Page last updated at 13:33 GMT, Monday, 28 September 2009 14:33 UK

Can Germany reform its economy?

By Tim Weber
Business editor, BBC News website

Guido Westerwelle
Liberal leader Guido Westerwelle says free markets can kickstart the economy

On the face of it, Germany's general election has delivered a clear mandate for economic reforms: neo-liberal but socially conservative, in favour of free markets and less regulation, hoping to boost the economy by lowering taxes.

This may be a surprise, given Germany's history of maintaining a highly regulated "social market economy," and the fact that its export-focused industry is suffering badly because of the market failure that has devastated industrialised economies the world over.

Pushing hard for reforms will be the junior party in Chancellor Angela Merkel's coalition, the liberal, self-proclaimed "pro-business" FDP. Boosted by strong election gains, its leaders say that they will force their business agenda into the pact that will outline the coalition's policies.

In contrast, Mrs Merkel's party, the Christian Democrats (CDU) and its Bavarian sister party CSU, lost votes, slumping to its worst showing at the polls in 60 years.

The liberals' election manifesto, however, is unlikely to survive contact with both Germany's economic situation and the realpolitik of coalition politics.

Unemployment threat

Germany's economy may be growing again - earlier than the US or the UK - but it also saw a sharper contraction than many other countries, and economic growth does not immediately translate into more jobs or higher tax revenues.

Angela Merkel
Chancellor Angela Merkel has been a cautious reformer

The state of Germany's public finances is dire. Already CDU politicians are warning their liberal partners-to-be that tax cuts are unaffordable right now.

Government spending is the other tough issue. Unemployment has been kept artificially low, with 1.4 million workers put on "Kurzarbeit" - where they work shorter hours while the government makes up some of the lost salary.

However, at many companies the arrangements for this salary subsidy are about to reach their statutory maximum duration. Unless the government is prepared to accept a sharp rise in unemployment, the FDP's neo-liberals will have to swallow their economic principles and accept more market-distorting state intervention.

Furthermore, the realities of German coalition building means that the FDP's political leverage will be fairly limited. FDP leader Guido Westerwelle firmly nailed his party's flag to the CDU mast.

There is no alternative coalition partner for him to fall back on, while the CDU could arguably (albeit reluctantly) continue its grand coalition with the Social Democrats.

Is Angela Merkel a reformer?

So what about Chancellor Merkel's ambitions? Four years ago, when the grand coalition got going, it pursued an ambitious agenda of economic reform. After a few early successes, it quickly got bogged down in squabbles over money and the protection of special interests.

Mrs Merkel, ever the seeker of consensus and campaigning on the promise of staking out the middle ground, did little to push reform.

Now conservative commentators in Germany are wondering whether Mrs Merkel will discover a taste for reform at last or whether she is a consensus-seeking social democrat at heart.

Chances are that she will turn out to be the true heir of the CDU's previous chancellor, Helmut Kohl. He was notorious for "sitting out" conflicts and avoiding bold economic decisions.

It would be politics as usual for Germany. But it is unlikely to be the recipe for leading Germany out of the economic quagmire.

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