Can Germany rescue its ailing neighbours?

Though it’s better known for its caviar service in first class and its swank lounges at Frankfurt International Airport, much of the excitement at Lufthansa last year took place at its comparatively drab cargo operations. The carrier’s hulking MD-11 freighters hauled 18 per cent more tonnes of time-sensitive goods—ranging from German-made luxury car parts to pricey chemicals—in 2011 than the year before, when a previous record was set. Even more impressive is the destination for many of those planes: “China remains the core market for air-freight transportation out of Germany with growth at 26 per cent,” says Florian Pfaff, a manager for Lufthansa Cargo.

Apparently, not everyone is losing jobs to Guangdong province.

Despite the deepening eurozone crisis, Germany is booming. While Ottawa might like to brag about its performance through the Great Recession, the real miracle story belongs to Germany, and its manufacturing and export-driven economy. The country of 82 million has enjoyed GDP growth of three per cent or better for the past two years, while exports topped $1.3 trillion for the first time ever in 2011. Unemployment, meanwhile, is sitting at a 20-year low of 6.7 per cent, compared to Canada’s 7.6 per cent. And although it experienced a run on its banks in 2008, Germany has no housing bubble, boasts a high personal savings rate and slays deficits with near-religious zeal.

Its performance is even more impressive next to its neighbours. Spain’s unemployment rate is 23 per cent, Ireland and Portugal have both been the recipients of emergency loans, and the Bank of England is still valiantly trying to prime the pump of the British economy. Nowhere are things worse, of course, than debt-addled Greece. Teetering on the brink of bankruptcy, politicians in Athens finally struck a deal this week to implement a fresh round of budget cuts—at Berlin’s insistence—in exchange for a new, European-led $170-billion bailout. But not before an estimated 80,000 protesters took to the streets of Athens, throwing rocks and torching storefronts. A Greek newspaper even ran a picture of German Chancellor Angela Merkel in full Nazi regalia on its front page.

The attacks on Merkel are over the top, but there is little doubt who is calling the shots on the Continent these days. No longer the “sick man of Europe,” Germany has emerged as the eurozone’s de facto leader and, if appearances are to be believed, unwilling saviour. Indeed, Merkel knows full well that German voters are furious at the thought of having to pay for the profligacy of their neighbours—hence the demands for “austerity.”

While Germany says Europe could handle a Greek bankruptcy better than a few years ago, many are still hoping Merkel won’t let it come to that. A Greek default threatens to not only plunge all of Europe into a crisis, but could spark a global downturn. “I think at the moment, we are really at a crossroads,” says Alexander Herzog-Stein, an economist and labour market expert for the Hans Böckler Foundation in Düsseldorf. “And that’s something you have to tell the German people—that the strong countries have to help the others.” Otherwise, he says, Germany risks cratering its own export markets.

Europe—indeed the world—needs Germany now more than ever. The question is whether Germany will decide it needs Europe too.

As little as a decade ago, Germany was still an economic mess. After the fall of the Berlin Wall in 1989, four million Germans lost their jobs as about 14,000 companies in the former East Germany were shut down or privatized as part of the reunification process. It wasn’t until 2003 that the tide began to turn following the implementation of labour market reforms under former chancellor Gerhard Schröder. They included the creation of millions of temporary and part-time “mini-jobs” that paid up to about $640 a month (there is no minimum wage in Germany), while exempting workers from paying taxes and social security.

The effect of the reforms, recommended by a committee headed by Volkswagen’s former personnel director, can still be felt today. Germany, contrary to its image as a wealthy, union-friendly nation, now boasts one of the biggest low-wage sectors in Europe, encompassing one-fifth of the workforce. Nowhere has this wage restraint been more important than in manufacturing, where average pay increased just 22 per cent between 2000 and 2010, compared to 36 per cent for the EU. Even so, Germany’s GDP grew at an anemic 0.8 per cent in 2005, while other European countries rode the global finance wave to riches.

Then the credit crisis hit. Suddenly, Germany’s stodgy manufacturing sector became a key competitive advantage. After bailing out its banks, Berlin implemented a program that effectively paid private companies that agreed to slash employees’ working hours. That prevented mass layoffs at factories and helped support domestic consumption. Unemployment barely budged. More importantly, when demand for German-made products returned suddenly in 2009 amid a global recovery, companies ranging from Siemens to chemical giant BASF had an army of skilled workers who could be brought back quickly, giving them a jump on their foreign rivals.

The nature of Germany’s exports (which account for nearly one-third of GDP) also gave it an edge during the recovery. Unlike the U.S. and Canada, Germany doesn’t have much in the way of raw materials or resources. And its labour costs, although low by European standards, can’t compete with China’s cheap, unskilled workers. Instead, Berlin decided long ago to draw on the country’s rich history of engineering expertise by encouraging the production of expensive, high-end products. Luxury cars. Pharmaceuticals. Precision factory machinery. Americans who lost their jobs and their houses will remember all too well the outrage over Wall Street executives at bailed-out investment banks taking home big bonus cheques. Turns out, they were spending them on pricey Sennheiser headphones and BMW coupes. The hard times were not shared by everyone equally and Germany cashed in more than most.

Ironically, that continues to be the case even as Europe sinks further into a hole. Thanks to a depressed euro, Germany’s competitive manufacturers have become even more profitable since they sell as much as 40 per cent of their products in foreign currencies. Sales for the Stuttgart-based Porsche were up five per cent in January, while Daimler recorded best-ever sales of Mercedes vehicles last year. And it’s not just big corporations reaping the rewards. So does Germany’s famed “Mittelstand,” the three million or so small- and medium-sized companies that work closely with universities and produce a dizzying array of unremarkable but profitable tools and machines for export. For example, a small family-owned firm in Nienhagen, near Hanover, made the precision tool that was used to keep drilling equipment perfectly vertical during the rescue of 33 Chilean miners two years ago.

At the same time, Berlin now enjoys an embarrassment of riches when it comes to borrowing money. While Italy, Spain and others are faced with punitive interest rates, nervous European investors are pouring their cash into Germany. Some are so desperate to find a safe haven that they’re effectively paying the German government for the privilege of lending it money. Last month, an auction of six-month government bills came with a negative interest rate. “That has never happened before,” a perplexed-sounding spokesman for Germany’s federal finance agency told Der Spiegel.

It all might seem like a perverse joke to the eurozone’s struggling and unflatteringly named PIIGS (Portugal, Ireland, Italy, Greece and Spain)—particularly as Germany, through EU finance bodies, tries to impose on them its brand of fiscal responsibility, which was shaped in part by memories of its painful bout with hyperinflation following the First World War (when one U.S. dollar was worth one trillion German marks).

In the case of Greece, though, the process of arriving at a workable rescue plan that satisfied Germany was akin to pounding the proverbial square peg into a round hole. With billions’ worth of bond payments coming due in late March, lawmakers in Athens spent weeks hammering out a difficult and deeply unpopular deal to implement a new round of required austerity measures. They included axing one in five civil service jobs and slashing minimum wages by more than a fifth. But no sooner had the agreement been announced than the so-called “troika” of the European Union, International Monetary Fund and European Central Bank told them to go back to the drawing board. “The Greek offer is not sufficient and they have to go away to come up with a revised plan,” sniffed a spokesman for the German Finance Ministry. As Greek officials gritted their teeth and resumed negotiations, angry workers took to the streets, throwing rocks and petrol bombs at a mostly sympathetic police force. Finally, politicians emerged with a revised plan, only to be told by a skeptical Germany that a final approval wouldn’t be given until early March.

While ordinary Germans would likely view the eurozone as better off without any of the PIIGS, the risks associated with a Greek default are significant. For one thing, Germany’s banks are heavily exposed to troubled eurozone members. And if Europe goes into the tank, there won’t be as much demand for German-made escalators and kitchen appliances. There are already signs of trouble. Despite Germany’s banner year for exports in 2011, the month of December showed a worrying 4.3 per cent decline, their biggest drop in three years.

So why is Germany still insisting on such harsh austerity measures? Domestic politics plays a key role. “Germans perceive the current situation as one where they’ll have to shell out money to save [the eurozone] financially,” says Christian Breunig, an assistant professor of political science at the University of Toronto who did post-doctoral work in Cologne. “So in return, they’re trying to get as many political concessions as they can.” He adds, however, that Merkel has so far done a poor job of explaining to ordinary Germans why a bailout of Greece is probably in their long-term interest. “Germany should have come in harder and more committed early on. That would have restored confidence.”

It’s not just German voters Merkel needs to worry about. When it comes to the eurozone, she must be cautious to avoid appearing as though Germany is acting unilaterally, lest it raise old fears about German power left unchecked. It’s a difficult balance to strike. Even as she is being depicted as a Nazi in Greece, Merkel is being called on to take a leadership role by such unlikely countries as Poland. Radek Sikorski, the Polish foreign minister, said in a speech last fall: “I will probably be the first Polish foreign minister in history to say so, but here it is: I fear German power less than I am beginning to fear German inactivity.”

Many believe Germany has an obligation to step up after years of reaping the rewards of anchoring the eurozone. As the monetary union’s biggest economy, Germany plays a key role in setting the value of the euro. That, in turn, takes away a key competitive tool—a cheaper currency—from smaller European countries seeking to develop their own manufacturing sectors. It’s essentially the strategy that Canada used vis-à-vis the U.S. for decades, and the reason why Ontario’s manufacturing base has been shrinking now that the loonie is near par.

At the same time, as a big European exporter, Germany carries a huge trade surplus—about $184.9 billion in 2009—while countries like Portugal and Spain have negative balances. It’s not an equitable relationship. “Germany is also responsible for the problems in Europe because we were so focused on an export-oriented strategy, becoming more competitive and relying completely on foreign demand to push our economy,” says Herzog-Stein. “So now it’s very crucial that Germany turn around and not only provide enough domestic demand so that the German economy can grow, but that it also helps other countries profit. I think that’s the responsibility of the largest country, and of those who can afford the burden. And we can afford it.”