It's all coming together

But the renaissance of European business also owes much to a change of climate in Germany, where many firms are now striking local deals with trade unions to get round inflexible labour practices. Workers at Volkswagen, fearful of losing their jobs, have in effect accepted pay cuts by agreeing to work longer hours for the same money. German firms are investing again after a long pause, profits as a share of national income are rising and business confidence is higher than it has been for years. Some of the reasons behind Germany's recent revival have implications for the whole continent.

The resilience of German business has allowed it to survive a dismal period for the German economy when the bills for unification came in. Germany has always had a rigorous tradition of technical education, which has suited companies concentrating on capital-intensive advanced engineering industries. The country also has a long tradition of exporting advanced products, and not just luxury cars and power stations. The world's biggest industrial-gases company is Germany's Linde; its biggest chemical company is BASF, which has defied the trend for such firms to fragment, as Britain's ICI did. There are other examples in specialist areas, such as Munich's Knorr-Bremse, the world's leading maker of railway brakes.

The struggle in the 1990s to overcome the disadvantages of a strong D-mark sharpened the competitive edge of many German exporters, whereas the Italians relied on devaluation. Since the arrival of the euro German companies have been much more disciplined than British or Italian firms about holding down wages, so they have sustained their advantage. For instance, at Opel, the German arm of General Motors, German workers have sacrificed pay and increased their productivity to hold on to their jobs, whereas the company's British factory on Merseyside has shrunk and may face closure in a couple of years. Ordinary Germans may have found the going tough in recent years, but German business has managed to retain its global competitiveness.

One reason for that may be changes in the financial sector as the country has started to move from a conservative, bank-based capitalism to a more entrepreneurial capital-markets system. The old model served German business well until the 1990s because it meant that companies had stable shareholders willing to stick around for the long term. Companies could plan and invest for the future without worrying too much about short-term ups and downs, which helped many leading German companies to develop and grow. But it has outlived its usefulness.

The new openness in the financial sector has three main causes. First, the introduction of the euro made it easier to compare the performance of different banks, exposing the German ones' low margins. Second, the Basel II accord on banks' reserve assets, due to come into effect next year, is already forcing German banks to pay more attention to the quality of their loan books. And third, the scrapping of the state guarantees enjoyed by Germany's state-owned Landesbanken and Sparkassen, at the insistence of the European Union, has acted as an incentive to banks to improve their profitability.

According to Paul Achleitner, chief financial officer in charge of investment at Allianz, German unification meant that for the first time in decades Germany needed to import capital rather than having enough to spare to export it. “Local banks stopped lending money at subsidised rates and companies needed to raise funds on the international markets. This meant they had to adapt to international norms in everything from accounting to managing for value and concentrating capital in core businesses. Slowly but surely we are seeing the dismantling of Fortress Germany; German companies are now among the most competitive in the world.”

The era of the stolid, traditional Deutschland AG (Germany Inc) is drawing to a close. According to Dirk Schumacher of Goldman Sachs, the collapse of the tech bubble and Germany's tax reform in 2000 were contributory factors. The bubble showed up the weakness in the core lending business of German banks, and the tax reform at last enabled banks to sell their long-standing shareholdings in German companies without incurring huge capital-gains tax bills.

But some observers think Germany has got it only half-right; it still needs to reform its labour market and its welfare system. According to Hans-Werner Sinn, head of the Ifo Institute, an economic-research centre in Munich, Germany needs “more wage negotiation on the level of the firm. The majority of workers in a firm must have the right to override union decisions if they do not like them.” He also thinks welfare should concentrate on topping up low wages rather than providing a substitute income for those not prepared to work at lower rates.