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German chancellor Angela Merkel has put the country back on the road to long-term economic growth

Not so long ago, Germany was, if not the sick man of Europe, at least plagued by a nasty cough. No longer. After almost a decade of poor performance, its economy is growing again and looks set to perform well for some time to come.

Between 1995 and 2005, annual real growth in the German economy averaged just 1.4 per cent compared with 2.9 per cent in the UK and 2.1 per cent in France. At the start of 2007, the figure for annual growth in Germany had jumped to 4 per cent.

Much of the upturn in fortunes has been attributed to Chancellor Angela Merkel, whose market reforms evoke memories of 1980s Britain. While comparisons with die Eiserne Lady were somewhat inevitable (although to English speakers, die Eiserne Kanzlerin may be more of a mouthful), Merkel’s style has been more lowkey than that of Margaret Thatcher. Moreover, many argue that the movement for change started in 2003 with the Hartz labour market reforms under Merkel’s predecessor Gerhard Schröder.

To be fair, German companies had been attempting to rein in costs and wages long before Merkel’s chancellorship but her less firm regulatory grip has abetted their efforts. As a result, many have gained a competitive advantage over their Spanish, French and Italian counterparts, who have struggled to do the same. Germany’s labour market may still be somewhat rigid and expensive but it is starting to show that it can compete with the low-cost competitors from Asia and central Europe.

Merkel may have been somewhat fortunate to be leading her country at a time of rapid global growth yet German industry is making the most of the opportunity. Its manufacturing and capital goods sectors are substantial – much more so than those of the UK, where the economy is more consumer-driven – and crucial to the economic health of the nation.

Many German companies are in as healthy a state as they have been in five years. Consequently, demand for the kind of manufacturing the country specialises in – typically, the more profitable end of final production – is healthy and likely to remain so for the foreseeable future.

An example of this is the construction industry, once considered the motor of the German economy but one which has sputtered for much of the past decade. Encouraged by the market reforms, the construction companies have been steadily trimming their workforce in an effort to become more competitive and their efforts are starting to bear fruit. In the first five months of 2007, German construction firms registered a 4.3 per cent year on year increase in orders and recently HDB, the German builders’ association, revised its forecast for the sector’s annual turnover growth to 5 per cent for 2007.

Exports, another essential ingredient of the German economy, are also experiencing something of a renaissance. As of October 2006, the country’s trade surplus stood at US$23bn and its exports of manufactured goods surpassed even the US. Many German firms which had been languishing since reunification are being put back to work with renewed vigour.

In particular, exports to the Bric economies of Brazil, Russia, India and China are expected to fuel growth.

Naturally, all this good news has boosted the domestic economy. Unemployment levels are at a 14-year low and consumer spending – in the face of a significant VAT hike at the start of the year – is picking up, aided by rising incomes and a boost in demand from Eastern Germany, whose residents are finding jobs easier to come by.

This looks to be the start of a three to four-year period in which the German market is likely to gain plenty of confidence. While it may not equate to the “economic miracle” Germany enjoyed following the Second World War, we may be witnessing something along the lines of ein kleines Wirtschaftswunder.

Nigel Bolton is head of European equities at Scottish Widows Investment Partnership

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