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  Basic Statistics of Germany, 2008
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  Executive summary
  The German economy is recovering from a severe recession that followed the collapse of world trade. As pre-crisis production levels are likely to be reached again only over the medium term, unemployment and the budget deficit are set to rise further. The crisis has demonstrated the high exposure of the economy to global developments and revealed some underlying structural weaknesses. In this context, the main challenges are to safeguard a sustainable recovery and boost Germany’s growth potential:
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  Assessment and recommendations
  After suffering the steepest downturn in post-war history, growth turned positive again in the spring of 2009. The current recovery is underpinned by fiscal stimulus, expansionary monetary conditions, an upswing in world trade, an improvement in financial conditions and restocking activities of companies. Even though the economy is recovering, the precrisis level of production is projected to be reached only by 2013. There will thus be substantial slack in the economy over the medium-term, notwithstanding the fact that the crisis is likely to have led also to a temporary reduction in the growth rate of potential output.
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  Emerging from the crisis
  After a sharp fall during the recession, real GDP growth has picked up, but the recovery is expected to be relatively slow. The global crisis has hit the economy mainly through the collapse of world trade, the driving force behind the boom period before the crisis. The challenge going forward is to tackle the damage done by the crisis on the labour market and to public finances. Growth prior to the crisis was mainly export-driven and characterized by the build-up of a large current account surplus. Factors behind this surplus were a rise in corporate and government net lending amid continued high and increasing saving by households. A large part of the capital outflows reflected foreign investments by the banking system. Structural challenges going forward should focus on raising the stability of the banking sector and removing domestic barriers to higher growth.
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  Facilitating structural change and preventing long-term unemployment
  Unemployment has fallen significantly prior to the crisis, not least due to past labour market reforms, and has remained surprisingly stable during this recession – both relative to past experience and vis-à-vis other OECD countries. This is primarily explained by more flexible working time arrangements, but the government’s subsidized short-time work scheme as well as voluntary labour hoarding due to prior skill shortages also played a role. Due to strict employment protection of regular jobs the burden of adjustment so far fell on the less-well protected workers. Going forward, labour market policy needs to adjust to the likely increase in unemployment which will result as firms try to regain their competitiveness. The key challenge is to prevent the build-up of long-term unemployment and to lower the strictness of employment protection legislation for regular job contracts to better allow for structural change in the economy.
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  After the crisis
  Past consolidation has allowed the automatic stabilisers operate fully during the crisis. Further fiscal easing in late 2008 and early 2009 contributed to a markedly widening fiscal deficit in 2010. A newly enacted fiscal rule, which limits the structural budget deficit of the federal government to a maximum of 0.35% of GDP and requires balanced structural budgets for the Länder, will help bring public finances back to a sustainable path. However, some elements of the new rule may need to be fine tuned in order for it to be more effective. To comply with the transition requirements of the new rule, consolidation beyond a mere phasing-out of the stimulus packages will be needed between 2011 and 2016. Priority should be given to reducing public expenditure, notably by improving public sector efficiency and by cutting back on grants and government consumption, and to phasing out distorting tax concessions. To improve the structure of the tax system, the government should consider raising the share of taxes on property and consumption in total tax revenues.
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  The banking system
  The German banking system came under pressure during the financial crisis, not least due to its significant exposure to toxic assets which originated in the US. In the short run, the stability of the system has been achieved, in large part through substantial government support measures. However, ensuring adequate capitalization of the banking system remains a major challenge going forward and may require more active government involvement. The underlying causes of the banking sector problems are related to: i) the activities of the Landesbanken which benefitted from government guarantees without a proper business model; ii) weak capitalization and high fragmentation of the whole banking system, possibly related to the particularly rigid three-pillar structure; and iii) deficiencies in banking regulation and supervision. The challenge is to address these three causes in order to raise the long-run stability of the banking system.
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  Structural reforms to lift potential growth in a globalised world
  The potential growth rate of the economy has been low for a long time and the crisis has had a further adverse impact. The meagre growth performance mainly reflects low growth in a number of services sectors; most manufacturing sectors, by contrast, expanded at a rapid pace in the years preceding the recent crisis, on the back of robust foreign demand. The challenge is to consolidate the past success of the export sector and to broaden it to the whole economy by making the policy framework more conducive to innovation and structural change. Specifically, product market regulation needs to be eased to prevent it from sheltering uncompetitive industries; the framework conditions for innovation need to be improved; the education system needs to be reformed further to supply a sufficiently large pool of highly qualified labour; and immigration policy needs to become more favourable to the immigration of high-skilled.
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