, the ka­leidoscope shifts as other countries line up behind them,� says one o�­cial. �That’s unprecedented in the history of the EU.�

German predominance is not all­encompassing. In foreign a�airsand military matters, for instance, France and Britain still play a much

Europe’s reluctant hegemon

Germany, now the dominant country in Europe, needs to rethink

the way it sees itself and the world, says Zanny Minton Beddoes

A C K N O W L E D G M E N T S

CONTENT S

This special report bene�ted from

help and insights from many people,

not all of whom are mentioned in

the text. The author would like to

acknowledge in particular Katinka

Barysch, Michael Burda, Daniel

Cohn­Bendit, Ulrike Guérot, Manfred

Güllner, Daniel Hamilton, Klaus­

Peter Hansen, Claudia Kemfert,

Markus Kerber, Claus König, Hans­

Helmut König, Norma Köser­Voitz,

Alexander Graf Lambsdor�, Kurt

Lauk, Johannes Ludewig, Christo­

pher Mallaby, Frank Mattern, Boris

Palmer, Volker Perthes, Jean

Pisani­Ferry, Adam Posen, Alex

Privitera, Gary Smith, Gabor

Steingart, Constanze Stelzenmüller,

Stephen Szabo, Jan Techau, Murat

Topal, Beatrice Weder Di Mauro,

Shahin Vallée, Dieter Wemmer,

Guntram Wol� and Robert Zoellick.

A list of sources is at

Economist.com/specialreports

An audio interview with

the author is at

Economist.com/audiovideo/specialreports

3 Election brie�ngColours of the rainbow

4 Germany and EuropeThe Merkel plan

6 The economyDissecting the miracle

9 EnergyTilting at windmills

11 LabourErasmus generation

13 German leadershipOvercoming the demons

SPECIAL REPORT

GERMANY

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2 The Economist June 15th 2013

GERMANY

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bigger role. But across a large swathe of European policy, Ger­many has become much more than a �rst among equals. Andjudging by France’s weakness, Britain’s ambivalence and south­ern Europe’s debt problems, for the next few years Europe’s fu­ture will continue to be disproportionately �Made in Germany�.

Outside Germany this dominance has become the subjectof lively debate. The �German question��about the role of acountry too big for Europe and too small for the world, as HenryKissinger famously put it�is back on the agenda. Many fret thatGermany is becoming too bossy. Newspaper cartoons in south­ern Europe show Mrs Merkel with a Hitler moustache. SouthernEuropean politicians say Germany is sel�shly wielding its cloutto impose austerity policies that will wreck their part of Europein order to protect German taxpayers.

Others are worried that Germany is being too passive. Ra­dek Sikorski, Poland’s foreign minister, fears German inactionmore than German power. On this view, Germany does notwant, and cannot exercise, the leadership required of a predomi­

nant power. In the language of politicalscientists, it lacks the capacity to act as Eu­rope’s hegemon�a leading country thattakes responsibility for the stability of aninternational system as a whole, as Amer­ica does for the world. William Patersonof Aston University in Birmingham hascalled Germany a �reluctant hegemon�.

Within Germany this debate is al­most wholly absent. Germans are deeplyambivalent about their growing role inEurope, and generally uncomfortabletalking about leadership. The mere vo­cabulary is fraught with historical echoes.The German world for leader is Führer,the title adopted by Adolf Hitler. Mentionthe word �hegemon�, and German politi­cians �inch. Mrs Merkel recently de­scribed the concept as �totally foreign tome�. Strategic thinking is strikingly ab­sent anywhere in government. Joschka Fi­scher, a former foreign minister, lamentsthat: �Germans have never had a seriousconversation about the destiny of a re­united Germany in Europe.�

This is unlikely to change soon, so itis not easy to assess where a German­dominated Europe may be heading. Thisspecial report will try to provide some an­swers by looking at the forces that will af­fect German priorities.

The most obvious short­term in�u­ence is the general election due on Sep­tember 22nd. Mrs Merkel is widely ex­pected to win a third term as chancellor.She is personally popular and her party,the Christian Democratic Union (CDU),together with its Bavarian wing, theChristian Social Union (CSU), is far aheadin the polls (see box, next page). But it isnot strong enough to govern alone, andsupport for its current coalition partner,the Free Democratic Party (FDP), hasslumped. Mrs Merkel might end up go­verning in a grand coalition with themain opposition party, the Social Demo­cratic Party (SPD). And given Germany’s

complicated system of proportional representation, it is not in­conceivable that Mrs Merkel will be defeated by a coalition ofthe SPD and the Green party.

Election politics has plainly in�uenced Germany’s recentreactions to the euro crisis. The country’s tough stance on bank­rupt Cyprus, for instance, re�ected the need to neutralise objec­tions by opposition parties to bailing out a place that had grownfat on laundered Russian money. But whatever its outcome, theelection is unlikely to prompt a sudden shift in Germany’s policytowards the euro or the EU: German attitudes to Europe and toleadership run deeper than party politics.

Where the past is ever­present

The most important place to look for explanations is his­tory. The shadows of the past weigh on Germany more heavily,and in more complicated ways, than on any other big country.Those shadows can be divided into three broad groups.

First, Germany has no historical experience of successful

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D E N M A R K

A U S T R I A

SWITZERLAND

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S e a

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MECKLENBURG-WEST POMERANIA

BRANDENBURG

SAXONY-ANHALT

THURINGIA

SAXONY

C Z E C HR E P U B L I C

SCHLESWIG-HOLSTEIN

NORTH RHINE-WESTPHALIA

HESSE

SAARLAND

BADEN-WÜRTTEMBERG

RHINELAND- PALATINATE

BAVARIA

LOWER SAXONY

BREMEN

NE

TH

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LA

ND

S P

OL

AN

D

F R A N C E

HAMBURG

Former boundarybetween East and

West Germany

StuttgartTübingen

Karlsruhe

Frankfurt

Dortmund

Düsseldorf

Cologne

Munich

Hamburg

B a l t i c S e a

Berlin

G E R M A N Y

150 km

<15 20-2415-19 >25Manufacturing industry as % of GDP, 2012

GDP% change on previous year

6

4

2

0

2

4

6

+

–

2003 05 07 09 1104 06 08 10 12*

Budget balance% of GDP

15

10

5

0

5

+

–

2003 05 07 09 11 12*

Sources: European Commission; Eurostat; German national statistics; IMF *Estimate

Current-account balance% of GDP

10

5

0

5

10

+

–

2003 05 07 09 11 12*

Unemployment rate%

0

2

4

6

8

10

12

2003 05 07 09 11 12*

France

Germany Britain

United States

The Economist June 15th 2013 3

SPECIAL REPORTGERMANY

2 international leadership. For centuries the German­speakingpeople lived in a collection of small, semi­independent states.The country’s two attempts at projecting power since its uni�ca­tion in 1871, by imperial Germany under the Kaiser and by theThird Reich, were disastrous. Germany’s economic miracle afterthe second world war, the Wirtschaftswunder, happened when itwas divided in two and its old capital, Berlin, was occupied byforeign armies. The former West Germany was a semi­sovereignpolitical pygmy, protected by America’s military might and withbarely any foreign policy of its own. As a result, the country hasno machinery or tradition of strategic thinking, and most Ger­

mans are loth to see their government take the lead. Germany’spreferred self­image is as a bigger version of Switzerland: eco­nomically successful but politically modest.

Germany’s second inheritance from history is a deep­seat­ed, if inchoate, belief in European integration. After the secondworld war Europe o�ered West Germany a route to reconcilia­tion and redemption as well as prosperity. In the preamble to itsconstitution it is described as an �equal partner in a united Eu­rope�. In the decentralised domestic political structure imposedon Germany by the Allies, power is divided between local, stateand federal government. Germans are used to federalism.

LIKE MUCH OF Germany’s democratic ma­chinery, its voting system is designed toavoid past mistakes. A combination of pro­portional representation and �rst­past­the­post majority voting fosters stable coalitionsand discourages small fringe parties.

When Germans go to the polls onSeptember 22nd, they will elect the mem­bers of the Bundestag, or lower house ofParliament. Whichever coalition of partiescan muster a majority of members will formthe federal government. (Members of theBundesrat, the upper chamber, are dele­gates of Germany’s 16 states, or Länder).

Germans have two votes. One is for acandidate to represent the local electoraldistrict (of which there are 299), chosen bysimple plurality of votes. The second vote isfor a party. Any party receiving 5% or moreof the total is entitled to seats in the Bun­destag, whether any of its candidates havewon a district or not. If a party gets moreseats through direct election than its shareof the overall vote merits, it can keep someof these �overhang� seats. Thanks to arecent change in the electoral law, the otherparties then get �compensatory� seats torestore the balance among the parties.These provisions mean the precise number ofBundestag members will not be known untilafter the election, but it could reach 700.

Germany’s biggest party is the rulingconservative Christian Democratic Union(CDU), led by Angela Merkel, together withits sister party in Bavaria, the ChristianSocial Union (CSU). The overall group isknown as the CDU/CSU. The group’s supporthas risen in recent years and is currentlyaround 40% in opinion polls (see chart 1).The second­biggest is the centre­left SocialDemocratic Party (SPD), support for whichhas fallen in recent years and is now about27%. Its candidate for chancellor is PeerSteinbrück. Neither of these two parties isbig enough to win a majority of seats in the

Bundestag on its own. In the past one or theother of them has formed a coalition withone or more of the smaller parties, or withthe other big one. The CDU/CSU currentlygoverns in coalition with the liberal, free­market Free Democratic Party (FDP), butsupport for that has been slipping and itmight not reach the 5% needed to be repre­sented in the lower house.

The fourth party in the Bundestag isDie Linke (�The Left�), formed from the rumpof East Germany’s communist party andjoined by defectors from the SPD. In Ger­many’s most recent federal election in 2009Die Linke got 12% of the vote. The SPD hasruled it out as a coalition partner.

Germany’s �fth party, in terms of seatsin the current Bundestag, are the Greens.They started life as an environmental partyin the early 1980s and now form part ofcoalition governments in several of Ger­many’s Länder. Polls suggest they could winabout 14% of the vote.

Two other small parties have beenformed in recent years. The Piraten (�Pi­rates�), dedicated to internet freedom,caused a splash when it �rst appeared in

2006, but has lost momentum and now getsonly about 3% in polls. The newest start­upis Alternative für Deutschland (�Alternativefor Germany�, AfD), a Eurosceptic partyformed in April this year. The latest opinionpolls give it 3% of the vote, but it is gainingground and could reach the 5% threshold.Since its support seems to be drawn mainlyfrom CDU and FDP voters, that would make avictory for the left more likely.

All this leaves the post­election politi­cal line­up uncertain. If the FDP performswell enough, the chances are that Mrs Merkelwill continue in government with the present�Black­Yellow� coalition of the CDU/CSU withthe FDP. If both current coalition partners dopoorly, Mr Steinbrück may try to put togeth­er a centre­left �Red­Green� grouping of hisSPD with the Greens. If there is insu�cientsupport for that too, the two big parties mayjoin in a �Black­Red� grand coalition, as theydid in Mrs Merkel’s �rst term of o�ce. This iswidely seen as the most likely outcome. Lasttime the voters did not seem keen on it,punishing the SPD in the subsequent elec­tion. But this time the polls suggest someenthusiasm for the idea.

Colours of the rainbow

A guide to Germany’s federal elections

1No longer a two-horse race

Source: Forsa

Support for political parties, % polled

2000 01 02 03 04 05 06 07 08 09 10 11 12 130

10

20

30

40

50

60

CDU/CSU

SPD

Greens

FDP

ELECTION ELECTION ELECTION

1

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History’s third legacy is a craving for stability, not least be­cause Germans have not had much of it. The 68 years since theend of the second world war have been the longest continuousperiod of peace in their patch of Europe since the 16th century. Inthe past 100 years Germans have been through hyperin�ationand several periods of economic collapse. The national obses­sion with price stability has become a stereotype, but it is truenonetheless. A recent study showed that Germans are moreworried about in�ation than about contracting a life­threateningdisease such as cancer. They attach huge importance to rules andinstitutions that promote stability and keep politicians in check.A uniquely German branch of economics that emphasises rules,called Ordnungspolitik, sets the intellectual tone. Guardians ofstability, from the Constitutional Court to the central bank, wieldgreat in�uence.

The euro crisis is problematic for German politicians be­cause it brings these powerful historical forces�reluctance tolead, desire for European integration and fear of instability�intocon�ict. Germans are instinctively pro­European. According to arecent Pew poll, 60% of them have a favourable view of the EU,far more than in Britain, France or Spain. Germany has no bigEurosceptic political movement. (A recently formed party, Alter­native für Deutschland, does advocate a euro break­up, but sup­port for it is in the low single digits.) Another new poll suggeststhat almost seven out of ten Germans support the single curren­cy, and the share is rising rather than falling. The governmentmight therefore be expected to act boldly to secure the single cur­rency’s future. But German europhilia is balanced by fears of in­stability. Mrs Merkel’s handling of the crisis gets high marks athome because she is seen as having �protected� her countrymenfrom the mess elsewhere.

Count us out

Germany’s confused attitude is compounded by its reluc­tance to lead. German politicians in general, and Mrs Merkel inparticular, have pandered to Germans’ small­country mentalityand their belief that responsibility for �xing the euro lies else­where. The one country with the capacity to lay out a strategic vi­sion for the single currency’s future is unwilling to do so.

Many Germans will say that Mrs Merkel does have a visionfor Europe’s economic revival, which revolves around increasedcompetitiveness; and that Germany is capable of acting boldly.As an example, they might point to its Energiewende, a dramaticswitch to sustainable energy and a commitment to turning o� itsnuclear reactors by 2022.

This special report will argue that, in both cases, Germanleadership is wanting. On the euro, Germany’s competitivenessagenda is insu�cient, and based on a distorted reading of thecountry’s own history. And Germany’s energy policy is less anexample of bold leadership than of an ill­planned unilateralismthat illustrates the country’s deep reluctance to think strategical­ly about international challenges. But the report will also showthat for all its obsession with rules, Germany is capable of prag­matism when needed. It was Germany, along with France,which �rst �outed the EU’s Maastricht de�cit rules in 2003.

Even more important, Germany is changing fast. Its popula­tion is the oldest in Europe, and the number of people of work­ing age is about to shrink sharply. A widespread shortage ofworkers will drive Germany to welcome more immigrants andencourage women to spend more time on paid work, which willprofoundly a�ect its economy and its society. In time, it will alsohave a big impact on the way it conducts itself in the EuropeanUnion. The new Europe will be �Made in Germany� not only be­cause of the changes Germany wants others to adopt, but alsobecause it will need to remake itself. 7

ANGELA MERKEL DOES not often muse publicly about theEuropean project. A physicist by training, she prefers solv­

ing concrete problems to holding forth about abstract ideas. Asunny morning in late April this year was a rare exception. At anevent to mark the publication of a new book on her foreign poli­cy by Stefan Kornelius, a journalist at a German daily, the Süd­deutsche Zeitung, Mrs Merkel debated the future of Europe withDonald Tusk, Poland’s prime minister.

Mr Tusk began with soaring rhetoric. Europe, he said, wasabout freedom, about ensuring that the horrors of history wouldnever be repeated. Mrs Merkel concurred that freedom was anessential part of Europe’s values, but argued that on its own itwas not enough. The European project was to secure the conti­nent’s prosperity in the 21st century, when emerging economieswere rising fast. Having seen one system collapse in her lifetime,added the chancellor (who grew up in East Germany), she didnot want to go through it again.

If Mrs Merkel’s vision is pragmatic, so too is her plan for im­plementing it. It can be boiled down to three statistics, a fewcharts and some facts on an A4 sheet of paper. The three �guresare 7%, 25% and 50%. Mrs Merkel never tires of saying that Europehas 7% of the world’s population, 25% of its GDP and 50% of itssocial spending. If the region is to prosper in competition withemerging countries, it cannot continue to be so generous.

Mrs Merkel’s charts show various measures of competi­tiveness, an obsession of hers. She produces graphs of unit la­bour costs (see chart 2) at EU meetings in much the same waythat the late Margaret Thatcher used to pull passages from Fried­rich Hayek’s �Road to Serfdom� from her handbag.

The A4 sheet of paper maps the political route Europe musttake to become more competitive. In his book Mr Kornelius de­scribes how in 2011 Nikolaus Meyer­Landrut, the chancellor’spowerful adviser on Europe, plotted European policy along twoaxes�the bits that worked and those that didn’t, those wherepower was devolved to Brussels and where it remained with na­tional governments. He found that all the problems that had led

Germany and Europe

The Merkel plan

Germany’s vision for Europe is all about making the

continent more competitive

2Miracle workers

Source: OECD *Estimate

Unit labour costs, 2000=100

95

100

105

110

115

120

125

130

135

140

2000 01 02 03 04 05 06 07 08 09 10 11 12*

France

Germany

Italy

Spain

Britain

United States

to the euro crisis (such as lack of budget discipline and extrava­gant welfare states) had arisen in areas where control remainedat national level, so either these policies had to be federalised bycreating a European �superstate�, or Europe would have to ac­quire a parallel architecture of rules to bind nation states.

Mrs Merkel went for the second option. At Germany’s be­hest, the EU treaties were amended in March 2012 to introducenew �scal rules for euro members, known as the ��scal com­pact�. Among other things, this required all euro members toamend their constitutions to install a �debt brake�, as Germanydid in 2009, prohibiting them from running structural budgetde�cits. The chancellor wants to introduce more such rules toforce Europe’s economies to become more competitive.

Mrs Merkel is quite willing to change Europe’s treaties, aswas necessary for the �scal compact, but for the sake of greatercompetitiveness rather than for political integration in its ownright. Her instinct is that agreements between governments willbe more e�ective than federalism in achieving the changes Eu­rope needs. But unlike the French, who have always preferred aEurope steered by national governments, she wants such agree­ments to limit individual countries’ scope for discretion.

�Solidarity� (ie, German cash) doesplay a role, but mainly as a means of buy­ing time and encouraging reform. That isthe idea behind the existing euro rescuefunds, which lend money to cash­strapped governments in exchange forcommitments to cut their budget de�citsand pursue structural reforms. Germanyhas proposed �contracts� under whichcountries in southern Europe get help inexchange for speci�c reforms, say, to tackleyouth unemployment. In recent weeks ithas o�ered bilateral help. Germany’s statedevelopment bank, for instance, may help�nance Spanish �rms. But Mrs Merkel hasno truck with Keynesian de�cit spending,and her government stands �rm againstEurobonds or any other explicit mutuali­sation of debts. Though o�cially commit­ted to a banking union, it is sceptical of el­ements, such as common depositinsurance, that imply mutual guarantees.

This vision of Europe is quite di�er­ent from the emotional European fealtythat dominated much of post­war Ger­man politics, reaching its zenith with the

introduction of the euro itself. The chief aim of Helmut Kohl, thechancellor who presided over German uni�cation and the cre­ation of the single currency, had been to draw a line under Eu­rope’s fractured history politically, with economics playing amuch lesser role.

Mrs Merkel works hard on her European politics: no otherEU leader spends as much time cultivating relations with col­leagues across the continent. But her approach is practical ratherthan emotional. For instance, she wants Poland to join the eurobecause it is a successful, competitive economy and a usefulcounterweight to statist France. Her attitude is not as utilitarianas Britain’s, where the argument for European integration boilsdown to weighing up economic costs and bene�ts. But like Da­vid Cameron, Britain’s prime minister, Mrs Merkel is concernedmainly with winning in the global economic race, which is onereason why Germany wants to keep Britain in the EU.

Mrs Merkel’s pragmatic approach is often attributed to herbackground. As post­war Germany’s �rst chancellor hailingfrom the east, she is said to lack the attachment to the EU felt bywest Germans. There may be something to that. But an upset inSeptember’s elections will not send Germany on a radically dif­ferent European course, for the broad strokes of her economicanalysis are widely shared. And in truth few German politicians(except those in the European Parliament) put a high priority on apush for European federalism.

O�cially, all German parties, including Mrs Merkel’s CDU/

CSU, are still committed to greater political union. The �nanceminister, Wolfgang Schäuble, is a long­standing advocate of afederal Europe. The parties’ election manifestos all include feder­alist pledges, but they seem increasingly formulaic.

Do as we do

With the exception of the Alternative für Deutschland, thenew fringe party, all the parties agree that the euro must be pre­served, but that Germany’s liabilities within the club must belimited and uncompetitive economies need to be cajoled to­wards reform. If there are di�erences between the Merkel gov­ernment and other mainstream politicians, they are about thepace of moving towards a banking union and the balance be­

The chiefaim ofHelmutKohl hadbeen todraw a lineunderEurope’sfracturedhistory

Merkel lays down the law

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SPECIAL REPORTGERMANY

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tween �adjustment� in southern Europe and �solidarity� fromGermany and other creditors. The SPD and the Greens might beless hesitant than Mrs Merkel to create a common resolutionscheme for European banks. Peer Steinbrück, the SPD’s candi­date for chancellor, frets about the �dangerous spiral of auster­ity� and says Germany needs to spend more money on Europe,though he does not say how much or how.

If the crisis intensi�es, the SPD might be more willing toconsider a �debt redemption fund�. First proposed in 2011by theGerman Council of Economic Advisers, such a fund would re­duce borrowing costs in southern Europe by replacing all euro­zone government debts above 60% of GDP with new bonds car­rying a joint guarantee, along with strict rules to ensure this ex­cess debt would be paid o� over the next two decades. MrsMerkel’s government immediately shot down the idea, arguingthat it was too similar to Eurobonds and would create unlimitedGerman liabilities. The SPD and Greens sounded more positive,and the SPD says in its election manifesto that such a fundshould be considered. But with �nancial markets now calmer,thanks to the European Central Bank, no one talks about it much.

Whoever wins the election will face the same constraints:the German public is �rmly opposed to large cash transfers tosouthern Europe. Germany is hemmed in by its own rules. Inparticular, because of the constitutional debt brake more moneyspent on rescue funds necessarily means higher taxes or lessspending at home. Perhaps most important, the ConstitutionalCourt is strongly opposed to anything that might oblige Germantaxpayers to assume unlimited liability for other countries’debts. The red­robed judges in Karlsruhe have become assertiveprotectors of German sovereignty.

All mainstream German politicians share Mrs Merkel’sbroad strategy because they interpret recent German history inmuch the same way that she does. As they see it, the key to eco­nomic success is export prowess, achieved by keeping budgetstight and wages competitive. In short, the rest of Europe needs tobecome more like Germany. Some politicians have said this in somany words. Volker Kauder, a prominent CDU politician, causeda fuss when he said that �Europe now speaks German.� Othersare more subtle, pointing to the virtues of Germany’s �scal prob­ity, praising the country’s tough labour­market reforms and la­menting southern Europe’s lack of manufacturing clout.

A plan that does not add up

To Mrs Merkel and much of Germany’s elite, making Eu­rope more prosperous by promoting competitiveness is strategyenough. But putting all the onus on Europe’s debtors does notmake sense. The more that wages and prices in southern Europeare squeezed, the less people and businesses there will be able topay back their debts, including those owed to Germany. The eurozone will recover faster and more easily if Germany spendsmore at home. Otherwise it will have to provide corresponding­ly more �nancial help to keep the euro together.

Many German economists acknowledge these trade­o�s,but Germany’s euro policy is driven by lawyers and rules, noteconomists. German politicians tend not to think broadly aboutGermany’s role in the euro in relation to other countries, butonly about its own successful policies, which they insist othersmust adopt. That is quite di�erent from formulating a strategywhich can work for the region as a whole. Paradoxically, thecountry that abhors nationalism is oddly national in its focus.

But Germany’s recipe for economic success falls short evenin its own terms because it is based on a selective analysis of thecountry’s recent history. Germany has indeed become muchmore competitive over the past decade, but not solely because oftough reforms and tight budgets, as the next section will show. 7

THE NECKAR VALLEY, not far from Stuttgart, is the epitomeof provincial Germany. A string of picturesque towns with

quaint Swabian names�Tübingen (home to a famous universi­ty), Reutlingen, Nürtingen, Wendlingen, Metzingen�stretchalong the river, separated by orchards and family farms and�anked by the hills of the Swabian Alb. But the small­town idyllis deceptive. The Neckar valley is also home to scores of Ger­many’s small and medium­sized companies known as the Mit­telstand, a highly successful component of the global economy.

Storopack, tucked inconspicuously down a side street inMetzingen, is a world leader in protective packaging. The �rm isfamily­owned�the current patriarch still lives next door�butthoroughly global, with 52 factories in 13 countries. The �rst Chi­nese facility opened in 2000. Now there are ten.

Rösch, a third­generation family textile �rm in Tübingenknown for upmarket nightwear, has also become one of Eu­rope’s biggest makers of specialist fabrics for the car industry. Itsunassuming buildings, down a small road by the river, contain

The economy

Dissecting the miracle

The ingredients of German economic success are more

complex than they seem

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vast computer­aided processing and dyeing machines that pro­duce the synthetic materials for lining car roofs.

These small­town champions, along with industrial giantssuch as Siemens, Bosch and BMW, help to maintain Germany’smanufacturing and export prowess. Manufacturing’s share ofGDP in Germany is bigger than in other rich countries and Ger­man exports, particularly to fast­growing emerging economies,are stronger. Half of Germany’s growth over the past decade hascome from exports. The external surplus, at ¤188 billion ($243 bil­lion), or 7% of GDP, is the world’s biggest in absolute terms, oneof the biggest relative to the size of the economy, and rising.

The working parts

In German eyes, strong exports and a big trade surplus aresymbols of economic virility. But foreigners are more impressedwith Germany’s recent employment record. A decade ago Ger­many had one of the worst jobless rates in the rich world. Todayits unemployment rate of 5.4% (using OECD �gures) is one of thelowest in Europe. Youth unemployment, below 8%, is half that inAmerica and a third of the European average. It is also the lowestGermany has seen for 20 years.

This is not the result of booming growth. Over the past de­cade Germany’s economy has on average grown more slowlythan America’s and Britain’s and barely faster than that of theeuro zone as a whole. But Germany managed to avoid a surge oflay­o�s after the �nancial crisis and has done far better than oth­ers at getting the young and the hard­to­employ into work.

How did it manage that? Most explanations heap praise onthe Mittelstand model and the system of vocational training.Firms such as Storopack or Rösch take on apprentices, mixingpractical training with classroom tuition. The German govern­ment also points out that the country �did its homework�, intro­ducing tough labour reforms from 2003 (known as �Agenda2010�) that freed up the job market. And the system of Mitbestim­mung (which gives trade unions seats on company boards) en­couraged wage restraint.

All these things helped, and the Agenda 2010 reforms, inparticular, made a big di�erence. But they are not the wholestory. A cheap currency, some dumb luck and a fair amount of�scal pragmatism also played a part.

Germany had begun the 21st century in bad shape. Wageshad soared after uni�cation in 1990; the budget was burdenedwith big transfers to the former East Germany; excessive regula­tion was sti�ing the economy. To get away from all this, German�rms, including many from the Mittelstand, shifted production tocheaper places in eastern Europe.

Shocked by high joblessness and the hollowing out of Ger­man industry, the SPD government under Gerhard Schröder in­troduced a set of sweeping tax, regulatory and labour reforms in2003. The most important part of this package were the so­calledHartz reforms (after Peter Hartz, who headed the commissionthat drew them up), which brought fundamental changes to thelow end of the German job market. They eliminated payroll tax­es on earnings of less than ¤400 a month (recently raised to¤450), thus encouraging the creation of part­time �mini­jobs�. A�at­rate bene�t nudged the long­term jobless back into work.These and other reforms cost Mr Schröder the 2005 election, butthey gave employers an incentive to create low­skilled and tem­porary jobs and the jobless a reason to take them.

They also made Germany more Anglo­Saxon. Some 20% ofGermans now work in �low­wage� jobs, about the same share asin Britain, not much lower than in America and almost twice asmuch as in France. Germany’s employment boom had less to dowith the Mittelstand than with this overhaul at the bottom,which pulled a lot of low­skilled people into work�though it

also exerted a downward pull on overall productivity. The reforms had big knock­on e�ects. In conjunction with a

move east by many German �rms, they persuaded Germany’sunions to accept years of tight wage restraint. Between 2001 and2010 German wages rose by an average of just 1.1% a year in nom­inal terms, leaving them �at in real terms. Unit labour costs fellsharply relative to those in other countries.

The belt­tightening was impressive, but German �rmswere also lucky to be making the right stu� at the right time. Ger­man manufacturers have traditionally been strong in three bigareas: machine tools, chemicals and cars. That proved a perfectcombination in a decade when emerging economies werebooming and China, especially, went on an investment binge.Almost half of German exports, and 72% of its exports to China,are machinery or transport goods.

The 2008 �nancial crisis temporarily sent exports into atailspin, and in the past three years demand from the euro zone’speriphery has collapsed. But Germany’s manufacturers havebeen more than compensated by the weak euro, which allowedits export machine to whirr on.

Fiscal pragmatism lent a helping hand. The year when Ger­many pushed through its �Agenda 2010� reforms, 2003, was alsothe year when it ignored the �Maastricht� criterion of a 3% cap onits budget de�cit, letting its borrowing rise rather than trying tobring it below the 3% limit. The Schröder government gave prior­ity to structural reforms over �scal consolidation, which today’sMerkel government regards as an egregious mistake. But Frank­Walter Steinmeier, an SPD leader who was Mr Schröder’s chiefof sta�, says he would do it again: �If we had dogmatically stuckto the Maastricht rules, we wouldn’t have had an Agenda andwe would be in the lower rung of Europe’s economies.�

The �nancial crisis prompted a more obvious whi� of Key­nesian policies. As demand for exports collapsed, the Germangovernment came up with several schemes to stem unemploy­ment, in particular Kurzarbeit, topping up the earnings of work­ers on shorter hours or paying for them to go on courses. As glo­bal car sales collapsed, Rösch, the Mittelstand company in

Tübingen, sent a number ofits workers for training at tax­payers’ expense. It survived a20% slump in sales withoutlay­o�s, and the workerscame back more productive.

If German success hasmore fathers than many Ger­mans like to admit, it has alsocome at a price that few ac­knowledge. Most Germans’living standards have stagnat­ed, wealth is highly skewedand national saving, embod­ied in the country’s vast cur­rent­account surpluses, hasbeen spectacularly badly in­vested. From American sub­prime securities to Spanishproperty loans, Germanbanks recycled the country’ssavings surpluses into allmanner of junk. A new studyby Marcel Fratzscher of theDIW economic research insti­tute in Berlin suggests thatGermany has lost the equiva­lent of 20% of GDP on the val­

3Dearly beloved

Source: Pew Research Centre

Opinions on the EU and euro% in agreement, polled spring 2013

0 10 20 30 40 50 60

Germany

Italy

Spain

Britain

Greece

France

Do you think your national economyhas been strengthened by Europeaneconomic integration?

0 10 20 30 40 50 60

Germany

Italy

Spain

Britain

Greece

France

Do you have a favourable opinionof the EU?

8 The Economist June 15th 2013

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uation of its foreign portfolio investments since 2006. Despite such losses, Germany as a country is rich, but a re­

cent study from the European Central Bank suggests that the typ­ical German household is not. Astonishingly, the median house­hold’s net assets, at ¤51,400, are less than those of the typicalItalian, Spanish or even Greek household (see chart 4). These �g­ures need careful interpretation. Households in Germany aresmaller than in those countries, and their average is draggeddown by the east, where 20 years ago no one had any assets tospeak of. Moreover, the �gures do not include pension promises.But the main reason for the poor showing is that far fewer peoplethan in other European countries own their homes. Most house­holds rent, and the housing stock is owned by a relatively smallnumber of people, so Germany ends up with the most unequaldistribution of household wealth in the euro zone. Moreover, agrowing share of its wealth sits on corporate balance­sheets, par­ticularly the family­owned Mittelstand �rms, which makes theoverall wealth distribution more unequal still. For a country thatlikes to think of itself as middle­class and egalitarian, Germany’swealth disparities are huge.

All this helps explain Germans’ attitudes towards the eurocrisis. German voters are sceptical of transfers to southern Eu­rope not just because of their fear of in�ation or their experiencewith pouring money into former East Germany, but also becausethe typical German worker feels that he is no better o� than theSpaniards he sees driving Audis when he holidays on the CostaBrava. After a decade of scant real wage growth, and given theunusually skewed wealth distribution, that perception is not al­together wrong.

What happens next? Outsiders, particularly Anglo­Saxons,have long argued that the German economy is dangerously dis­torted: too reliant on a few traditional manufacturing sectors,and with too little domestic demand. On this logic, if China’seconomy stumbles, or indeed as it produces ever more of its ownhigh­end investment goods, Germany will be in trouble. It needsmore innovation, more services and a better balance.

At �rst sight German industry does seem stolid. Its main

components�cars, chemicals, machine tools�have been thesame for decades. Although Berlin has become a bit of a Euro­pean digital hub, and Germany’s SAP is the world’s third­largestsoftware company, the country has no Apple, Facebook or anyother household name of the new economy.

Look more closely, though, and German �rms dominatesome less obvious but crucial arteries of globalisation. FromDHL to Kuehne & Nagel, the world’s biggest logistics �rms areGerman. And even in manufacturing, making things is increas­ingly bundled with a clutch of high­end services. Storopack’sgrowth, for instance, depends ever more on the technicians whodream up whizzy solutions for speci�c packaging problems.

A new report from the German arm of McKinsey, a consul­tancy, predicts another decade of strong, export­led growthbased on Germany’s traditional sectors. It argues that industrial­isation in emerging economies will keep up demand for mach­ine tools, chemicals and the like, and that German �rms are inno­vating fast enough to maintain their dominance in premiumniche markets. The report forecasts that between now and 2025German exports will rise by 80%, pushing their share in the econ­

omy from 50% to 68% of GDP. If McKinsey is even half

right, German exporters havea rosy future. But it will be afuture focused outside Eu­rope. The euro zone now ac­counts for 37% of German ex­ports, down from 46% in2000. By 2025, reckonsMcKinsey, the euro zone’sshare of German exports islikely to be down to around30%. That diminishing rolewill surely a�ect the attitudeof German business. Sharinga currency with weaklingswill be a �llip in global mar­

kets, but for business the euro zone will matter ever less. JohnKornblum, a former American ambassador to Berlin, argues that�psychologically, German industry has already left the EU.�

Yet becoming more indi�erent to Europe is not in Ger­many’s interest. The country is better o� with the single curren­cy than without; and the economic rebalancing that would helpthe rest of the euro zone is also what the German economy itselfbadly needs.

Spend, spend, spend

With a culture of thrift and, now, a fast­ageing society, Ger­many naturally saves more than it spends. (Barring a few yearsafter uni�cation, it has run an almost uninterrupted surplussince 1952.) But its current­account surplus, at 7% of GDP, is nowmore than three times higher than it was a decade ago, largelythanks to an arti�cially cheap currency and squeezed wages. It isunhealthy, both for Germans (who forgo higher living standardsto pile up savings that are poorly invested abroad) and for othersin the euro zone and beyond.

German economists recognise that this has to change.Hans­Werner Sinn of Munich’s IFO eco­nomic research institute says the countryis �too cheap�. But how best to rebalancethe economy: through less saving or moreinvestment? As a share of GDP Germaninvestment has fallen sharply, from 22% in2000 to 17% in 2012. Public investment hasbeen squeezed, �rms have been cautious

about capital spending and in the absence of a property boomthere has been little investment in construction.

Property is now beginning to look up. Ultra­low interestrates are pushing up house prices and spurring building. After adecade of stagnation, German property prices rose by 5% (innominal terms) in both 2011 and 2012. Cities like Berlin and Mu­nich have seen much bigger jumps. Taxi drivers o�er tips on thebest place to buy a �at. But there is a long way to go. Relative toincome, German property prices are still 20% undervalued.

Wages have also started to pick up. In 2012 IG Metall, thebiggest union, won a pay deal worth 4.3% over 13 months, the big­gest jump in 20 years. Across the economy, wages increased by2.7% last year, about 0.6% above the rate of in�ation. Judging bythe �rst agreements, this year’s crop of wage deals will be slightlymore generous.

Faster wage growth and a minor construction boom haveyet to dent Germany’s huge surplus, which increased further lastyear, but they have already fuelled German fears about assetbubbles and a loss of stability. The Bundesbank has given publicwarning about frothiness in the housing market. German politi­

4Asset-poor

Source: European Central Bank

Median net wealth per household¤’000, 2010 or latest available year

0 50 100 150 200

Spain

Italy

France

Greece

Austria

Germany

Most Germans’ living standards have stagnated, wealth is highly skewed and national saving has beenspectacularly badly invested

The Economist June 15th 2013 9

SPECIAL REPORTGERMANY

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cians were furious at recent suggestions from France that higherGerman wages might be part of the solution to the euro crisis.The constant refrain is that �making Germany less competitivecannot help Europe become more competitive.�

This gets to heart of the problem with Germany and Eu­rope. The German government wants others to become morelike them, but sees no reason for its own model to change. TheMerkel government has done strikingly little to encourage aneconomic rebalancing towards more investment and consump­tion in Germany. The debt ceiling constrains public investment,but the government also brags about how fast it is reducing itsde�cit. Leaving aside minor measures, such as the deregulationof long­distance buses, there has been little in the way of struc­tural reforms to encourage �rms to invest. Mrs Merkel’s 2009election pledges to simplify the tax system and encourage entre­preneurship have gone nowhere. According to the Cologne Insti­tute for Economic Research, the momentum for domestic reformin Mrs Merkel’s second term has been much weaker than in her�rst. The OECD says that since 2007 Germany has brought infewer pro­growth reforms than has any other of its members.

But it is not just a question of missed opportunities. Insteadof making the right choices, Germany may be about to introducecounterproductive measures. Opposition parties are campaign­ing for increasing taxes sharply and rolling back some of theHartz rules. The SPD and the Greens, for instance, want to raisethe top rate of income tax to 49% (from 42%) and reintroduce awealth tax. They also want to toughen the rules for employerscreating mini­jobs and reduce the work requirements that bene­�t recipients must meet. So if the election were to result in a Red­Green coalition, German business would �nd itself in a less fa­vourable tax environment. Even a grand coalition could bringsome tax rises at the top�enough to deter investment and harmthe economy. As one political insider quipped, �It’s a good thingforeigners don’t read German.�

But all this is small beer compared with what Germany isdoing as part of its Energiewende, or change in energy policy. Thecountry’s wholesale move to renewable energy betrays an ill­planned unilateralism. 7

OSTERATH’S 12,000 citizens are angry. Their quiet backwa­ter in the Ruhr, close to Düsseldorf, is the proposed site for

the biggest converter station in Europe. This vast installation willtransform high­voltage direct current to alternating current. Itwill be an important link in Germany’s new �power highway�, anetwork of transmission lines that will send electricity generat­ed by wind farms in the north of the country, and o�shore in theNorth and Baltic Seas, to the manufacturing belt in the south.Osterath’s residents reckon it will be a monstrous eyesore, andintend to stop it. A bill to determine the outlines of the new pow­er highway is making its way through the federal parliament. Of3,300 objections from the public, 2,300 are from Osterath.

This kind of nimbyism is only one of many problems fac­ing Germany’s Energiewende. The literal translation is energychange or turn, but this is more of a revolution, designed to con­

vert Europe’s biggest industrial economy so that it runs largelyon renewable energy. This includes ambitious conservation ande�ciency goals, but above all it involves changing the powersupply. By 2022 all nuclear power plants, which now produce16% of the country’s electricity, are to be switched o�. And by2050 about 80% of electricity is to come from renewable sources,compared with 22% now.

In principle, this bold plan brings huge opportunities forGermany, not only to help save the planet but to become a globalleader in tomorrow’s energy­e�cient and green technologies.The reality has been messier, marked by price distortions, politi­cal U­turns, surging costs and inadequate infrastructure.

Businessmen say the Energiewende will kill German indus­try. Power experts worry about blackouts. Voters are furiousabout ever higher fuel bills. The chaos undermines Germany’sclaim to e�ciency, threatens its vaunted competitiveness andunnecessarily burdens households. It also demonstrates Ger­many’s curious refusal to think about Europe strategically.

Germans have long had a greener streak than other Euro­peans and a greater fear of nuclear power. Some put this down tocultural romanticism, but more probably the worries stem fromliving in a country with a dense population and few natural re­sources, and a culture that values earnest e�orts to do good.Whatever their origin, the environmental convictions run deep.The Greens, an environmentalist party founded only three de­cades ago, are now a powerful political force. They won morethan 10% of the national vote in the 2009 federal elections anddo a lot better still in many urban areas.

The Energiewende’s formal targets were set in the early2000s, when the Greens were the junior partner in a coalitionwith the SPD under Gerhard Schröder. A renewable­energy lawpassed in 2000 promised 20 years of guaranteed prices and pri­ority access to the power grid for anyone who installed wind, so­lar or other renewable sources. These �feed­in tari�s� were paid

Energy

Tilting at windmills

Germany’s Energiewende bodes ill for the country’s

European leadership

Great in theory, messy in practice

10 The Economist June 15th 2013

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for by a surcharge on all electricity bills. To protect German com­petitiveness, the most energy­intensive �rms, such as producersof chemicals, were spared the extra whack.

The incentives were designed to be predictable, but energypolicy, particularly in Mrs Merkel’s second term, has been any­thing but. The �rst U­turn came in 2010, with the passage of anew law that nuclear power plants, originally destined to bephased out by 2022, would be switched o� only when theyreached the end of their working life. That decision, deeply un­popular with many Germans, was reversed only six months lat­er, prompted by Japan’s Fukushima nuclear disaster in March2011. The day after Fukushima Mrs Merkel decided that Ger­many would ditch nuclear power after all. Eight reactors were tobe switched o� immediately, the rest by 2022.

The chancellor claimed that her second U­turn was a rea­sonable response to the Fukushima catastrophe. The dangers ofnuclear power had been made all too clear. Cynics saw an ulteri­or political motive. Largely because of its pro­nuclear stance, MrsMerkel’s CDU party, which had long dominated politics in Ba­den­Württemberg, a big southern state, was slipping in the pollsbefore an election there. The change of mind was a desperate at­tempt to show green credentials. In political terms it failed: theCDU lost and the Greens gained their �rst state premier. Econom­ically the switch brought huge uncertainty.

Germans had responded with gusto to the generousfeed­in tari�s, installing anything from solar panels on roofs toindustrial­scale wind parks. Bavaria now has more photovoltaiccapacity than America, with only 0.7% of its land mass. Theshare of Germany’s electricity derived from renewable sourcesrose from 15% in 2008 to 22% in 2012. On current plans it will be48% by 2022, says Stephan Kohler, head of the German EnergyAgency, a research group.

The trouble is that most wind and solar power is generateda long way from the parts of the country where the nuclearplants are to be switched o�, so new power grids have to be built(see map). Their construction is far behind schedule. On currentplans Germany needs more than 4,000km of new transmissionlines by 2022, of which less than 300km have been built. Onereason is the Osterath mentality: people see no paradox in de­manding an end to nuclear power but objecting to the new trans­mission grid being built in their backyard. Another is the lack ofco­ordination between di�erent states. Political wrangling hasmade cross­country projects hard to planand harder to �nance. Fifteen out of 24grid­expansion projects are up to sevenyears behind schedule.

A second problem is that manysources of renewable energy are intermit­tent. The wind does not blow, nor doesthe sun shine, all the time. Bulk electricitystorage is still in its infancy, and there arenot enough mountains for much hydro­electric storage, so Germany still needs abig back­up capacity of conventionallygenerated power. But because so much re­newable power has come on stream, andbecause it has priority access to the grid,the spot price of electricity has fallen to alevel at which modern, clean natural­gaspower plants are not viable. Only ageing,dirty brown­coal power stations withlow variable costs can compete.

The result is a web of grotesque dis­tortions. On sunny days Germany pushesits excess power into the European grid at

a loss. Because producers of renewables are paid a �xed price,their subsidy rises as the spot price of electricity falls. On cloudydays Germany relies ever more on brown coal. Last year its CO2

emissions rose. The cost of this mess is passed on to electricity users.

Household fuel bills have gone up by a quarter over the pastthree years, to 40­50% above the EU average. And because thecontracts guaranteeing renewables prices are set for 20 years, theproblem will get worse as more such supplies come on stream.Thomas Vahlenkamp of McKinsey reckons that the cost of theEnergiewende will double over the next decade. Rising electricitybills will dampen German consumers’ spending, exactly the op­posite of what is needed to rebalance the economy.

Winners and losers

The impact on German business is complicated. Some�rms have grown fat on the renewables surge. Siemens now gets40% of its revenues from energy­saving and green technologies.But industrial power users are in a bind. As the renewables sur­charge has risen, ever more companies have demanded exemp­tions. The number of o�cially �energy­intensive� �rms has ris­en from 59 in 2003 to over 2,000 today. Between them they usearound a �fth of Germany’s power. Companies that do not qual­ify for the exemption but still use a lot of power are increasinglybuilding their own generating capacity to avoid paying the greenlevy. For instance, Storopack, the packaging �rm described in theprevious section, has built a biomass­fuelled generator at itsplant in Mainleus. As more �rms generate their own power, few­er contribute to the high prices promised to renewables produc­ers. And the European Commission has started to investigate theexemptions as a possibly illegal form of state aid.

All this is happening as prices for natural gas and electricityin North America are plunging, thanks to the shale revolution, soGermany’s most energy­intensive industries are now eyeing ex­pansion on the other side of the Atlantic. There is a risk of a rip­ple e�ect as their customers start to move, too.

In recent months e�orts to keep a lid on companies’ powercosts have led to even more perverse policy shifts. Germany, Eu­rope’s self­professed leader in the �ght against climate change,did nothing to stop the collapse of the European carbon­tradingsystem (the EU’s main collective tool for reducing carbon emis­sions). The market had not been working well, largely because

too many permits to emit carbon hadbeen issued. The European Commissionproposed reducing their number, but MrsMerkel refused to support the proposal,mainly to avoid spooking big German�rms already worried about power costs.Silence from Europe’s most powerful gov­ernment helped to sink the commission’splan in the European Parliament.

Back in Germany no politician iswilling to renege on the promise to ditchnuclear power by 2022, let alone on thecommitment to renewables. The ques­tion is how boldly to revise the plans forgetting there. With the election looming,Mrs Merkel has taken a timid, tactical ap­proach. The talk is of tinkering withfeed­in tari�s, �ddling with corporate ex­emptions and encouraging the states tospeed up the expansion of the grid.

The strategically minded are push­ing for more fundamental overhauls.Bold ideas include replacing the pricing

D E N M A R KB a l t i c

S e aN o r t h

S e a

C Z E C HR E P U B L I C

PO

LA

ND

FRANCE

NETH.

Berlin

Stuttgart

Munich

Osterath

SWITZ. AUST.

Powerlines

Source: Bundes- netzagentur

Existing

Plannednew

Plannedupgrade

100 km

G E R M A N Y

The Economist June 15th 2013 11

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distortions with a market based on production capacity ratherthan output: power producers would be paid by the amount ofcapacity they had installed rather than the amount of electricitythey actually produced. There would also be a greater focus onenergy conservation, including more incentives for investmentin retro�tting buildings; more public investment into energy­storage research; and, from planning the expansion of the grid tothe creation of new renewables capacity, a European, rather thana national, vision for the Energiewende.

Such boldness would be good for German economic rebal­ancing and for Europe as a whole. After all, Europeans live soclose to each other that a national energy policy makes littlesense: how safe is a reactor­free Germany when nuclear powerstations go on running next door in France, the Czech Republicand, in due course, in Poland? And in a supposedly single Euro­pean market, is a renewables revolution at national level evenpossible? Instead of a national Energiewende marked by U­turnsand uncertainty, Germany needs to think European. Fortunatelyit has already begun to do so to manage its second big economictransformation: its looming skills shortage. 7

5Europe’s handicapIndustrial energy prices, ¤ cents per kWh

Source: Enerdata/McKinsey *Estimate

Electricity Gas

0

2

4

6

8

10

12

2000 02 04 06 08 10 12

Germany

EU average

United States

*

0

1

2

3

4

2000 02 04 06 08 10 12

Germany

EU average

United States

*

A YEAR AGO Werner Santiago Medina was an unem­ployed engineer in Las Palmas, the biggest city in Spain’s

Canary Islands. Today he is an electrician in Munich, employedby a small �rm that specialises in converting old o�ce buildings.He has brought his family and is slowly learning German. Hisseven­year­old daughter is already �uent. He still supports Bar­celona football team but reckons his future is in Germany.

Mr Medina’s path from the Canaries to Bavaria wasmapped, in part, by Heinrich Traublinger, proprietor of a stringof Munich bakeries, who heads the Upper Bavarian craftsmen’strade association. Mr Traublinger was shocked by a 2011 surveyof his 79,000 members which showed that more than one in sixof them was short of workers. When he saw television reports ofhigh Spanish unemployment not long afterwards, he spotted anopportunity. The trade association now runs a scheme to attract

Spanish craftsmen of many kinds, from bakers to stonemasons.It organises interviews via Skype and provides help with accom­modation and German lessons.

Messrs Medina and Traublinger are at the leading edge of atrend that could transform Germany. With the world’s second­oldest population (after Japan) and one of the lowest birth ratesin Europe, the country is facing a demographic bust. Its numberof workers is set to drop by 6.5m between now and 2025, theequivalent of losing every worker in Bavaria. By 2050 the num­ber of working­age people in Germany will be a lot smaller thanin France or Britain, even though its overall population is bigger.Over the next ten years the public sector will need to replace 1memployees, a quarter of the total. Half of all teachers are over 50.And there will simply not be enough young people around to �llthe apprentice slots in German �rms.

This shortage of workers can be countered in two ways.One is to look outwards, like Mr Traublinger, and encouragemore foreigners to come to Germany. The other is to coax morework from the existing population by persuading older peopleto retire later, women to do more paid work and making betteruse of the least skilled. In practice both approaches will have torun in parallel. This will have profound e�ects on Germany’seconomy and society.

Open wider

Start with migration. Germany has long had a complex atti­tude to outsiders. As its economy boomed during the Wirt­schaftswunder years in the 1950s and 1960s, it imported hugenumbers of foreign workers from southern Europe and Turkey.Know as Gastarbeiter (guest workers), they were meant to betemporary, and no e�ort was made to integrate them. Yet most ofthem settled. Their o�spring form the core of Germany’s large,and largely low­skilled, migrant community. In the 1990s Ger­many absorbed huge numbers of ethnic Germans from the east,particularly Russia, Ukraine and Kazakhstan. The eastward ex­pansion of the EU, and the gradual removal of barriers to labourmobility, brought a surge of Poles, Romanians and Bulgarians. Asa result Germany already has the largest immigrant populationin Europe. According to the latest census, just out, some 6.2m ofits 80.2m inhabitants, or 8%, are not German citizens, and severalmillion more were born abroad.

But Germany has never thought of itself as an immigrantcountry. Until 2000 citizenship was mostly reserved for ethnicGermans. In recent years Gastarbeiter and their o�spring havebeen able to apply for citizenship, but dual nationality is stillbarred to those over 23. For many years migration was tolerated,not encouraged. Newcomers were, on average, less skilled thanGermans. For most of the past decade the net number of incom­ers has failed to make up for the falling number of native Ger­mans, and the population as a whole has been shrinking.

That is now changing. Thanks to the strong economy athome and the troubles elsewhere in Europe, the number of new­comers is rising. In 2012 more than 1m people moved to Germanyand net immigration stood at 370,000, the highest level for al­most two decades. Most of the new arrivals came from withinthe EU, particularly Poland, Romania and Bulgaria. The numberscoming from southern Europe are also rising fast, though from asmall base. According to o�cial �gures, the number of peoplefrom euro­zone crisis countries who moved to Germany lastyear was over 130,000, a 40% rise on the year before.

The new arrivals are younger and better educated thantheir predecessors. German newspapers are full of stories about�welfare migrants� sponging on the country’s generous social­security system, but they are overblown. Almost 70% of Roma­nian and Bulgarian migrants are highly quali�ed, often with uni­

Labour

Erasmus generation

To overcome its skills shortage, Germany needs to

remodel its society

Many German graduates have them­selves studied elsewhere in Europe,thanks to the EU’s Erasmus schemewhich facilitates student exchanges. Ge­org Fichtner, head of the Stuttgart Cham­ber of Commerce and Industry, says it istime to talk about o�ering apprenticeshipexams in English.

Home­grown talent

Nonetheless, migration alone can­not solve Germany’s skill shortage. Interms of sheer numbers, the more impor­tant part will be to get Germans to workmore. Older folk are already staying onlonger. Germany has the EU’s third­high­est labour­force participation rate for theover­55s (after Sweden and Estonia). MostGerman women, too, hold down jobs: at72%, the participation rate for women ofworking age is well above the EU average.They just do not spend a lot of time doingthem. Almost half of working women arepart­time, putting in an average of only18.6 hours a week. West German societylong frowned on combining motherhoodand work and its social infrastructure wasnot set up for it. A mother who took uppaid employment instead of caring forher children full­time was denounced asa Rabenmutter (�raven mother�). WestGerman schools traditionally �nished atlunchtime, and provision for youngerchildren was poor. (East Germany, whereunder communism almost all women

worked, has lots more all­day schools and child­care facilities.)Politicians have long recognised the need for change. A de­

cade ago Mr Schröder’s government boosted federal pre­schoolfunding and launched a drive for all­day schools. Even Mrs Mer­kel’s CDU, despite its heritage of traditional family values, haspushed for reform. The main force behind this has been Mrs vonder Leyen, herself a mother of seven, �rst as family minister andnow as labour minister. She introduced paid paternal leave, in­creased federal funding for pre­school care and fought for newstatutory requirements. From August this year all German chil­dren will have the right to a day­care place from the age of one.

Not everyone in the CDU is happy with this shift. To placateher conservative wing, Mrs Merkel agreed to an additional child­care bene�t for full­time mothers. But most politicians recognisethat the economy needs more women to spend more hours at ajob. There is a limit, though, to what the federal government cando. For example, it cannot simply insist on all­day schools, be­cause education is devolved to the states. And the debt ceilingconstrains public investment at both federal and local level. Agood deal of progress has been made: around half the schoolsare now open all day. But there is more to do.

All­day schools and better pre­school provision would alsoboost another potential source of workers: the children of mi­grants who currently fall o� the education ladder. The �gures aregrim. A quarter of young people with a migrant background lacka secondary­school diploma; less than 7% graduate from univer­sity; and as a group they are more than twice as likely to be un­employed as the national average. Poor language skills are a bigpart of the problem, reinforced by a system in which childrenspend so little time at school. Many third­ or even fourth­gener­

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versity degrees, says Klaus Bade, a migration expert. Migrantsfrom the euro zone’s crisis countries, like Mr Medina, are evenmore likely to be young and well educated.

With labour shortages looming, the o�cial attitude to­wards migration has been slowly shifting. Mr Schröder’s govern­ment paved the way in the early 2000s, with changes in citizen­ship rules and a scheme to encourage foreign engineers and ITexperts to come to Germany. In 2012 Mrs Merkel’s governmentbecame one of the EU’s �rst to implement a new �blue card� sys­tem to admit skilled foreign workers from outside the EU. In thesame year the federal government passed a law recognising for­eign technical quali�cations. The economics ministry has awhizzy bilingual website called �Make it in Germany� which of­fers tips on applying for a job. The idea, says Ursula von derLeyen, the labour minister, is to create a �welcoming culture�.

The trouble is that old rigidities die hard. Although the fed­eral government now recognises foreign technical quali�ca­tions, only �ve of the states do. Germany’s apprenticeship sys­tem still creates, in e�ect, a closed shop. Virtually the only routeto many technical occupations is to join as a 16­year­old school­leaver. One study suggests that 3m immigrants in Germany workin jobs well beneath their technical quali�cations. Language isalso a big barrier. Mr Traublinger’s attempt to recruit a Spanishoptician for a Bavarian village failed because the candidate didnot speak enough German to understand his clients.

Such barriers will not be broken down overnight, but Ger­mans are trying harder to do so. The Goethe Institute, a govern­ment­funded network of cultural centres abroad, is expandingits o�erings of German lessons. For younger, well­educated Ger­mans, working with colleagues from abroad comes naturally.

Many more needed

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ation Turkish migrants still cannot speak German properly. But, here too, there are signs of progress. At the Rütli high

school in Neukölln, a Turkish­ and Arab­dominated district inBerlin, virtually all the students come from migrant homes. In2006 the school achieved national notoriety, having become soviolent and dysfunctional that its teachers asked the Berlin stategovernment to close it. Now it has become a model all­day highschool. A cadre of support sta� help with homework and extralessons in the afternoon, and grades have shot up.

From mothers to migrants, Germany is faced with a longto­do list. Whether it can act fast enough to compensate for thedemographic bust is not clear, but it seems at least to have gotmoving. Helpfully, all the changes it needs to make are likely toboost domestic spending. The growing scarcity of workers willpush up wages, leaving more disposable income. A higher la­bour­force participation rate means increased household in­comes and higher consumption. As women work more, theywill spend more money on things from child care to conveniencefood. More immigration will boost demand for housing. But justas important, German society will change as more people likeMr Medina come to call it home. 7

6Missing millions

Source: OECD

German labour force, m

41

40

39

38

42

43

44

45

1991 95 2000 05 10 15 20 25

F O R E C A S T

FAST­FORWARD SEVEN years to 2020, the 30th anniversa­ry of German uni�cation (and, counting from the �rst

Greek rescue package, the tenth anniversary of the start of theeuro crisis). Leaders from across the European Union are arrivingin Berlin for Germany’s birthday celebrations. What sort of Ger­many will they be dealing with, and what sort of Europe willthey be living in?

First, let your optimism run wild. Imagine that the euroarea is growing at a healthy pace, well into a recovery kick­start­ed by the comprehensive clean­up and restructuring of Euro­pean banks after the creation of the European banking union in2014. Southern Europe’s economies have had a complete make­over, with far freer labour markets, smaller, more e�cient gov­ernment and a number of bold privatisations. Unemployment

is falling steadily. Much of the credit for that goes to domestic re­forms, prodded by the euro zone’s new German­inspired com­petitiveness rules, but outside �nancial help also played a role.Austerity was eased and rescue funds provided by other euromembers were converted into low­rate loans extended over sev­eral decades. The European Transformation Fund, a German­in­spired EU initiative, encouraged foreign investment in public­private partnerships.

In this rosy future vision of Europe the division between astrong north and a weak south is less stark. A booming export­oriented industrial belt stretching from northern Italy to theNetherlands, with Germany at the centre, attracts a steadystream of workers from all over Europe. So, too, does Germany’s�Agenda 2020�, a package of reforms introduced after the 2013election to boost public and private domestic investment in pro­jects ranging from education to energy conservation in order torebalance the economy. All those new jobs have prompted aGerman construction boom as property prices have risen. Butthe movement of people has not been all one way. Thanks to theshake­up in the EU’s health­insurance rules, for instance, Spainnow has a �ourishing business looking after elderly Germans.

Through a glass, darkly

Yet looking around the euro zone today, darker outcomesseem much more plausible. It is all too easy to imagine the Eu­rope of 2020 having su�ered a lost decade, with no growth, anever bigger debt burden and chronically high unemployment. Inmuch of the continent de�ation and a mentality resigned to de­cline will have set in, as they did earlier in Japan. Southern Eu­rope will still be down in the dumps, and even France’s economywill remain moribund. These countries’ capacity to grow willhave been permanently damaged as a generation of young peo­ple have grown up without any experience of work.

In this pessimistic scenario, the odds of political backlashare high. Several southern European economies have left the sin­gle currency after Eurosceptic parties took power. The euro, nowcon�ned to a group of northern European economies, hassoared, hitting the German export machine hard. German �rmsand banks are battling with defaulting debtors. Capital controlsare ubiquitous. With fragmentation as the dominant economictheme, Europe’s post­war integration project is in tatters. And inthe minds of many foreign guests at Germany’s birthday party,their hosts will bear most of the responsibility for the mess. Afew may even mutter, unkindly, that Germany, for the third timein just over a century, has wrecked the continent.

How can Europe avoid this grim outcome and improve thechances of a better future? What needs to be done will be di�­cult but not impossible. The euro zone does not need a super­state or full political union to recover its momentum. A bankingunion and a proper euro­wide bank restructuring will draw aline under the �nancial bust, cleaning up balance­sheets, recap­italising viable banks and allocating losses. The common rulesto boost competitiveness on which Germany is so keen can beintroduced without a wholesale revision of Europe’s treaties.Sensible schemes to encourage investment in southern Europedo not require the creation of a permanent transfer union.

This special report has argued that disproportionate re­sponsibility lies with Germany not only to lead Europe’s reformagenda but also to change at home�and the reforms needed tosecure Europe’s future will do a lot of good at home too. More do­mestic demand will help ease the adjustment in Europe’s south­ern economies, but it will also bring real gains to Germans whohave been forgoing higher living standards for a savings surplusthat has been poorly invested abroad. An overhaul of the Ener­giewende aiming at a more sensible pricing system, more invest­

German leadership

Overcoming thedemons

A successful Europe requires a new kind of Germany

country mentality to responsi­ble leadership is similar. Evenfor America it was hard to make:Congress rejected key elementsof the proposed internationaleconomic machinery, such asthe International Trade Organi­sation. But, overall, it looked be­yond narrow national interestto create the IMF, the WorldBank, the �xed­exchange­ratesystem and other pillars of thepost­war economic order.

Germany does not need tocreate a new institutional archi­tecture, as America did. The EU

has plenty of that. But it needsto think boldly about how theEuropean system, and the eurozone’s economies, �t together.That means complementingMrs Merkel’s competitivenessagenda with a �nancial frame­work for Europe’s peripheraleconomies, a strategy for pull­ing along a weakened Franceand a vision for rebalancing theGerman economy.

For the moment, there isnot much sign in Berlin of anybold thinking along these lines.The government has �oated afew modest bilateral proposals in recent weeks, such as usingGermany’s development bank to help �nance southern Euro­pean �rms and to encourage investment in venture­capitalfunds. But so far these ideas seem to be more about softeningGermany’s image than changing its strategy. There will be no biginitiatives until after the election, and whatever its outcome,Germany’s attitude to leadership and policy towards Europe isunlikely to change suddenly or radically. German politicianshave not even begun to acknowledge the inconsistency andshort­sightedness of their current approach, let alone o�er a bol­der and better one. In the short term, therefore, it is hard to seeGermany doing what it needs to do if the euro is to survive andthe EU to prosper. But further ahead there is at least a chance that

this might change, for two reasons. First, if Mrs Merkel wins the elec­

tion, she will be looking for her place inthe history books. She will want to be theone who �xed Europe, not the one whoallowed it to fail. And second, even if Ger­many’s politicians act less boldly thanthey should, the country is already pro­grammed to change sharply over the nextfew years. The demographic arithmetic isvirtually certain to boost domestic spend­ing and make German society more inter­national. By 2020 Germany will havemany more skilled migrants and morewomen in the workplace. It will becomemore of a modern European melting pot.So the best reason to be hopeful is that,though the future of Europe will be madein Germany, the future of Germany willalso be made in Europe. 7

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The Arab spring July 13thBiodiversity September 14thBrazil September 28thThe world economy October 12th

SPECIAL REPORT

14 The Economist June 15th 2013

2

GERMANY

ment in energy conservation and the rapid completion of a newsmart power grid will boost German growth and form the coreof a coherent European energy policy. Reforms that encourageimmigration and the investment in child care and schools thatwill allow women to do more paid work will bene�t both Ger­many and Europe.

The question is not whether Germany can lead Europe to abetter future, but whether it is willing to do so. More than any­thing else, that demands a change of mindset. This special reporthas argued that Germans have a skewed view of the euro crisis(�It’s due to failures in the periphery economies�); an incompleteinterpretation of their own economic success (�It’s because wetightened our belts�) and limited awareness of the links betweentheir own economy and others (�Germany must be protectedfrom the mess elsewhere�).

Look outwards

As a result, too many German politicians believe that alarge external surplus is a sign of strength to which other coun­tries, too, should aspire, and de�ne Europe’s action plan almostwholly in terms of what others must do. They regard their do­mestic decisions, whether eschewing nuclear power or bringingforward their budget consolidation, as intellectually and practi­cally distinct from the future of Europe. The narrowness of Ger­many’s approach is reinforced by its emphasis on legalism ratherthan economics. At a time of record low interest rates, for in­stance, it makes economic sense for Germany to borrow more toinvest in schools or in the new power grid. But the new constitu­tional debt brake, strictly interpreted, makes it impossible to dothat without imposing spending cuts elsewhere.

Can this attitude change, and change in time? The shift re­quired is huge. Germany’s politicians must switch from a small­country mentality to one in which their country thinks morebroadly about the interests of Europe as a whole. They must doso in a way that maintains support from voters who fear that �­nancial stability and European integration are at odds. And theymust lead in a manner that other Europeans can accept.

Perhaps Germany can draw inspiration from the experi­ence of another hegemon, America. Having shunned globalleadership in the 1930s, America took responsibility for the inter­national system after the second world war. Germany’s circum­stances today are di�erent in crucial ways: there is no military di­mension, and the economic gap between itself and the rest ofEurope is far smaller than the historic one between America anda Europe devastated by war. But the need for a shift from a small­

The questionis notwhetherGermanycan leadEurope toa betterfuture, butwhether itis willing todo so