Germany Flexes Some New Muscle

The latest unemployment report adds to the country's gathering momentum. German companies are even getting acquisitive

Is the German economy getting its mojo back? It certainly seems that way. The positive indicators keep coming, most recently a report from the Federal Labor Office that the normal December rise in unemployment was unusually low. That offers hope for a decline in joblessness, the nation's most stubborn economic problem.

And it comes after a series of unexpectedly positive reports on business confidence, industrial orders, and investment that prompted the German Institute for Economic Research in Berlin, a leading think tank, to boost its prognosis for 2006 growth to 1.7% from 1.2%. The European economy is also looking better, with forecasters such as Dresdner Bank predicting growth of 2% for the year, with unemployment falling to 8.1% from 8.5% in 2005.

As if to underline the nation's growing economic confidence, German companies are also getting expansionary. On Jan. 3, Ludwigshafen-based chemical giant BASF (BF ) made a $4.9 billion unsolicited takeover offer for Engelhard (EC ), an Iselin (N.J.)-based chemical maker that has about a third of the U.S. market for automobile catalytic converters. And Dusseldorf steelmaker ThyssenKrupp raised its bid for Canada's Dofasco (T.DFS ) to $63 Canadian ($54.56) per share, from a previous offer of $61.50 ($53.30). ThyssenKrupp is in a bidding war for the Canadian steel and auto-parts maker with Luxembourg-based Arcelor.

THE PAIN IS PAYING OFF. In fact, German corporate aggressiveness and German economic performance are only tenuously linked. BASF, like most of the country's other big companies, has for years been reducing its dependence on the slow-growth domestic economy, which currently provides about 40% of sales. The Engelhard bid is part of a continuing effort to build market share in the U.S. "BASF is a global company. There is a low correlation with the German economy," says Sasa Todorovic, a fund manager at Frankfurt Trust Investment.

A common thread does link corporate and macroeconomic performance, though: Years of restructuring, often painful, is paying off. In BASF's case, the company has cut $570 million in costs from its German operations. Job reductions and divestments led to a net 5% decrease in global employment, to 80,695. The leaner operations helped third-quarter profit more than double, to $970 million, on sales of $12.4 billion -- and gave BASF the reserves it needs to offer all cash for Engelhard.

The German government cut benefits for long-term unemployed people last year and put more pressure on them to move or accept lower-paying jobs. Though highly unpopular, the reforms contributed to the unexpectedly small increase in December joblessness. The number of unemployed rose by 75,000, to 4.6 million, or 11.1%. That's well below the average December increase of 175,000 seen in the last five years. If Germany can finally get unemployment under control, consumption -- long the missing element in the country's growth -- might finally begin to rise.

"DAMPENING EFFECT." The question is whether Germany can continue to gain momentum -- or will the growth peter out after a year or so? Unfortunately, based on current trends, growth will probably slow in 2006 as corporate investment in equipment peaks and the government raises the value-added tax to bring the national budget into accord with European Union guidelines. Dresdner Bank expects growth in 2007 to slide to an unimpressive 1% as the higher sales tax drains some $30 million from consumption. ''The dampening effect is coming from government policy,'' says Dresdner economist Wolfgang Leim.

But slower growth could be avoided. The new government led by Christian Democrat Angela Merkel is riding high in the polls. If Merkel's popularity holds, she might have the political clout needed to cut government spending rather than raising taxes. That and a steady drop in unemployment could boost consumption. If oil prices hold steady, the world economy remains strong, and there are no other shocks, 2006 could indeed be the year when mojo returned to Deutschland.

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Ewing is BusinessWeek's Frankfurt bureau chief

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