Merkel Moves to Heat Up German Economy

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Kai Pfaffenbach/ Reuters

People rush past a man begging for money in front of a shop window promoting a sale on the main shopping street, Zeil, in downtown Frankfurt

Just a few weeks ago, Chancellor Angela Merkel seemed content to coast along and see just how bad the financial crisis would get before taking action. As world leaders were piling up huge bailouts, Merkel promised only modest aid for the German economy, and members of her Cabinet even ridiculed other European leaders for engaging in a race to see who could spend the most. But as the new year gets under way, Merkel has clearly joined the race and may be moving ahead of the pack.

As temperatures dropped to record lows outside, freezing rail lines and bringing mass transport to a halt, Merkel has huddled with her political allies and opponents alike to hammer out a new approach. The shift comes after a raft of bad economic news, with the government now pressing ahead on a number of fronts. Merkel's coalition nearly doubled its stimulus package to €50 billion this week and is drafting plans for a €100 billion Germany Fund to provide credit for midsize businesses. And Commerzbank, Germany's second biggest bank, has said it is to be partly nationalized. The German government's bank-rescue fund, the Financial Markets Stabilization Fund (SoFFin), will provide €10 billion in fresh cash to Commerzbank in exchange for a 25% stake plus one share in the bank. "We are weatherproofing our bank for an economically stormy environment. This will enable us to fulfill our responsibility to offer loans to the German economy and to ensure we will continue to be a reliable partner for our clients," said Martin Blessing, chairman of the Commerzbank Board of managing directors.

Government officials say the stimulus money will be earmarked for investment in long-term infrastructure projects that will help revive the construction industry, for aid to companies to reduce layoffs and for education. Data on German industrial orders indicate there will be no respite soon. Figures out Thursday showed orders fell a huge 6% in November from the month before, and orders in the final quarter of 2008 were down 43.6% from the same quarter a year ago. (See pictures of the global financial crisis.)

The government is also hatching new plans to support small businesses, many of which are family-owned, have little access to capital markets and are getting squeezed by the credit crunch. Ronald Pofalla, the general secretary of Merkel's Christian Democratic Union (CDU), says, "We think that now is the right time to consider creating a Germany Fund, especially to help midsize industry in this difficult period and ensure optimal availability of financing."

The change in Merkel's thinking was forced by the acceptance of economic and political realities. The German economy is sinking faster than most experts thought a month ago. Just this week, Germany's three-year job boom came to a screeching halt when the labor office reported that in December unemployment rose by a seasonally adjusted 18,000, nearly twice the level predicted in a poll of 30 economists by the news agency Bloomberg. It was the first increase in joblessness since February 2006. "The economic crisis has reached the labor market," said Frank-Juergen Weise, head of the Labor Agency. On Thursday, the government reported that German exports, the main driver of the country's economy, plunged 10.6% in November from the month before, the largest monthly decline since 1969. Joerg Kraemer, a Commerzbank economist, says the data support a bleak outlook on the overall economy. "We continue to expect German GDP to decline between 2% and 3% this year," says Kraemer.

And Merkel faces a re-election fight in September. Her main opponents are her current partners in government, the Social Democratic Party (SPD). Both parties will be measured by their response to the financial crisis. An early test comes on Jan. 18, when the first of several key state and municipal elections takes place in Hesse. According to polls, Merkel's CDU has a good chance of beating the SPD. It was against this political backdrop that Merkel this week dropped her vehement opposition to cutting taxes, under pressure from allies within her conservative alliance. "The people expect tax relief," said Bavarian Premier Horst Seehofer, who has fought Merkel for weeks to push through tax cuts. "It's not about winners and losers, but doing the right thing."

Merkel is also returning to the international stage. After being seen as a major power broker in the first two years of her administration — Forbes has twice picked her as the world's most powerful woman — when the financial crisis hit, Merkel seemed to wilt, clueless as to how to respond. But now she is moving out in front again, showing that Germany is keen to play an active role in resolving international crises. Germany was quick to supply troops to fight pirates in the Gulf of Aden, and Merkel has been urging a cease-fire in Gaza and has taken the lead in European efforts to deflate the gas war between Russia and Ukraine. Germany is not worried about going without heat — its gas reserves cover about 25% of its annual gas consumption — but when gas deliveries to Germany abruptly stopped this week, Merkel went into action to try to keep the political conflict between Russia and Ukraine from escalating and to ensure the long-term security of gas supplies. She called Russian Prime Minister Vladimir Putin and his Ukranian counterpart Yulia Tymoshenko on Wednesday, persuading them to allow European experts to help resolve the conflict.

Merkel is also keen to play an active role in shaping the debate about what international financial market regulation should look like after the crisis. At the Paris conference on the future of capitalism hosted this week by Nicolas Sarkozy and Tony Blair, Merkel was pushing for greater regulation of financial markets, according to government officials. The German delegation to the G20, which meets again in April, has been pressing for tough regulation of banks, hedge funds and private equity. Next week, Merkel plays host to British Prime Minister Gordon Brown, whose own bailout plans created the template for the U.S.'s, to discuss efforts to revive the European economy. (Watch a TIME video with Gordon Brown.)

The German Chancellor may not have started from pole position, but she is catching up in the race to provide a solution to Europe's economic woes. At last, she is doing something. The economy, and voters, will decide if she's doing the right thing.

See pictures of East Germany making light of its past.

Read how Adolf Merckle became a financial casualty.