Assessment and recommendations
Germany has been experiencing a strong economic recovery after a prolonged period of stagnation in the early years of the current decade. With corporate balance sheets and profitability robust and the government structural budget near balance, solid foundations have been laid for the continuation of the upswing. Nevertheless, for high economic growth to be more enduring, as intended by the authorities, it will be necessary to raise the growth rate of potential output. Past reforms, notably in the labour market have helped to lift growth in potential output recently, but there is still considerable scope to increase hours worked per capita, despite the progress made during the current upswing, and to improve productivity, notably in certain network industries. In the long run, improving education outcomes, including by reducing the impact of socio-economic background on outcomes, will be central to sustaining high economic growth and social cohesion.
Sustaining higher economic growth
Germany has been enjoying a strong cyclical rebound in economic growth after a long period of stagnation. With strong corporate and household balance sheets and government finances having been consolidated, solid foundations have been laid for sustaining the cyclical upswing or at least mitigating the adverse effects of recent global financial market turmoil. Nevertheless, for more enduring high economic growth, it will be necessary to make reforms that raise growth in potential output. A good start in this regard has been made with the labour market reforms of recent years, which have already contributed to the impressive performance in increasing labour utilisation during the current upswing. Even so, there remains considerable scope to increase the total number of hours worked per person of working age. It will also be important to contain the long-run growth in healthcare expenditures as large increases in social security contributions to finance such expenditures would depress work incentives. Strengthening product market competition, notably in network industries, would increase productivity growth, further lifting potential output. Such product-market reforms would also reduce income inequality, contributing to social sustainability. In the long term, improving education outcomes, notably by reducing the impact of socio-economic background on student achievement and increasing the proportion of younger cohorts with tertiary education, will be central to raising potential output and enhancing social equality of opportunity.
Preserving past achievements in fiscal policy and making the tax system more efficient
Government finances have improved significantly over the past years on account of both cyclically higher revenues and structural expenditure restraint. In order to preserve these achievements for the longer term, the government should consider replacing the fiscal rule currently enshrined in the constitution, which has proved to be ineffective in preventing an increase in the debt level. Safeguarding future tax receipts is also a challenge and the implemented corporate tax reform will be helpful in this respect. In this chapter, further options to reduce the tax burden even more for mobile bases are considered. Finally, options are explored for making tax collection more efficient.
Maintaining the reform drive to make labour market improvements more lasting
Labour market outcomes are improving rapidly in the current upswing, also reflecting previous reform efforts. To make those improvements more lasting, but also to widen the positive effects, further reform efforts should focus on: i) raising the number of hours worked per person employed; ii) reducing the high share of long-term unemployed; and iii) further increasing employment rates of older workers. These challenges require new reform efforts in some areas, such as reducing barriers to taking up work for second-earners and reforming employment protection legislation for regular work contracts. In other areas it should be ensured that past reforms are not rolled back and that the reform drive is maintained. This relates above all to past increases in work incentives for the long-term unemployed and measures to phase out early retirement options for older workers. Also, potential negative employment effects associated with the introduction of minimum wages should be minimised.
Improving education outcomes
Improving education outcomes is important for Germany’s long-term economic performance and social cohesion. While student achievement is above the OECD average in science and at the OECD average in reading and mathematics according to the 2006 OECD PISA study, weaker students tend to do badly by international comparison and socio-economic and/or immigrant backgrounds have a large impact. Another problem is that the proportion of younger people that completes tertiary education is relatively low. The authorities are undertaking wide ranging reforms touching all levels of education to tackle these problems. Nevertheless, there is scope to go further by: increasing participation in early childhood education and care of children from less advantaged socio-economic backgrounds and improving the quality of such education; improving teaching quality; reducing stratification in the school system; and making tertiary education more attractive and responsive to labour-market requirements. With the reforms underway or suggested, Germany would be able to look forward to higher education achievement and attainment and, especially, greater equality of education opportunity.
Reaping the benefits of stronger competition in network industries
The potential to strengthen productivity growth and enhance consumer welfare through more competition is large in the energy and railway sectors. Lowering entry barriers, including through the option of stronger forms of vertical separation between network access provision and potentially competitive services will be the main challenge for Germany going forward. In particular, it will be a crucial point in designing the envisaged privatisation of state stakes in the railway sector market incumbent Deutsche Bahn AG. In the energy sector, concentration in the wholesale market is another crucial issue that Germany will need to tackle, including by fostering market integration with neighbouring countries as well as market entry of newcomers. A more systematic approach to tendering unprofitable transport services will be key in the railway sector.
Moving towards more sustainable healthcare financing
The aim of the recent healthcare reform was to increase the sustainability of healthcare finances, by reducing its negative impact on employment and increasing cost-effectiveness via enhanced competition. Higher budget contributions will help decouple healthcare finances from labour income a bit, if and once they materialise. An improved risk adjustment between insurers could reduce incentives for risk selection, raising chances for competition to lead to more cost-effectiveness instead. However, the segmentation of the healthcare system in a private and a social insurance market will continue to pose equity and efficiency problems. Owing to its design, the price signal in the new financing system for social health insurance will be both weak and distorted and this will need to be corrected for competition to produce desired results. More freedom for contractual relations between insurers, healthcare providers and pharmaceutical companies could help to better reap the benefits of competition, but the government will need to watch the results closely and adjust framework conditions if needed.
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