BERLIN (Reuters) -- Angela Merkel learned early in her political career that taking on the German car industry carries risks. It was the spring of 1995 and the newly appointed environment minister was trying to convince her cabinet colleagues to back a bold new set of anti-smog rules that included tougher speed limits and summer driving bans.

But Matthias Wissmann, the transport minister with close ties to industry, was having none of it. He questioned whether Merkel's measures would cut pollution levels at all and vowed to fight any attempt to impose speed limits on the Autobahn. Wissmann's argument won the day, reducing Merkel to tears, according to a 2010 biography by Gerd Langguth. For the ambitious young minister from the communist East, it was a lesson about how politics worked in a united Germany.

Much has changed in the intervening years. Merkel is now in her third term as chancellor. Wissmann heads the Verband der Automobilindustrie (VDA), the influential lobby group for German automakers.

But there is one constant: the clout of the auto industry in German politics. This relationship, which some describe as symbiotic, bordering on incestuous, is in the spotlight now, as Volkswagen AG, the country's largest carmaker, reels from an emissions scandal that has forced out the long-time Volkswagen Group CEO Martin Winterkorn and sent the company's share price careening lower.

There are no indications that German politicians were aware that VW was rigging its diesel emissions tests. Merkel and her leading ministers have expressed surprise and indignation at the revelations, urging VW to clear them up swiftly.

But authorities in Germany and elsewhere in Europe had known for years about the widening gap between emissions values measured in official laboratory tests and those recorded in real-world environments.

Yet, critics say, Berlin fought hard to shield its carmakers from closer scrutiny and, in a high-profile clash with its European partners two years ago, from tougher emissions targets. Merkel has defended the stance as necessary to protect jobs in the industry.

Some see the VW scandal as symptomatic of a deeper problem in which German car companies have been allowed to do as they please without oversight or fear of reprisals from Berlin.

"The Volkswagen scandal is a warning shot to the politicians," said Christina Deckwirth of Berlin-based Lobby Control. "It shows they need to spend less time protecting the auto industry and more time overseeing it."

Poster Child

There are good reasons why Berlin stands by its car companies. The industry employs more than 750,000 people in Germany, has been a poster child for German engineering prowess and dwarfs other sectors of the economy.

In 2014, the big three carmakers -- Volkswagen, Daimler AG and Bayerische Motoren Werke AG -- hauled in revenue of 413 billion euros ($462.33 billion), far bigger than the German federal budget, which stood at just under 300 billion ($335.84 billion). This has bred a cozy relationship between the industry and politicians. Top auto lobbyist Wissmann is a veteran of Merkel's Christian Democratic Union (CDU) who, despite their cabinet clash 20 years ago, uses the familiar "Du" with the chancellor.

Daimler's chief lobbyist is Eckart von Klaeden, a senior CDU politician who worked under Merkel in the chancellery and whose abrupt switch to the Mercedes manufacturer in 2013 prompted an investigation by Berlin prosecutors and new rules on "cooling off" periods. His predecessor at Daimler was Martin Jaeger, now the representative of Finance Minister Wolfgang Schaeuble.

The ties cross party lines. Thomas Steg, a former spokesman under Social Democrat (SPD) Chancellor Gerhard Schroeder, heads up government affairs at Volkswagen. Even former Foreign Minister Joschka Fischer of the environmentalist Greens has done ads for BMW in recent years.

The political connections are particularly strong at Volkswagen, whose arcane shareholder structure is laid out in the so-called Volkswagen Law, which dates back to 1960 and has faced repeated legal challenges at the European level. The law effectively shields the company from takeovers and bestow influence on Lower Saxony, a state in central Germany that owns a 20 percent stake in VW and has been a stepping-stone to national power for countless politicians.

Premiers of Lower Saxony who have sat on VW's board include Schroeder, nicknamed the Auto Chancellor, current Vice Chancellor Sigmar Gabriel and former President Christian Wulff. When Schroeder launched his far-reaching reform of the German labor market in 2003, he turned to Peter Hartz, the human-resources chief of VW, to steer it.

Years later, Hartz was at the center of another major scandal to hit VW, a tale of corruption involving lavish company trips for employee representatives, including visits to prostitutes. He received a suspended sentence and a fine.

The VW scandal has also exposed the toothlessness of Germany's regulatory regime, opposition parties and industry experts say. The main oversight agency for the car sector, the Federal Motor Transport Authority, falls under the Transport Ministry in Berlin, raising questions about its independence and readiness to police the sector.

"The worst of all is that the automobile industry was left to do these tests themselves, there was no control," Oliver Kirscher, a lawmaker for the Greens said in a debate in the German parliament Friday.

The industry group VDA rejects the idea that controls were lax and says it has been pressing for reform of the test regime for emissions "intensively and constructively" for years.

Emissions Fight

Unlike her predecessor Schroeder, Merkel has no direct ties to the car industry. But her stance has clearly evolved since her days as an environment minister under Helmut Kohl.

Back in 2009, in the months before she would run for a second term, she oversaw a controversial and ultimately unsuccessful rescue of German carmaker Opel, going against the advice of her economy minister, who argued that the General Motors unit should be allowed to go bankrupt.

Four years later, in the run-up to the next election and amid heavy pressure from the VDA, her government lobbied aggressively in Brussels -- even threatening other countries to win their backing, according to diplomats -- to water down new European rules on CO2 emissions that Daimler and BMW opposed. In a "Dear Angela" letter that later leaked, causing an uproar in the German media, Wissmann urged Merkel to fight the more ambitious targets.

"I think we need to ensure that in our drive to protect the environment we are not damaging our own industrial base," Merkel said at the time.

Months later, and only weeks after Merkel had won a third term, her party received donations totaling 690,000 euros ($772,420) from the family that controls BMW. The news sparked a backlash from opposition parties and the German media. The CDU said the money had "no connection to any political decisions."

Critics say that by doubling down on its premium carmakers and heeding their warnings about introducing ambitious emissions targets, Berlin has unwittingly discouraged innovation and harmed the industry's long-term prospects.

Germany is a laggard on electric cars and is widely expected to miss a target of selling 1 million of them by the end of the decade.  

"Until now, the German auto industry has been handled with kid gloves by the politicians," said Klaus Mueller, head of the Federation of German Consumer Organizations. "Emissions targets were set at less than ambitious levels and agreement on new testing rules was delayed. Even worse, there was no mechanism for overseeing whether legal emissions limits were being met, at the cost of the environment and the consumer, as the VW case has now shown."

(Reporting by Noah Barkin; Editing by Janet McBride)