The challenge in this context is to make improvements in a variety of areas – long-term growth, employment creation, public finance sustainability – while at the same time preserving what could well be a genuine recovery in short-run activity extending beyond the export sector. A well-integrated strategy is necessary, with policies interacting positively with each other, including further progress in areas with a potential to boost aggregate growth and labour income. Both domestic and international factors can contribute to assuring a dynamic expansion, although only domestic factors are subject to policy measures which the German government can choose. Internationally, continued strong world growth and favourable monetary conditions are important. Domestically, product market reform (the in-depth chapter of this Survey) is precisely an area that has the potential to boost long-term growth and labour income and reduce public deficits through a strengthening of the tax base.

Fiscal consolidation on the spending side needs to be linked to public sector reform. While significant progress has been made in recent years in curbing spending, deficit targets have repeatedly been missed and the debt-to-GDP ratio is high. A credible consolidation policy is needed that links expenditure control with public sector reform covering federal fiscal relations, removing distortions in the tax system and making the key government services more efficient. VAT will be increased in order to rapidly reduce the structural deficit by compensating for revenue losses from past reductions in direct taxation. A considerable part of increased revenues will be used to lower social security contributions. It is important to make clear that further consolidation focus on the expenditure side.

Source: OECD

The efficiency of the education system needs to be increased. Securing the supply of highly skilled workers is crucial for the generation and absorption of new technologies. Schools should be regularly evaluated against country-wide or state-wide standards, while leaving schools more freedom in determining suitable ways to reach their targets. Allocation of government funding to universities should be more strongly oriented toward output indicators. All universities should be made independent entities and given the opportunity to introduce student fees coupled with a loan scheme and income-contingent repayments.

Continued labour market reform is necessary to boost employment. Major steps in labour market reform were implemented over the last three years. Many measures are steps in the right direction. However, reform needs to be deepened and broadened to create the momentum for sustainable improvements in employment. Further institutional reform of the Public Employment Service is required to better activate the unemployed. Hurdles to labour force participation of older employees and females need to be further reduced. Moreover, more flexible employment contracts are necessary, while at the same time avoiding labour market segmentation. Wage rigidities need to be reduced further to fight very high unemployment rates among the low-qualified.

Regulation of domestic markets for goods and services needs to become more competition-friendly. While Germany’s outward policies are largely open, and the general competition legislation and enforcement framework is, in most respects, effective, measures need to be taken to reduce the administrative burdens on entrepreneurship and reduce the involvement of the government in business sector activities, notably through accelerated privatisation. Policies favouring small enterprises need to be revised, exposing them to competition of larger firms and avoiding disincentives to grow. In network industries, non-discriminatory access of market entrants needs to be improved. Regulation of professions is among the tightest in the OECD, requiring deregulation in order to reduce barriers to entry. Similarly, qualification-related entry requirements in the crafts sector should be abolished.

A recovery is slowly gaining ground

The OECD says that German economic performance continues to be marked by strong exports, reflecting many years of trend improvement in external competitiveness, but persistently weak domestic demand. To some extent these two trends are linked. Wage moderation, while strengthening competitiveness, has meant weak household income growth, holding back consumption; and lower inflation than in other euro area countries has raised the real interest rate in Germany, while the absence of exchange rate movements due to the single currency is likely to have supported exports. Signs of a pick up of domestic demand have emerged, and soft data on business confidence and incoming orders signal that the recovery may become broader in the near future. However, hard data from quarterly GDP statistics indicate that this process was not yet firmly established until the end of 2005. Overall, the OECD projects that real GDP will grow somewhat above potential in 2006, at around 1¾%, after growth of 1.1% in 2005 (working day adjusted). Continued structural reform can contribute to stronger domestic activity and would improve the

The challenge confronting Germany is to make improvements in a variety of areas – long-term growth, employment creation, public finance sustainability – while at the same time preserving what could well be a genuine recovery in short-run activity extending beyond the export sector.

To meet such a multifaceted challenge a well-integrated strategy is necessary, with policies interacting positively with each other. Labour market reforms can be particularly difficult to implement, especially as there is a risk of impacting negatively on household confidence. This is why they need to be part of a global package, where further progress is achieved in areas with a potential to boost aggregate growth and labour income.

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Copyright OECD 2006