THE Germans, supposedly not prone to giddy humour, have been laughing their rumps off these past few years about that whole East German thing. With a slew of German New Wave comedies, they've made light of their Cold War commie half brother, known as the GDR, and the time-frozen denizens who emerged blinking after the Berlin Wall came down. As if the funny looking cars and the retro fashion were all just a bad dream.

But maybe it was nervous twittering; after all, totalitarianism, as seen through the eyes of The Lives of Others, is deadly and soul destroying. In the harsh light of the interrogator's lamp, it is certainly no laughing matter.

This is a beautiful, haunting picture about a nation under surveillance and the final, crumbling years behind the German iron curtain - a clambering frenzy of paranoia and enforced treachery.

It is written and directed by Florian Henckel von Donnersmarck. It's his first film, but already it has the look and feel of a classic. He rolls the film to its heartbreaking conclusion like a slowly advancing juggernaut. Such is his handling, and such is the film's complex emotional tenor, it edged past Guillermo del Toro's astonishing Pan's Labyrinth to win this year's Best Foreign Language Picture Oscar.

These two powerhouse films share similar anxieties: they both address the nightmare of 20thcentury totalitarianism and how it asphyxiates art and the imagination. But while del Toro's message, set in Franco's fascistic Spain, was ultimately pessimistic about human nature, The Lives of Others is more convinced of our capacity for goodness. Here, decency and indecency pull on opposing threads until the whole cloak unravels: it's a film that restores faith in humanity out of our darkest moments and shows us, too, how great art can be reborn of it.

The story is set in 1984, a time when "Glasnost is nowhere in sight". The atmosphere is oppressive - everyone is under suspicion.

Gerd Wiesler (Ulrich Muhe) is a captain in the Stasi - East Germany's paranoid ministry of state security. He is also a college lecturer in the techniques of interrogation.

Muhe plays it like an authoritarian automaton, his entire being a reflection of state control and constraint - a drab greyness, from the charcoal suits and strangled grey ties to his eyes of cold steel, makes him an ideal surveillance expert, a man quick to blend into concrete.

He is ordered by the oily, smugly powerful Stasi minister Bruno Hempf (Thomas Thieme) to spy on a couple: actress Christa-Maria Sieland (Martina Gedeck) and her playwright boyfriend Georg Dreyman (Sebastian Koch, last seen in Black Book).

She's emotionally fragile, a delicate artist, but is handled lovingly by Dreyman. He is loyal to the GDR, and considered above suspicion, but the minister has doubts about his "loyalty to the party", and that's enough to make him guilty.

The film comes into its own when Wiesler and his team bug their apartment and he installs a listening post in the building's attic. A neighbour's split-second glance through a peephole is met with a warning: shut up or your daughter will lose her place at university. The state knows everybody and everything.

Then, with headphones, Wiesler pores over every detail of their lives - their small talk, their making love, a 40th birthday party in which an argument only displays Dreyman's loyalty to the state.

But pressure still comes from on high to find something on him.

Wielser finds himself becoming touched by their lives. But then he stumbles on something that causes his faith in the system to crack: he is spying on Dreyman because the minister has coerced the actress into having an affair with him - and he wants to banish the playwright.

The big lie, that everybody is guilty, is laid bare. So he begins invisibly to interfere and to protect the couple. When Dreyman's friend - a theatre director who had been blacklisted by the minister - commits suicide, the playwright's ideology too starts to unravel.

Cinematographer Hagen Bogdanski does a superb job, casting the film in dual shades - the rigid world of Captain Wiesler is shot in numb greys and strangled blues; the world of Dreyman and Sieland more alive in toned-down autumnal shades. Both Ulrich Muhe and Sebastian Kochfinely are superlative, while Martina Gedek is haunting as an actress depressed and forced by the minister into an act of betrayal.

Like Arthur Koestler's novel Darkness At Noon, The Lives of Others shows how totalitarianism begins to eat itself to survive and that paranoia ultimately becomes the nature of its downfall. For my money, it is the best film so far of 2007 - a story about courage, but courage in the most noble sense because astonishing sacrifices are made that go unseen and unrewarded in the most dangerous of circumstances. And because of that, it is a film about honest to goodness humanity and a riposte to the remorseless totalitarianism it depicts so terrifyingly.