It was once the powerhouse of Europe. A place where social stability was seemingly guaranteed. With a skilled labour force on tap, high productivity was a given. Coupled with a strong belief in research & development, and a fabled contract between management and unions, so-called 'Rhineland capitalism' was long-regarded with envy.

Now there seems uncertainty. The system which allowed Germany to become the third largest economy in the world is under pressure. Despite the championing of such figures as Will Hutton and the advantages of 'stakeholder capitalism', Anglo-Saxon economists shake their heads when talking of the Rheinish miracle.

Notwithstanding some signs of a tentative recovery, the country is still counting the costs of reunification. An expensive entry into the Euro and a reluctance for reform – among a populace used to generous benefits – have further complicated matters.

As Germany grapples with recession, budget deficit, corporate downsizing, and more than 4.5 million people out of work, everyone agrees that something must be done. Chancellor Gerhard Schröder has faced down rebels from his Social Democratic Party (SPD) to push through key social and economic reforms. But confronting state-heavy Rheinish capitalism is not easy.

''Germany is already rich, it is just not growing very fast,'' explained Andrew Warner recently, of Harvard University's Center for International Development. The country was placed 24th in an exhaustive competitiveness study commissioned last year by the World Economic Forum in Switzerland, trailing well behind the United States at No. 3, Britain at No. 4 and the Netherlands at No. 7.

''Germany would change dramatically in our rankings if it had a leaner government, lower taxes and more labour market flexibility,'' said Warner, who carried out the study. ''It could jump 10 or 15 points.''

The state-run pension system, which eats nearly 11 percent of GDP, is far too expensive, he said. At $32 an hour, the average German worker still costs more than in any of the 52 other countries surveyed. Even with unprecedented concessions by German unions in recent years, the survey ranks German labour flexibility 51st out of the 53 countries. Redundancy is notoriously difficult and corporate taxes are the highest in the world.

But is it all bad? Are there lessons for better corporate governance amidst Germany's besieged economic foundations? After all, it has a long-held reputation for its commercial stability and harmony, thanks to a strongly-ingrained management culture. And interestingly enough, the German government has recently introduced a new corporate governance code.

The Guardian's Larry Elliott argues: "The US [economic] model, hailed as the only way to do business, is being tarnished daily by the unfolding tale of corporate malfeasance, itself the by-product of a speculative bubble that disguised the true state of the world's biggest economy. If ever there was a time for traditional German virtues – long-termism, quality, trust-based business relationships – then this should be it."

Just over a decade ago, this might have been the case. In his book Capitalism v. Capitalism, 1992, the former director of the French State Planning Office, Michel Albert, argued: "The Rhineland model...attaches great value to collective success, consensus and long-term concerns...The last ten years have demonstrated that the Rhineland model, that up to now was not seen as a separate system, is both fairer and more efficient [than its Anglo-Saxon equivalent]."

Professor Ken Peasnell, of Lancaster University Management School, puts it thus: "For years Germany and Japan were widely touted as countries which had got it right and we had got it wrong."

Like so many things German, the management culture harks back to the medieval guild and merchant tradition. It has been characterised by seeking market share rather than market domination. Many companies compete – at least historically – for a specific niche and despise price competition. They have engaged in what is described as Leistungswettbewerb, competition on the basis of excellence in their products and services. Some say the nation also has a paternalist tradition with regard to welfare, dating back at least to Bismarck's time.

In turn, the system of co-determination, Mitbestimmung – the post-war compact between German unions and management (and strongly influenced by British trade unionists) – allows German workers to sit on governing boards or on factory councils of most German firms. To its defenders, it is an ideal way of reconciling apparent opposites.

Says John Kaler of Plymouth University Business School: "If I had to pick any one factor as the most significant here, it would be the influence of Catholic social teaching – with its rejection of both liberalism and socialism – in favour of partnership between capital and labour. It's no accident, I think, that the prevailing system of corporate governance in Germany was established by a Catholic-dominated Christian Democrat party, in a West German state that was proportionally more Catholic than Germany as a whole."

Co-determination did not come about in a single step. It evolved and expanded through five different West German laws, beginning in 1951 and continuing until 1976. Similar to the 'corporatism' of Japan, it takes place through two structures, the Aufsichtsrat (supervisory board) in a large enterprise and/or the Betriebsrat (factory council) in most companies.

Over two-thirds of all German firms have a Betriebsrat. Only about one-fourth have an Aufsichtsrat (if over 2,000 employees). Many large firms have both. If so, the workers are twice represented. Depending on the size of the company, the Aufsichtsrat must have between one-third and one-half worker membership, including union representatives. About half of all workers belong to one of 17 national unions, arraigned along industry lines. The Betriebsrat is composed entirely of employee representatives.

The Aufsichtsrat may only meet four times a year, but the role of its (theoretically) independent directors is to oversee the work of the Vorstand (management board), on which the executive officers sit. For example, it will appoint the firm's auditors. There is equal representation of workers and investors on the supervisory board (usually between 12-20 in total), although the chairperson appointed by the investors often has two votes. "Also, the union and labour representatives have far more say on 'social' issues and less on the financial side," suggests Rory MacDonald, a consultant with Kudos Marketing, who spent several years working and studying in Germany. Shareholders are also represented at general shareholders' meetings.

As Stephan Deutsch, communications manager at the German subsidiary of MCI, points out: "This is the main difference in the structure of a German traded company (AG): while in other countries the board is a seamless structure with directors from inside the company and the outside (independent directors), the AG in Germany has this two-layer structure."

MacDonald talks of "a stakeholder capitalist focus as opposed to the Anglo-Saxon capitalist shareholder focus. In English this means that the company is run for and takes more account of all 'stakeholders' – shareholders, employees, customers, partners, even the local community around the company. This contrasts against the company being run purely in the interests of the shareholders."

"In theory," he suggests, "this means that German companies will take a more long-term view, and are less likely to focus on short-term profit and the short-termist tactics sometimes necessary to hold up a share price."

Recently, the world of Anglo-Saxon commerce and the Rheinish have come into widely-publicised conflict. When British mobile phone company, Vodafone, launched a £120bn offer to buy German engineering-to-telecoms group Mannesmann late in 1999, the bid rapidly turned into a cause célèbre. Hostile bids (the incumbent management hated the idea) from foreign companies were virtually unknown. Germans were aghast and even Chancellor Schröder got involved in the ensuing melée. Only a few in Germany's financial sector seemed to consider the merits of shaking up the status quo. Many saw little wrong with directors sitting on each other's boards, watched over by powerful shareholders from the banking and insurance sector.

However, champions of Rhineland capitalism and particularly the co-determination system contend that scandals such as Enron or Worldcom are less likely to have occurred in Germany, partly because of the supervisory boards. Ken Peasnell says that: "American business has its own problems which are at the other end of the spectrum. The managers are incredibly incentivised to perform. The pay level is vastly higher than their German counterparts. But getting access to information that outsiders don't have can go too far: for example, as in Enron."

In Germany senior executives often have to justify their salary and remuneration packages to the supervisory board – a good thing, say employees and union representatives – and it has even been said that the historically different forms of shareholding within German corporations (shares often being held by banks, for example) might mean investors have a longer-term interest than those focused solely on results in the current quarter or next.

In fact, says Dr Martin Pohl, a consultant for Germany's main construction union (Industriegewerkschaft Bauen - Agrar - Umwelt) and Aufsichtsrat member himself, the supervisory board system has become stronger not weaker in recent years. "Mainly due to the bankruptcy of some companies here and examples like Enron abroad."

From Pohl's perspective, control of a firm's accountants, for example, allows the supervisory board members to examine specific areas of a company operation. This can be a good thing, he argues. "I've asked specific questions of a company which has operations in 38 countries and in various economic sectors," he says. "The management said that the Japanese plant was not doing well and they wanted to move operations to Malaysia, so I wanted to know why it's not doing well and the relevant director has to report back to me on this question."

This doesn't mean that redundancies are opposed with a blanket policy. Far from it, says Pohl. The union-management compact has allowed for retraining and agreement where redundancy has been inevitable, particularly in an industry (construction) which has lost almost half its workforce in 10 years. "In that sense it's very useful for the management, as once [redundancy] negotiations have been completed it can all be done very quickly." Industrial action still remains low as a result, he contends, and unions well-understand a company's need to make money. "It's a rather efficient system and people respect each other better."

However, as Rory MacDonald acknowledges: "Whilst this makes for a far more relaxed, inclusive society, of a type which I personally would rather live in, the sad fact is that in global capitalism it is uncompetitive and does not have a long-term future. At the low end it makes production costs too high and German goods too expensive. At the high end it leads to a brain-drain where the true talent looks to go to US and UK companies where the money lies."

That said, he also believes that with the development of corporate social responsibility (CSR), many Anglo-Saxon corporations are "taking more account of all their stakeholders" – though new regulations in UK and US still focus on the unitary board and strengthening of non-executive directors, rather than moving towards the Rheinish model.

Interestingly, Martin Pohl agrees there are problems, too, in Germany. "People don't always have the time to track what is happening because they might be supervisory members on three or four Aufsichtsrat and it's almost impossible for them to do a good job."

The Allies' post-war reconstructive efforts meant the ownership of many companies ended up interwoven with that of financial institutions. Many independent directors from the banking sector now have a form of control in German business. Board members at one company can hold a lot of control functions at supervisory boards of others, and vice-versa. Professor Ken Peasnell believes that a cosy arrangement can occur when a chief executive retires and joins his corporation's supervisory board. "Often the great and the good from the company follow this route".

"The biggest problems can occur on the capital side," Pohl maintains. "You might have a banker from a bank giving credit to a company, and in which it also owns shares. If he's on the supervisory board he might know the company is not doing well. Does he make decisions in the name of the company – as he is legally obliged to do – or at the same time as employee of the bank?" In another situation, he recalls, a representative from the country's second-largest construction firm was allowed to sit on its main rival, due to a 10 percent shareholding.

However, despite such potential conflicts of interest, Pohl disagrees that foreign investors are necessarily hesitant to move into Germany because of co-determination. "For example, Vodafone is now reporting better [to the supervisory board] than when it was Mannesmann! So I don't think co-determination is limiting decisions on financial matters in a company."

There have been well-documented problems, however. Last year nearly 60 percent of shareholders in airline firm Lufthansa adopted a motion condemning Frank Bsirske, supervisory board vice-chairman and head of the mighty Verdi trade union, for encouraging strikes that cost the airline millions of euros (to be fair, he didn't personally authorise or recommend the strikes, although it was argued he didn't stop his deputies from doing so). "This is the first time a minority motion is endorsed by the majority of equity holders," said Hans-Martin Buhlmann, head of VIP, the association of institutional shareholders that tabled the motion. "It is impossible for the debate on co-determination not to rebound after that."

Whether cumbersome obstacle or harmonious partnership, change is coming. The need to raise ever-increasing amounts of capital has led German firms to turn to foreign equity markets, away from their traditional benefactors in the banking sector. "Outside investors would know that managers might not be pursuing their interests, necessarily," suggests Ken Peasnell. So there have been pressures to move to more open structures, with clearer financial reporting.

Under Germany's new corporate governance code, guidelines will also prohibit union representatives negotiating salaries and being represented on the supervisory board at the same time. Firms breaching any of the corporate guidelines are likely to find themselves de-listed from their stock exchange.

With the European Company Statute about to brought into EU law, the Anglo-Saxon and co-deteminist models are to become more closely acquainted. As far as the European Company is concerned, the problem of dealing with a single all-powerful board of directors or an executive committee with day-to-day responsibility, but answerable to a supervisory body above it, has been neatly side-stepped. Those setting up such a body for the first time can choose between either option.

"This sensible and practical approach could be helpful in the wider debate on Corporate Governance," argues the website for The Institute of Economic and Social Research, in the Hans Böckler Foundation. "It would be a major step forward if the current sterile debate on supposed superiority or alleged convergence of the two systems could be replaced by an attempt to understand them... It does not simply mean that the German legislation should be translated and explained in simple terms to foreign shareholders. German companies should also adopt international standards in terms of transparency and the amount of information they make publicly available."

For Martin Pohl, "there has to be an understanding about each other's system, to find a common way forward and good sense." But, concludes Ken Peasnell, "the trends everywhere are more likely to be toward the Anglo-American model. We are not in the world of company men anymore. Turbulence has removed the self-assured edge of the older large companies. That's the world today, a place where everything is more uncertain. Shareholders have to bear more risk, and with that power moves to shareholders."

This article first appeared in Company & Shareholder magazine, cover feature ©2004