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Germany is undergoing a surprisingly robust economic rebound while Angela Merkel’s divided government is facing accusations of immobility.

Even hardened sceptics agree the economy has turned round and public finances are in much better shape after a year of Merkel’s chancellorship.

On the political front, the “grand coalition” has been struggling to maintain the pace of reforms, leading to some disappointment. Germany’s ageing population presents challenges ahead, but experts warn against undue pessimism.

Is the recovery sustainable and are the country’s leaders missing the golden opportunity afforded by the supportive environment to forge ahead with structural reforms?

A panel of experts, including Michael Heise, chief economist at Allianz Group/Dresdner Bank, and Dirk Schumacher, senior European economist at Goldman Sachs, answer your questions below.

Does the economic turn-around come too early as it may hinder politicians from implementing necessary reforms?
Markus Wandt, Frankfurt, Germany

Michael Heise: At least tax reforms, like the withholding tax project, should be facilitated by the economic upswing and strong fiscal revenue. The same applies to labour market reforms. But nonetheless your concern is not completely unfounded.

Dirk Schumacher: I would argue that the real reforms so far were taking place in the corporate level. The government prepared the ground with the Hartz reforms but the pressure to adjust is coming from the corporate sector/globalisation and this is not going away. The starting point was the failed strike of IG Metall in 2003. Some have argued that the worse things get, the better as this would lead to radical reforms. I am not sure this is the way it has to be.

Pension reform was a brave attempt to create a more dynamic economy, but why is it that Germany’s post-Second World War legacy remains largely intact and German economic results are improving? Is the economy no longer based on industrial expansion, and more linked to currency issues?
Hugh Gracey, London, UK

Michael Heise: On one aspect of the question one can say that industrial expansion is surprisingly strong. The share of manufacturing in GDP has actually been increasing - no sign of de-industrialisation. But as productivity has been soaring in manufacturing, employment

has gone down until recently. Of course the sector is vulnerable regarding major currency revaluations.

Dirk Schumacher: Not sure that things have remained the same. If you look how the collective wage setting has changed a lot has happened. Moreover, the whole financial system has moved (and still is) from a bank based to a capital market based system. This had huge implications in terms of how the corporate sector is run.

I am a Brazilian production engineer of 29 years of age. I work for a German company in Brazil related to renewable energy. I speak fluent English, have been learning German for a year and been through a MBA course. Regarding the aging population in Germany, what are the possibilities of me becoming a competitive professional in Germany at the same level as the Germans?
Fabrcio Gusmo, Brazil

Michael Heise: Despite generally high unemployment there is already today a lack of specific qualifications on the German labour market. So your chances are excellent especially as the industry for renewable energy is growing at breakneck speed. Good luck!

Dirk Schumacher: They should be very good. The government is trying to bring qualified people into the country and there is already some evidence of shortage for qualified employees..

What is the likely impact of the World Cup on the German economy based on its repercussions so far?
Valentin Unverricht, Bolton, UK

Michael Heise: On balance, there is no major impact on the German economy. Of course, World cup tourism led to some positive consumption effect and construction was also given a fillip up to June. But on the other hand, there were also negative demand shifts due to World cup “avoidance”, and production and consumption losses due to public viewing etc.

Dirk Schumacher: In terms of GDP growth maybe some 0.2 per cent, but not really important. But it was fun anyway and helped to dispel some of the negativism.

My question relates to the housing market. Statistics (e.g. The Economist’s house-price indicators published this week) show that house prices across Germany are down by about 1 per cent over the last 12 months, whereas my ‘anecdotal/personal’ experience of having managed a housing-investment fund over the last 18/12 months is that prices are sky-rocketing due to hugely increased demand from foreign investors. Can you offer any insight into the difference between the statistics and the on the ground reality (which many investors share), and what is your view of the German housing market (still under-valued?).
John Kehoe, UK

Michael Heise: Real estate prices have increased substantially due to the activity of foreign investors. But their level is still not high, on average still well below 1,000 euros per square metre, if I remember the data correctly of recent deals that have been published.

Dirk Schumacher: Statistics about house prices in Germany are generally of poor quality (when compared to the statistics available in other countries). So they should be interpreted with some caution. More to the point, there are quite significant regional differences, that need to be taken into account when comparing statistics with anecdotal evidence. German real estate in general still looks cheap when compared to other countries but one has to really look at the regional differences.

There has been a lot of talk about structural reasons for the disappointing growth in Germany in recent years. Could it be that the real reason has rather been that Germany may have joined the EMU at an overvalued deutschemark exchange rate? The necessary adjustment of wages downwards now causes the lack of demand and, at the same time, high real interest rates hamper the recovery?
Hans J Hunemorder, Lausanne, Switzerland

Michael Heise: Germany did indeed join EMU at a high exchange rate which has since been adjusted for by comparatively low wage growth and price inflation. In the past five years, however, you are right - real interest rates were high and that dampened domestic demand. But on the other hand export growth has been fostered by the integration of the European markets and that has been a benefit.

In the meantime we can establish that years of moderate wage growth have obviously restored competitiveness and consequently employment is finally growing. This is most important for consumer demand.

Dirk Schumacher: The recovery is now pretty strong so there is nothing that is holding back the recovery currently. Germany probably entered EMU at a too high rate; but not much according to our calculations. The period of slow growth was rather, in my view, the adjustment to a changed financial system and pressure from globalisation. That adjustment is not over, but we are well advanced.

In general terms, when does the panel expect the best time will be for the small scale UK/outside investor to invest in Germany (small business/ franchises and small property portfolio; 200-400,000 euro total investment).I have recently made enquiries in Germany for the above and the environment still appears difficult to approach and also costly in terms of tax and costs.
Andrew Scott, London, England

Dirk Schumacher: In terms of cyclical strength we probably have seen the peak in the growth momentum (because fiscal tightening will slow the economy somewhat next year) but the fundamental position of the German economy remains very sound. In fact,

I think that Germany will be a major beneficiary of globalisation and the rise of the BRIC’s (exports to the BRICs are soaring). So the party is not over. That being said I would wait to see how much damage the VAT hike will actually cause (coming into effect Jan 07). The risk that this will derail the economy are small but it remains a risk.

What are Germany’s economic and social prospects over the medium term? What are the chances that eastern Germany will benefit more from the economic upswing?
Joerg-Uwe Richter, Bethesda, Maryland, US

Dirk Schumacher: There are parts in east Germany today that can be almost considered model regions. In fact you will find the most productive manufacturing sites today in east Germany and the east German manufacturing sector has outgrown (from a very low base) its West German counterpart.

So east Germany is not necessarily a hopeless case. I think that the medium-term outlook for the whole of Germany is generally good. Germany has gone through a phase of brutal restructuring and is now reaping the benefits and this will last, unless some big external shock comes along. There are of course policy fields where more reform is needed (health care, pension) but the last couple of years have shown that the country can move in the right direction.

Michael Heise: Economic prospects in my view are positive for the next couple of years. Corporate restructuring and investment will enhance productivity growth (total factor productivity) which has been so low in recent years. And changes in the incentives and regulations on the labour market will increase labour input. In my view potential growth will rise above 2 per cent in a short period of time.

Abundant labour supply and low wages in east Germany will benefit this region’s economy. It will grow faster than the west.

The present rebound is a false dawn. Surely the pensions/welfare time bomb that Germany is in denial about mean the present ‘reforms’ are just re-arranging the deck-chairs on the Titanic?
Paddy Digan, Dublin, Ireland

Michael Heise: It is true that there is a demographic time-bomb - significant population decline and ageing will set in in about 10 years time. I would argue that the pension time-bomb has more or less been defused, recent “reforms” have reduced the purchasing power of public pension payments by about 15 per cent for 2030. On the health front the bomb is still ticking. But that in any case does not mean that the present recovery is a false dawn.

Dirk Schumacher: I don’t think that the German pension problem is much worse than the one in other countries (though the demographics look a bit weaker). There is a natural solution which is making people work longer. The current government has made a first step, more will come. This time bomb is in principle easy to defuse, although it is politically difficult to do.

I have just read in the Lex Column of today’s FT and I wonder what is it happening in Germany. I’ve read that foreigners account for more than 70 per cent of property turnover (historically only 5 per cent) and that 25 per cent of the European real state investment is made in Germany during 2006 (8 per cent in 2005). With this numbers I would like to know how much of this funds are speculative or how much are real investment that are supposing a real and sustained recovery in Germany? In the last case, the investment rebound is due to the perspectives of private consumption; are they thinking that the consumer is coming to stay?
Silvia Hernndez, Madrid

Michael Heise: It is true that foreign investors (mainly funds) account for the bulk of property investment in Germany. Given the low level of interest rates - below the rental yield of residential property - these investments are profitable, as the Lex column points out. They are not only speculative in nature. Given generally low prices of residential real estate the investments will probably turn out positive.

Dirk Schumacher: It is true that there has been a lot of interest from foreigners in the German real estate market. The main reason for this interest probably being the fact that real estate prices in Germany, unlike in any other industrialised country (with the exception of Japan), have been roughly stable since 1995. This makes German real estate look cheap compared to other countries. This, couple with a general turnaround of the German economy from being ‘Europe’s sick man’ to new ‘growth engine’ makes these kind of investments look attractive. How much of this is speculative? Not sure how you define this.

Given that many of the investors are from the private equity world they certainly intend to sell their investment at some point. As far as private consumption is concerned the relationship between consumption and real estate is not tight in Germany as roughly 60 per cent of households rent.

How could Germany implement pro-market reforms to boost the economy and lower unemployment considering how unpopular these reforms are in the population and therefore the little politic support for them?
Tomas Grimm, Spain

Michael Heise: Unemployment has gone down substantially since 2005. Labour market reforms would help to speed up the decline. Unpopular, yes, but with the tailwind of a strong economy but not completely impossible. Let’s hope for some surprises.

Dirk Schumacher:I am not so sure how unpopular these reforms were in the end. Unions tried to rally against the reforms but they never succeeded to get more than 100,000 people to the streets across Germany (many more showed about in Iraq war protests). This is not to say that the reforms were popular but there was (and still is probably) a sense that reforms are necessary.

Also, Schöder was forced to call for early elections because his party was no willing to follow him anymore, so it was not that easy to implement these reforms but he remained firm. Final point, the more important things happened anyway on the company level (restructuring, cutting wages costs etc).

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