Lands of the cautiously rising sun

Is Germany's economy following the path of Japan's? Until recently that prospect brought fear. Now it brings a glimmer of hope.

Germany has spent the past year or so hoping to avoid becoming the next Japan. Disappointing growth, dilatory monetary policy, dysfunctional banks and the prospect of deflation all suggested that Germany might be heading for a long period of economic stagnation like the one Japan had been suffering until recently. But now the prospects of both countries—the world's second and third largest economies, respectively—are looking less gloomy. Spurred by rising exports to a recovering world economy, Japan's real GDP grew at an annualised rate of 2.2% in the third quarter, according to figures released on Friday November 14th—the country's seventh consecutive quarter of growth. Germany, mired in recession since last winter, is now being pulled along by the same global recovery. According to figures released last week, its economy grew by 0.9% in the third quarter (at an annualised rate) after shrinking for three quarters in a row. Perhaps following in Japan's footsteps is not so bad after all.

This cyclical turnaround should not obscure the deeper problems that still beset the two economic giants. Japan still suffers from "stubborn" deflation, in the words of Heizo Takenaka, Japan's financial-affairs minister. The country is producing more, but the prices it can fetch for those products are falling just as quickly. As a result, in nominal terms, Japan’s economy actually shrank in the third quarter. Such stubborn deflation makes life harder for borrowers. On Friday, Japan's Financial Services Agency said that the country's big banks ought to set aside ￥900 billion ($8.3 billion) to cover losses on loans. Stockmarket investors, who have been betting on a recovery for most of this year, took some of their chips off the table on Monday, bringing the Nikkei average below 10,000 for the first time in three months.

The German recovery is heavily reliant on foreign demand. Europe's titan has been waiting supine for America to pull it out of trouble. Foreign orders for German manufactured goods shot up in the third quarter by 8.9% at an annual pace. Domestic orders grew by only 1%. Germany is good at supplying other countries’ investment booms, not so good at generating one of its own.

Both countries remain vulnerable to a falling dollar. The euro has strengthened by 35% against the dollar in the past two years. The yen has strengthened to 108 to the dollar, from around 120 in the summer. Many Japanese exporters, such as Sony, plan their operations on the assumption the yen will be no stronger than 115 to the dollar. They can take some comfort in the knowledge that the Japanese authorities, which have already spent over ￥13 trillion this year trying to keep its value down, will do their best to slow any further appreciation. But the European Central Bank will not sell one single euro to help out Germany's exporters.

Both economies, once widely-admired growth machines, are now in need of fundamental re-engineering. But the will to reform is frustrated by the dead hand of the past. Both countries have ageing populations, a bloated capital stock, and vested interests opposed to change. In the eyes of some, to tinker with the economic model is to risk dismantling the social order.

On November 9th, Japanese voters risked a little tinkering with the political order. They gave the opposition Democratic Party of Japan (DPJ) 40 extra seats and, by doing so, gave the ruling Liberal Democratic Party (LDP) its first serious challenger in half a century (see second chart). In general, of course, the opposition’s job is to oppose. But what if the opposition is more radical than the government? What if it wants to do more, faster? Junichiro Koizumi's government strikes some radical notes, but the chief opponents of his reforms belong to his own party: the political patrons of the post office he wants to privatise or the rural constituencies he wants to stop subsidising. In this respect, his position is similar to that of Gerhard Schroeder, Germany's chancellor. His wish to reform the country's labour laws and welfare benefits is largely shared by the opposition Christian Democrats (CDU) and Christian Social Union (CSU), while being opposed fiercely by elements of his own Social Democratic Party (SPD).

Many Japan-watchers hope that a stronger opposition will embolden Mr Koizumi. The DPJ and Mr Koizumi's wing of the LDP must now compete for the reform mantle. In this, the parallels with Germany may again be instructive. Mr Schroeder promised great things when running for his first term as chancellor, won easily, and then failed to deliver. He only just squeaked through to re-election last year, and, faced with a strengthened opposition, his spine has stiffened. He has staked his political future on forcing through a raft of reforms dubbed Agenda 2010.

By stealing their best tunes, Mr Schroeder has put the opposition in an awkward spot: if they oppose the government, they will stymie reform; but if they back reform, they may bolster the government. In the Bundesrat, Germany's upper house, the CDU-CSU alliance has a majority. This gives it the power to block and delay Mr Schroeder's Agenda 2010 at will. Earlier in the year, the opposition chose to co-operate with the chancellor on his health-care reforms. But when presented with Mr Schroeder's proposals to streamline unemployment benefits and cut taxes by EURO 5.6 billion ($17.9 billion) next year, it was more than they could bear to help him a second time. Their no vote on November 7th has consigned Mr Schroeder's proposals to the purgatory of the "mediation committee", where the two houses must hash out a compromise over the next month. Before then, Mr Schroeder must endure purgatory of a different kind at what promises to be a fractious SPD party conference beginning on Monday November 17th. Dealing with the official opposition may be easy by comparison.

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