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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:

Adjusting labour market policy. Unemployment has barely increased during the downturn as firms substantially reduced working time instead of laying off employees. This reflects primarily increased flexibility on the company level and earlier labour market reforms, as well as the subsidized short-time worker scheme. Going forward, labour market policy needs to prepare for a marked increase in the jobless rate, notably by ensuring sufficient job counselling capacities and reforming the administration of the basic income scheme for jobseekers. The crisis has revealed the risk that a dual labour market may emerge. To avoid this and to facilitate structural change, consideration should be given to easing the strict protection of regular workers, once the economy has recovered.

Restoring fiscal sustainability. As a result of the downturn, the fiscal deficit continues to widen considerably, owing to the working of automatic stabilizers and the fiscal stimulus packages. A new fiscal rule should help to bring public finances back to a sustainable path in the medium term, though some implementation issues are tricky and need careful monitoring. Compliance with the new rule will require a combination of spending cuts and revenue-raising measures. Priority should be given to spending cuts as they are likely to be less harmful for economic growth than tax increases. To the extent that tax revenues are raised, this should preferably be done by reducing exemptions. To improve the structure of the tax system, the government should consider shifting the burden from highly distortionary taxes and contributions on economic activity to taxes with a lower damaging impact on economic growth, notably taxes on real estate and consumption. While the coalition agreement acknowledges the need for responsible fiscal policy it nevertheless makes proposals for spending increases and tax cuts for which fiscal room has yet to be found. It is therefore important that the government soon presents a specific plan how it intends to comply with the new fiscal rule.

Ensuring stability in the banking sector. After substantial government interventions, the situation in the banking sector has stabilized. However, authorities should continue to play an active role by closely monitoring capital adequacy, notably including the application of stress tests, and maintaining support instruments in order to, if needed and as a last resort, provide public capital to those banks that are not able to raise funds from private sources. A reform of the Landesbanken is a priority, but opening up the savings bank sector to private ownership should also be considered. Further necessary reforms include implementing the planned consolidation of supervision at the Bundesbank, widening the scope for supervision beyond compliance with quantitative requirements, considering the introduction of a binding leverage ratio and introducing a framework for restructuring and winding-up of systemically relevant banks.

Broadening growth beyond exports. Germany's export sector has benefited from strong competitive forces, which have spurred innovation, efficient allocation of resources and strong investment. This enabled the sector to maintain and create employment opportunities. The challenges going forward are to ensure the continued high performance of the export sector and broaden this performance to the other sectors of the economy. While many reforms have been put in place already, more needs to be done to boost potential growth in sectors serving domestic demand. In particular, the policy framework needs to become more conducive to innovation and structural change. Product market regulation needs to be eased to strengthen competition; the innovation framework needs to be improved to ensure a continuously high level of R&D spending as well as its sectoral broadening; the ongoing reform of the education system should continue so that it can supply a larger pool of highly qualified and flexible workers; and migration policy needs to become more favourable to the immigration of high-skilled workers in order to prevent the emergence of skilled labour shortages.
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Publication:OECD Economic Surveys - Germany
Geographic Code:4EUGE
Date:Mar 1, 2010
Previous Article:Basic statistics of Germany, 2008.
Next Article:Assessment and recommendations.

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