Santa Claus was a Turkish Dervish who in the middle ages traveled through Central and Northern Europe, giving gifts to children and claiming to be the re-incarnation of Greek St. Nicholas, who preached in the fourth century. Together with the Christmas tree, Sankt Niklaus, as the Germans called the benefactor, became a central figure in German Christmas habits. In the seventeenth and eighteenth centuries, German immigrants, the so-called Pennsylvania Dutch, carried them to the United States, from where they later spread to the rest of the world, if only as marketing icons for Coca Cola.

In 2006, Santa Claus again came from Germany with a sack full of good news about the business cycle. The Ifo business climate indicator, which had been rising since the second half of 2005, reached its highest level since Germany’s unification boom. After years of stagnant growth, the German economy has been growing at an annual rate of about 2.5% in 2006. While the value-added tax will rise by three percentage points in 2007, economic growth will remain healthy, at nearly 2%.

The Ifo business climate indicator is generated every month by asking 7,000 firms, primarily from German manufacturing industry, about their current business situation and their expectations for the next six months. It has been produced for half a century, and, according to a poll conducted by Reuters, it is Europe’s most prominent business indicator, outperforming even official EU indicators.

In early 2006, when the Ifo indicator foresaw an economic upturn while the German Federal Statistical Office reported meager quarterly GDP growth figures, some commentators scoffed. But when the Office later revised its data upward, it became clear that the Ifo indicator was right.

This is good news not only for Germany, but also for Europe as a whole, as the business climate for German manufacturers reflects that in the rest of Europe – their main export market. In 2006, the euro-zone economies may have grown by 2.7% on average, and should grow by 2.2% in 2007.

However, there are substantial differences among these economies. Some are doing very well, indeed. In 2006, Ireland’s GDP may grow by 5.2%, Finland’s by 5.8% and Spain’s by 3.7%. By contrast, Portugal and Italy are currently Europe’s laggards, with growth rates of just 1.5% and 1.7%, respectively, in 2006. Somewhat surprisingly, France also seems to be having a hard time keeping up, with a below-average growth rate of 2.1%.

More importantly, despite the promising news coming from Germany these days, it would be an overstatement to call the German economy a growth engine for Europe, given that it, too, is growing more slowly than the euro zone as a whole. Nevertheless, given that, aside from Italy, Germany recorded the EU’s lowest growth rate from 1995 to 2005, the improving performance of Europe’s largest economy is a source of relief. While the US economy begins to stagnate, across the Atlantic the business cycle seems to have turned upward at last.

As the world’s second largest exporter, the German boom was initially driven by foreign sales. Indeed, German exports grew by 6.9% in 2005 and 11.2% in 2006. But, given increasing capacity utilization in the export industries, as well as higher investment requirements owing to the normal capital replacement cycle, domestic investment demand is now also rising. Annual investment in equipment increased by 7.7% in 2006, while overall investment, including construction, was up by 5%. Although Germany’s net investment as a share of GNP remains one of the lowest in the developed world, the additional investment implies more jobs in the construction and machine tool industries, followed by rising employment wherever the investment is placed.

Unfortunately, however, the upturn in the business cycle cannot be taken as a sign of structural improvement in the German economy. Since 1970, Germany’s business cycles have been surprisingly regular: a downswing in the first half of each decade, followed by an upswing in the second half. Unemployment has always reached its lowest point at the end of the decade or a year later, driven by cyclical movements in equipment investment that followed the textbook multiplier-accelerator model. However, unemployment has increased from one boom to the next, with the lowest rate in each business cycle following a linear upward trend.

It is too early to speculate whether Germany will be able to break this pattern and reverse that trend. Despite the boom, and despite various programs that stimulated part-time employment, unemployment in absolute terms was about 4.5 million in 2006 and will be 4.1 million in 2007, compared to the last low point of 3.9 million in 2000. Germany’s economic development will have to be observed well into the next full decade in order to judge the potential for a structural trend reversal.

Nevertheless, there is every reason to expect the German economy’s upswing to continue for the time being. With some luck, good times for Germany, and for Europe as a whole, could last until the end of the decade.

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