July 18 (Bloomberg) -- We have become used to reading about the dire state of the German economy. Unemployment soars, incomes flag, the birthrate declines, and the government stumbles toward an almost certain electoral defeat.

That's why it comes as a surprise to read about an economy of a German-speaking country that is doing pretty well.

In a quiet way, Austria has been consistently outperforming its close cultural and linguistic neighbor. There are lessons in that about where Germany itself went wrong, and about its prospects for transforming itself in the years ahead.

``Reforms have been carried out in Austria faster,'' said Marcus Scheiblecker, an economist at the Austrian Institute for Economic Research in Vienna, in an e-mailed response to questions. ``Furthermore, labor markets in Austria are more flexible, making enterprises not so hesitant to hire,'' he added.

In terms of economic history, structure and prospects, Austria and Germany are about as similar as any two countries can possibly be. Clearly, Austria is a lot smaller, with a population of 8.1 million compared with Germany's 82 million people. Yet both nations are rooted in high-end manufacturing, are strong exporters and share the same language and culture. And both are, of course, members of the European Union and the euro region.

Yet, the divergence in their economic performance has been striking in the past few years.

Fewer Out of Work

In May, the Austrian unemployment rate was 4.6 percent, compared with 9.6 percent in Germany, according to seasonally adjusted figures compiled by Eurostat, the EU's statistics office in Luxembourg. Austria has one of the lowest jobless rates among the 12 countries sharing the euro. Only Ireland had a lower unemployment rate in May.

Economic growth is robust, at least by the feeble standards of the euro area. Austria's economy expanded 2 percent in the first quarter, according to the Austrian Institute for Economic Research. The euro area grew 1.3 percent in the same period. The Austrian National Bank forecasts 2.2 percent growth for the country next year, though rising oil prices may trim that figure.

The trade balance is strong. In June, the country reported a surplus of 244.7 million euros ($294.5 million) for April, after a deficit of 74.3 million euros a year earlier.

The Austrian picture is respectable rather than astounding. Still, it's markedly better than the German situation. The Berlin- based DIW institute on June 29 cut its forecast for economic growth this year to 0.9 percent, half the figure it previously predicted. Austria is doing twice as well as that.

``The Austrian economy is maintaining its position among the top performing European economies,'' the Paris-based Organization for Economic Cooperation and Development said in May.

Stock Market

Austria's trouncing of many of its neighbors has been most visible in its stock market. The Austrian Traded Index rose 34 percent in 2003, 57 percent in 2004, and 26 percent so far this year. That makes it one of Europe's best-performing markets over the last three years.

Indeed, Germans themselves have been noticing the prospects are better across their southern border. Magazines have been running interviews with Germans going to Austria to find work. That rarely happened in the past -- indeed it was always Austrians who headed to the bigger, richer country to make their mark.

(There is a telling comparison with the relationship between the U.K. and Ireland. The Irish have been consistently besting the British in recent years, and are now richer, measured by gross domestic product per capita. The U.K. press has been churning out stories of British builders going to Ireland for work -- a stunning reversal of several hundred years of history.)

So what went right in Austria?

Two factors worked to its advantage compared with Germany.

German Reunification

First, Germany had to deal with reunification. That imposed huge costs on its economy, leaving a lasting burden. Austria hasn't had to face anything on that scale (at least not since it combined to form a dual monarchy with central European countries in the 1860s).

Next, Austria's geographical and cultural proximity to the booming new economies of eastern Europe helps as well. Vienna is emerging as one of the hubs of trade with that region. Austrian Airlines Group, for example, already has flights to more than 30 eastern European cities and is planning to expand in the region.

Remember, Austria and Hungary were part of the same empire for a big chunk of their history. Austrians have become the natural middlemen for the booming trade between eastern and western Europe.

Pension Overhaul

Still, those factors aside, Austria also started reshaping its welfare state much earlier than Germany did.

Pension systems have been overhauled. The labor markets have been freed up. Flexibility has been built into the economy in a way that it hasn't in Germany. Scheiblecker says that although Germany is still competitive -- it was the world's No. 1 exporter in dollar terms last year -- Austria has done even better by keeping a firm lid on labor costs, particularly in the manufacturing sector.

The lesson for the bigger of the two German-speaking economies is simple. If Austria can prosper, so can Germany. Austria's big cousin just needs to find the will power to change.

To contact the writer of this column: Matthew Lynn in London at matthewlynn@bloomberg.net.

Last Updated: July 17, 2005 19:04 EDT