Opinion: Germany Should Capitalize on Current Optimism

Finally: Germany's economy has gained a foothold and is starting to climb. While the economy was stagnant in the last quarter of 2005, the first quarter of the current year saw 0.4 percent growth, and all signs show that trend improving. The government's growth forecast of 1.6 percent may well be reached this year -- and perhaps even exceeded.

Such growth is desperately needed in order to solve the country's diverse economic problems, from joblessness to the growing national debt. The old rule still applies: Growth isn't everything, but without growth, everything comes to nothing.

There have been some recognizable, early successes. Job losses are narrowing, and tax revenue is up. Semiannual tax estimates showed a likely 8.1 billion euro ($10.4 billion) increase in revenue for the state this year, compared to last November.

Bid to meet EU stability criteria

That's good news, because the increase is coming, above all, from income-related corporate and trade taxes, as well as income taxes from executives and employees. Businesses and business owners are doing better this year than last, with estimations running to a revenue increase of more than 20 billion euros.

It seems likely that by 2007 at the latest, Germany will meet the EU's deficit criteria for the European Growth and Stability Pact, which was set up alongside the introduction of the euro currency. For the past four years, Germany has breached the criteria set by the pact, which limits government budget deficits to 3 percent of the gross domestic product.

German Chancellor Angela Merkel has said she is determined to meet the rules next year. The problem with this, however, is that if the criteria are met, it will not be because of reductions in state spending but thanks to greater tax revenues.

A planned 3 percent increase in the value-added tax starting in 2007 is likely to significantly curtail private consumption. So anyone planning to buy a new car, washing machine or set of living-room furniture will be sure to buy it before the end of December, as such goods will be at least 3 percent more expensive in 2007. Experience also shows that businesses often take such tax increases as an opportunity to boost prices a little further.

Illusory gains?

This, in turn, means personal consumption is likely to show a strong increase in the second half of the year -- and is just as likely to plummet in the beginning of next year. Thus any economic improvement tied to personal consumption is more illusory than real.

For years, the economic mood of the country was worse than the reality. Now, the opposite is true. Optimism has displaced reality. This is a welcome phenomenon since a large part of successful economic policy relies on applied psychology. And it's especially true when dealing with private consumption, which accounts for nearly two-thirds of the gross national product.

The German government is trying to stimulate the economy this year to such a degree that it can withstand the major setbacks that are widely expected with increasing the VAT tax next year. At this point, the government can't do away with the tax increase -- the money has long been accounted for. So it is left hoping that the economy will in fact become so strong that it can survive the unavoidable blow.