New questions for Germany

ECONOMIC VIEW

The leak yesterday of the new forecast by the German government that growth this year would be only 1.5 per cent coincided with tough decisions at Daimler-Benz over its Fokker affiliate in the Netherlands. The latter has both symbolic and practical importance, and follows Daimler- Benz's decision to dismember its loss-making consumer products subsidiary, AEG.

It is symbolic in the sense that Germany's largest manufacturing company is now prepared to walk away from failure, rather than commit more resources into trying to turn things round. And it is practical in that this not only throws out of work people who might have assumed a few years ago that they had reasonable job security; it demonstrates to others once again that German companies are unable to offer job security.

That affects the former piece of news, the downgrading of German growth prospects, for the greater the sense of job insecurity in Germany (or for that matter, the Netherlands) the greater the resistance among German consumers to go out and spend. These dynamics - the fact that worsening job prospects cut consumption which in turn cuts final demand which in turn is likely to lead to further job cuts - suggest that even the 1.5 per cent forecast may prove over-optimistic. Put it this way: the forecast is more likely to be under-shot than over-shot, which means that the former West Germany is expected to grow at only 1 per cent, with the faster growth being all in the east.

This downgrading of German growth prospects has already led to several lines of debate. One is the implications for Germany's ability to meet the Maastricht convergence criteria, for growth at that level will lead to an increase in the budget deficit which last year was already at 3.6 per cent of GDP. To tighten fiscal policy in near-recession would be deeply unpopular and perhaps even counter-productive since it would slow growth further.

A second line of debate concerns the monetary implications: the extent to which the Bundesbank will eventually be forced to drop interest rates, and the impact on its neighbours if it is tardy in so doing.

But I think there is another and ultimately more important issue - yes, even more important than Maastricht - which is the extent to which Germany is making the necessary structural changes in re-orienting its economy away from manufacturing and towards services. The downsizing and refocusing of the Daimler-Benz growth obviously represents one side of the shift. So Germany can cut, but the financial imperative to do so had become overwhelming. Can it grow?

I do not think it is possible to give a satisfactory answer to this at this stage, but I do think it is possible to set the stage. It is important to distinguish between services which are internationally traded and those which are not. Of course Germany can develop new service industries for the domestic market. Its service sector is smaller than that of the UK, France or Italy, but it is not so different from that of other European economies.

In services which are not internationally traded, such as retailing, the quality of output - in terms of the level of convenience to the customer and the hours at which service is available - is significantly lower than that of most other developed nations.

There are other examples of inefficiency, such as the cost of package holidays or of telecommunications, where again Germany's service industries have failed to move with the times.

But in those services which are internationally traded, it is harder to see inefficiencies. Take finance: the explosive growth of the German banks abroad, buying top UK merchant banks like Kleinwort and Morgan Grenfell, shows a willingness and ability to play out from the domestic base and use home-generated money to push their way into the global marketplace. It is very impressive.

The weaknesses come in two main areas. One is the areas in which, for social or linguistic reasons, Germany has historically found difficult to be competitive. An obvious example is tourism, with foreigners reluctant to spend their holidays in Germany. Another is higher education, which takes up to six years to lift students to the level which the British university system does in three.

More serious, because it is growing so fast, is the situation in the entertainment industries. The problem is not just that foreigners do not watch German films; Germans do not watch them either, and half the films made in Germany are never shown to a paying audience. It is Germany's failure to develop exports in this sort of "soft" industry which accounts for the fact that it has the second largest deficit (after Japan) on trade in intellectual property.

The other area of weakness is entrepreneurship. Our own experience shows how the key generator of jobs is the private sector service industries: tiny companies thinking of new services to sell both at home and abroad. It is not just a problem of new company creation, though that is a large part of it.

It is not just a problem of the lack of growth in self-employment, which is exceptionally low by UK standards. It is equally that the companies founded by the post-war generation tend to be in manufacturing, and face the same squeeze on costs as their larger cousins. In the past, when large companies in Germany have downsized, any labour shed has been picked up by smaller ones. That is not happening this time .

So the structural problem is in part a generational problem. The brilliant companies created or revived in the 1950s and 1960s are now middle-aged, and they are not being replaced, or rather not at an adequate pace. Creating the new industries takes an element of discomfort, even fear. Things like those growth figures or the plight of Daimler-Benz supply this. But it takes time too.