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  Assessment and Recommendations

  With the effects of adverse external shocks diminishing, the German economy is currently recovering, ending a couple of years in stagnation on the back of its traditionally strong, competitive and innovative export-oriented manufacturing sector. However, the economy is far from operating at full strength due to the weakness of final domestic demand. Poor labour market performance continues to weigh on consumer sentiment and business confidence remains volatile. The labour market suffers from weak growth and distorted incentives, with both contributing to problems in taking up work and providing employment. Although monetary conditions should remain supportive for GDP growth in the euro ...

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  Main Issues and Policy Challenges

  Germany is still a strong economy in various respects, as reflected in its vigorous export performance and high innovative capacity. However, the economy has fallen back. For a period of more than ten years real GDP growth has fallen short of that in other European countries and North America. This is reflected in potential GDP having decelerated to a growth rate of just 1.5 per cent annually while structural unemployment has trended upwards. In addition actual GDP has tended to substantially undershoot potential. While convergence of GDP per capita with the US peaked already ...

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  Linking Fiscal Consolidation to Public Sector Reform

  Over the last three years Germany’s general government deficit has drifted upwards to almost 4 per cent of GDP. While part of the deterioration was caused by the cyclical downswing after 2000, it also reflected the fact that the underlying rate of growth is low. Following the phased income tax reductions, which contributed to the rise in the structural deficit, preference should now be given to balancing the budget over a limited number of years. For the consolidation process to have maximum beneficial effects on economic activity, much will depend on casting it within a consistent framework that links budgetary improvement to public sector spending reform.

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  Increasing the Capacity of the Economy to Create Employment

  The government has embarked on a substantial reform programme, improving incentives for individuals out of work to take up jobs and for firms to hire workers. Indeed, the protracted weak performance of the labour market continues to underline the need for labour market reforms. Further progress is necessary to ensure that the reforms achieve a substantial and lasting increase in employment, as outlined below. The Annex summarises recommendations for structural reform and action taken since the 2003 Economic Survey.

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  Fostering Product Market Competition

  As outlined in the 2003 Economic Survey, pro-competitive regulation of product markets can contribute to improving productivity performance, in part through stimulating innovation (see Chapter 5). Recent empirical evidence also shows that a regulatory stance conducive to product market competition increases investment, as producers in competitive markets have stronger incentives to expand production capacity when product demand increases.93 Competitive product markets, by reducing monopoly rents, also encourage wage moderation, especially in countries with unionised wage bargaining, such as Germany. The government has embarked on a number of reforms since the previous Economic Survey, notably in the handicrafts sector, which move the economy towards a more pro-competitive stance. However, scope for improvement remains. In the network ...

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  Improving the Capacity to Innovate

  Reviving the dynamism of the German economy also requires policy measures that strengthen productivity growth. Total factor productivity growth -- the growth in output, which can be achieved given all inputs combined -- decelerated in Germany in the 1990s, as it did in several other countries within the OECD. Innovation is a key element stimulating total factor productivity. This, in turn, can potentially spur higher employment of both capital and labour, which is a source of higher economic growth in its own. Indeed, empirical studies establish a strong positive relationship between research and development (R&D) and per capita GDP growth.105 The recent policy debate in Germany has therefore focussed increasingly on innovation as a means to foster economic activity. This led the federal government to establish a commission whose task is to propose policy measures, in the second ...

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