http://online.wsj.com/public/article/SB115698141965850020-VAmFFxk2HZ8Kb48bNj_g329AOHI_20060906.html?mod=regionallinks

BERLIN -- German Chancellor Angela Merkel's authority is in decline as her fragile coalition government proves unable to capitalize on an economic upswing to introduce badly needed changes in the world's third-biggest national economy.

Falling approval ratings for Ms. Merkel and her government are compounding the problem by making it harder for the already fractious coalition to agree on how to create jobs and turn the economic improvement into better growth over a longer period.

Ms. Merkel is playing down the negative. She promised this week that her left-right coalition government would push forward long-promised overhauls of the health-care system and business taxes. At the same time, however, she was forced to admit: "Citizen support isn't there."

Indeed, her approval rating has declined to 56%, far below the 80% approval she enjoyed early this year. Voter support is falling for her conservative Christian Democratic Union and its coalition partner, the left-leaning Social Democrats. That, in turn, is leading to squabbling inside the government about the pace and direction of economic retooling at a critical time. Germany, the powerhouse of the European economy, is enjoying a moderate economic recovery driven by improved efficiency in German industry. The economy is expected to expand by more than 2% this year after five years of stagnation.

But faster growth is only slowly lowering the country's high unemployment rate of more than 10% amid continuing labor-market weaknesses, including strict regulations on layoffs and high payroll taxes used to fund welfare supports.

Some German business leaders fear improved growth could reduce the pressure on politicians to make unpopular changes, such as loosening labor laws. "The present cyclical upturn is no reason to lean back, but rather a chance to introduce reforms quickly," J¨¹rgen Thumann, the influential head of the Federation of German Industries, said. He attacked the government for proposing no new major initiatives, beyond implementing policies already agreed upon.

The longer-term outlook for Germany's economy, with its relatively generous social-safety net, remains bleak because of the surging cost of health care and pensions as the population ages, combined with a steady loss of jobs in manufacturing to lower-cost countries in Eastern Europe and Asia.

Ms. Merkel isn't alone in her difficulties. Governments in France and Italy also have had problems enacting economic changes, particularly regarding labor. Long a model for its neighbors, in recent years Germany has become a warning to the rest of Europe about the consequences of adapting too slowly to a changing world by failing to help new industries expand to replace manufacturing-job losses.

Ms. Merkel ran for office a year ago as a free-market economic radical in the mold of Britain's former prime minister Margaret Thatcher, promising to renew Germany's economic dynamism by deregulating the labor market. But a disappointing showing in national elections forced her into a coalition with her main rivals, the Social Democrats. They have strong ties to labor unions and mostly oppose freer markets and fewer protections for workers.

Since taking office in November, Ms. Merkel has sought to forge compromises. Many Germans initially warmed to their new chancellor's pragmatic, low-key style.

Now, they increasingly are unsure of what she really stands for.

"She has no identity. This is her main problem," said Manfred G¨¹llner, head of market-research institute Forsa in Berlin. "The early euphoria about her is subsiding as people look at what is actually being achieved."

Supporters of Ms. Merkel's conservatives are growing frustrated. They say compromises with the left are slowing market-oriented changes to the economy. Business leaders welcomed the government's plan to cut the headline rate of tax on corporate income from nearly 39% to less than 30%, but were angered by a proposal to recoup some lost revenue by taxing companies' interest expenses.

Voter support for Ms. Merkel's Christian Democratic Union has fallen to 30%, according to a Forsa poll this week, down from an election result of 35% last year. The party would need well more than 40% support to form a government without an alliance with another major party.

The CDU's partners in power, the Social Democrats, have the support of 29% of voters, Forsa found.

Still, the government is unlikely to fall because neither party can assemble a viable alternative majority in Germany's fractured parliament."The two parties are welded together, whatever conflicts arise," Mr. G¨¹llner said.

Ms. Merkel's efforts this summer to fix Germany's costly health-care system have hurt her badly. Her plan: Encourage hiring by shifting some of the burden of funding health services away from payroll taxes. But conservatives' preference for individual insurance clashed with Social Democrats' preference for collective insurance. After tortuous negotiations, Ms. Merkel produced a compromise in July that merely tinkered with the current, mixed system.

The government has said payroll taxes will have to rise by half a percentage point next year to cover rising costs. "The proposal has nothing to do with the far-reaching reform the public expected," said J¨¹rgen Michels, an economist with Citigroup Inc. in London.