Merkel must keep her promise

Not many politicians get a dress rehearsal for government. German Chancellor Angela Merkel is one of them.

In retrospect, the first four years of Merkel's time in office might well prove to be a trial run. Now with a successful campaign for re-election behind her, and at the head of a centre-right government rather than the uneasy 'grand coalition' with Social Democrats of her first term, she has a chance to show what she is genuinely made of.

In her next term, she has the opportunity to be what she promised four years ago: a reforming, pro-business leader in the style of Margaret Thatcher of the UK two decades ago.

Germany certainly needs it. So does Europe. The pace of change in Germany has been glacial. It needs a dynamic liberalising of its market to unleash the kind of entrepreneurial vigour that transformed its economy in the 1950s.

The euro-area economy needs one country to lead it. France under President Nicolas Sarkozy appears to have lost interest in economic progress. The UK looks set to spend a decade dealing with the mess created by the credit crunch. Spain is no better. If any country is going to have the capacity to lead Europe out of this recession, it can only be Germany. Will it happen? The opportunity is certainly there.

The German elections held over the weekend turned into an easy victory for the centre-right. Instead of having to govern in coalition with the Social Democrats, the way is now clear for Merkel to form a coalition with the pro-market Free Democratic Party.

Moreover, the left now looks to be permanently fractured. The Social Democrats scored a dismal 23 per cent of the vote. That wasn't so much because Germans have drifted right because the left has split. The anti-capitalist Left Party won 11.9 per cent while the Greens scored 10.7 per cent. That matters. With the left broken into three parties, it is unlikely it can win power again for at least a generation. Merkel, together with the FDP, now has the chance to shift Germany dramatically in a pro-market direction.

That doesn't mean it will happen. The markets were disappointed by Merkel's first term. After campaigning on a radical platform, prompting hopes among investors, she turned into a traditional German consensus politician. That might have been because she was hemmed in by a coalition with the Social Democrats. It might be because those are her core beliefs. We are probably about to find out.

"A CDU/CSU-FDP coalition could bring about far-reaching reforms," Barclays chief economist Thorsten Polleit said in a note to investors on the elections.

Indeed it could. The Free Democrats promised tax reform, with a top rate of 35 per cent for income tax, and a bottom rate of 10 per cent. A plan like that would almost make Germany a tax haven. It might even turn Frankfurt back into a major financial centre once again: just think about the comparison with the top tax rate of 50 per cent planned for London's financiers.

There is little debate about the kind of reform that Germany needs.

Its big-company, export-led, manufacturing-dominated economy must be reinvented for the 21st century. It needs small companies that concentrate as much on design and marketing as on precision engineering; more-flexible employment rules to create new jobs as fast as it gets rid of old ones; a financial sector that can deliver plenty of capital to entrepreneurs; a retail sector that gets Germans shopping again; and a tax system that rewards work and success, instead of punishing it.

The rest of the world tends to view Germany as an intensively conservative country, wedded to its social-market model. But, of course, in the 1950s it was one of the most creatively entrepreneurial countries in the world. With the right policies it can be again.

Germany has a chance to influence how the global economy develops in the next five years in two significant ways. When political leaders talk about rebalancing the global economy, they tend to be referring to China. Yet Germany is the other big economy with a huge trade surplus. A tax-cutting, growing, consuming Germany would be a big step toward that rebalanced economy.

And it could take over the leadership of a European economy that looks bereft of inspiration. With the UK and Spain, the powerhouses of the continent's growth in the past decade, stuck in recessions, growth has to come from somewhere. Germany is the only realistic option. Now it is up to Merkel and her new allies to deliver.