Germany: Staff Report for the 2002 Article IV Consultation

This 2002 Article IV Consultation highlights that Germany’s economy is poised for a fragile recovery, after having barely grown since mid-2000. The earlier price shocks and interest rate hikes that contributed to the current slowdown have now unwound. However, sluggish global growth, stock market declines, weak credit growth, and the withdrawal implied by planned fiscal consolidation may stand in the way of a strong recovery. Real GDP growth in 2002 is estimated at about 0.5 percent, with the general government deficit set to exceed 3 percent of GDP.

Abstract

This 2002 Article IV Consultation highlights that Germany’s economy is poised for a fragile recovery, after having barely grown since mid-2000. The earlier price shocks and interest rate hikes that contributed to the current slowdown have now unwound. However, sluggish global growth, stock market declines, weak credit growth, and the withdrawal implied by planned fiscal consolidation may stand in the way of a strong recovery. Real GDP growth in 2002 is estimated at about 0.5 percent, with the general government deficit set to exceed 3 percent of GDP.

I. Introduction

1. The 2002 consultation discussions took place at a time when the economy appeared poised for recovery after stagnation since mid–2000 and almost a decade of low growth.1 The strength and durability of recovery, however, remained uncertain. Moreover, with the general government deficit running close to the 3 percent of GDP ceiling, macroeconomic policy options for actively supporting recovery were constrained by Stability and Growth Pact (SGP) obligations. In recent years, the authorities have made progress in strengthening the supply side of the economy through tax reform and product market liberalization. In addition, the introduction of a private pension pillar has provided a better institutional framework for addressing looming demographic strains. However, less attention has been directed to labor market constraints on growth (Box 1). At the time of the discussions, clear directions for structural policies were awaiting the outcome of a September general election, which re–elected the SPD/Green coalition.

Germany: Policy Recommendations and Implementation

Going back as far as unification, Executive Directors have strongly supported fiscal consolidation in Germany, although the authorities’ efforts to achieve budget balance have been frustrated in part by low potential growth. Fiscal policy advice has been nuanced to fit specific circumstances. Thus, at the conclusion of the 2000 consultation, Directors broadly accepted a pause in deficit reduction when needed tax reform was introduced. And last year, some Directors saw a case for advancing planned tax cuts if the economy took a turn for the worse—a suggestion the authorities resisted even though growth did in fact disappoint.

Calls for labor market reforms in staff reports and in Article IV Board meetings on Germany are at least as long standing. The authorities’ approach has been to foster wage moderation through tri–partite consensus (the “Alliance for Jobs”). Measures to encourage more flexible working conditions (e.g., in part–time employment) have been modest. Generous welfare systems that dampen work incentives have been left largely untouched.

On other key policy themes, Directors have called for pension reform and reductions in the tax burden. Thus in 2000–01, they welcomed the introduction of a private pension pillar and the tax reform that significantly reduced marginal income tax rates and ironed out inefficiencies in the corporate tax code. Directors have generally recognized Germany’s efforts as a leader within the EU in recent years in implementing product market reforms.

II. Background

2. Low growth in Germany over the past decade has been influenced by long–standing rigidities in labor markets, which have lengthened the adjustment to the economic impact of unification. During 1992–2001, per capita real GDP growth averaged 1 ⅓ percent a year, the lowest rate in the European Union (EU). The growth gap is exaggerated by cyclical factors: due to the boom around the time of unification, Germany entered the 1990s with unemployment well below the natural rate and output exceeding potential, unlike elsewhere in the EU.2 In the following ten years, relative cyclical positions were reversed as Germany, in adjusting to the public costs of unification, undertook a larger fiscal consolidation than many other countries and struggled with an appreciated exchange rate. Even so, differences in cyclical positions only explain about half of the growth gap with higher–growth EU partners, such as the Netherlands and the United Kingdom. The remainder reflects lower potential output growth owing to smaller increases in the contribution from labor.

Output Gaps

(In percent of potential GDP)

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Rolling Per Capital Real GDP Growth

Citation: IMF Staff Country Reports 2002, 239; 10.5089/9781451810363.002.A001

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Real Effective Exchange Rates 1/

Citation: IMF Staff Country Reports 2002, 239; 10.5089/9781451810363.002.A001

1/ Normalized unit labor costs in manufacturing.

3. Behind this slower increase in labor input has been generous assistance for the jobless, which has inhibited wage adjustment. Wages in the west were already growing rapidly before unification, and wages in the east were set on a convergence path to those in the west. With the welfare system absorbing the job losers into long–term unemployment and early retirement, wage moderation was held up in the first half of the 1990s, and the structural unemployment rate—which, at about 7 percent, is not particularly high by European standards—did not fall, as it did most markedly in the high growth countries. Unemployment is particularly severe in the new Lander, where it remains around 15 percent (EU–standardized). Since the mid–1990s, however, wage growth has moderated, albeit later than in other European economies where recent growth has been more job–rich.3 Also, with average productivity growth generally matching European performance, Germany has not experienced the “new economy” productivity burst seen in the United States.

uA01fig03

Labour Contribution to Real GDP Growth

Citation: IMF Staff Country Reports 2002, 239; 10.5089/9781451810363.002.A001

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Unemployment-Adjusted Real Effective Wages 1/

Citation: IMF Staff Country Reports 2002, 239; 10.5089/9781451810363.002.A001

1/ Wages that are adjusted for productivity and cyclical pressures in the labor market

4. In this environment, growth spurts could not be sustained for long and downturns have tended to be more severe than in other European countries. The latest downturn was prompted by oil and food price shocks, as well as ECB interest rate hikes, that reduced domestic demand (Table 1). Some of the factors contributing to the relative depth of Germany’s latest downturn include:

  • With wage moderation less established than in other EU countries, employers have been more tentative in hiring. Accordingly, workers’ real disposable incomes failed to accelerate in 2001 despite the tax cut. The impact on consumption was compounded by a reversal of the downtrend in the savings rate.

  • Fixed investment had peaked earlier than in other EU countries, partly because tax changes prompted entrepreneurs to advance expenditure on machinery and equipment to a record level in 2000.4 The contraction in investment was particularly marked because of the ongoing, post–unification slump in construction.

  • As in the past, Germany was affected faster and more severely than other European countries by the U.S. slowdown. Econometric evidence for the 1990s would associate the 3 ½ percentage point drop in U.S. GDP growth during 2001 with an investment–led 1½ percentage point reduction in output growth in Germany, compared with less than 1 percentage point for the euro area.5 This is consistent with Germany’s greater reliance on merchandise exports.

Table 1.

Germany: Basic Data

Sources: Deutsche Bundesbank; Federal Statistical Office; IMF, World Economic Outlook; IMF, International Financial Statistics; and staff estimates and projections.

IMF staff projections.

Growth contribution

According to place of residence.

Unemployment as defined by Eurostat.

Deflated by the national accounts deflator for private consumption.

IMF staff projections.

Data for federal government are on an administrative basis. Data for the general government are on a national accounts basis. Debt data are end-of-year data for the general government in accordance with Maastricht definitions.

Government expenditure in 2000 includes, as a negative entry, the proceeds from the sales of mobile phone licenses of euro 50.8 billion (2.5 percent of GDP). The proceeds also affect the financial (but not structural) balances and the government debt

Including supplementary trade items.

From 1999 onward data reflect Germany’s position in the euro area.

Data for 2002 refer to July 2002.

Data reflect Germany’s contribution to M3 of the euro area.

Data for 2002 refer to September 20, 2002.

Data for 2002 refer to August 2002.

Based on relative normalized unit labor cost in manufacturing.

Table 2.

Germany: Indicators of External and Financial Vulnerability

(In percent of GDP, unless otherwise indicated)

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Sources: Deutsche Bundesbank; IMF, International Financial Statistics; IMF, World Economic Outlook.

Staff estimates and projections, unless otherwise indicated.

Data for 2002 refer to end-July.

From 1999 onward data present Germany’s position in the euro area.

For 2002 data are as of July.

DAX 30 stock market index.

DataStream indices; includes German bank stocks

TMT is telecom, media, and information technology

1999 growth due to low mortgage interest rates and expiration of special depreciation allowances in eastern Germany

Share of housing loans in percent of total lending to private sector.

Share of housing loans in percent of total lending to nonfinancial private sector.

German commercial law definition of non-performing loans.

German commercial law definition of risk provisions.

Consolidated basis, risk-weighted, national definitions of capital.

After-tax profit as percent of average capital.

Insolvencies of only those included in the credit register with loans of greater than Euro 1.5 million.

uA01fig05

Growth, Oil Prices, and Interest Rates.

Citation: IMF Staff Country Reports 2002, 239; 10.5089/9781451810363.002.A001

uA01fig06

Saving Rate

Citation: IMF Staff Country Reports 2002, 239; 10.5089/9781451810363.002.A001

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Fixed Investment in Percent of GDP

Citation: IMF Staff Country Reports 2002, 239; 10.5089/9781451810363.002.A001

Exports of Goods

(In percent of GDP)

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5. Conditions for recovery have improved somewhat, but domestic and international financial strains continue to weigh on demand. The earlier oil price–induced terms of trade losses have largely been absorbed, and high interest rates were unwound in 2001. In addition, assessments of inventory levels have been lowered toward normal levels. However, tight credit conditions, declining stock markets, euro appreciation, and fiscal consolidation are restraining conditions for strong recovery, particularly in investment:

  • Firm’s financing conditions have improved by less than might have been expected on the basis of falling interest rates. Accordingly, credit growth lies below the historical relation with output and interest rates. While this may be due to an investment overhang—as evidenced by falling capacity utilization rates—it may also stem from growing risk aversion by banks, partly in anticipation of tougher capital requirements under Basel ii (expected to come into effect in 2006) and the phasing out of guarantees to public banks over the next three years (Box 2).

  • The decline in equity markets is casting a further pall over a revival in investment. Historically, the direct effects of the stock market have been limited.6 But the drop in the DAX—some 45 percent since March—has been unusually large. And Germany will suffer from the second–round effects of the correction in global equity markets. While external demand has rebounded, a vigorous recovery is contingent on a pick up of investment in the United States and other countries because final consumption goods account for only 15 percent of German merchandise exports.

  • The recent appreciation of the euro, which has added some 2½ percent to Germany’s real effective exchange rate since March, will slow export growth even though Germany’s overall level of competitiveness remains comfortable.7

  • Fiscal consolidation is restraining demand. Although the general government deficit in 2002, at about 3 percent of GDP, will be marginally higher than last year’s level, staff estimates that the structural deficit will decline by about 1½ percentage point of GDP this year. Moreover, the authorities’ expenditure plans to consolidate the public finances imply, according to staff analysis, a further tightening of the fiscal stance by % percentage point of GDP in both 2003 and 2004. The brunt of expenditure adjustment is to fall on public consumption and investment.8

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Assessment of Inventory Levels

Citation: IMF Staff Country Reports 2002, 239; 10.5089/9781451810363.002.A001

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Capacity Utilization

(In Percent)

Citation: IMF Staff Country Reports 2002, 239; 10.5089/9781451810363.002.A001

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Imports From Germany by Industrial Countries

Citation: IMF Staff Country Reports 2002, 239; 10.5089/9781451810363.002.A001

Germany: A Credit Drought?

A simple econometric model linking the growth in domestic private sector credit to nominal GDP growth and lending rates overpredicts credit growth for each quarter of the year ending March 2002.’ The cumulative shortfall amounts to 3 ½ percent of the March 2002 1 credit level. Adding variables to the model that might proxy banks’ risk aversion—such as the difference between lending and deposit rates and the ratio of capital plus general provisions to assets—does not substantially alter the result (see figure). Periods of unusually depressed credit growth have occurred in the past, but the duration of the current weakness is longer than the last significant episode in 1994. Cyclical factors could still lie at the root of the current credit drought as demand composition effects—and the steep slump in investment—are not captured by the model. However, it is also likely that the explanation lies with supply–side developments, such as a tightening of banks’ lending standards, which are not captured by aggregate spreads, capital, and provisions.

1A detailed discussion of the methodology can be found in the Selected Issues paper.

6. Consistent with this picture, business sentiment remains below its historical average level. Business confidence revived from its low point following the September 11, 2001 terrorist attacks in the United States, but sentiment has been slipping again in the latest observations. Forward–looking indicators point to little acceleration in real GDP growth in the second half of 2002, from a sluggish 1 percent rate in the first half. Demand created by repair of severe flood damage in some parts of the country may boost growth in the fourth quarter. Nonetheless, average real GDP growth for the year is expected to be only about ½ percent. Repair of flood damage, provisionally estimated at about €15 billion (¼ percent of GDP), will continue to support demand in 2003. However, the authorities’ plan to postpone next year’s programmed income tax cuts to finance about €7 billion of a €10 billion ½ percent of GDP) flood–relief package will likely dampen the net stimulus.9

uA01fig12

IFO Business Climate Index

Citation: IMF Staff Country Reports 2002, 239; 10.5089/9781451810363.002.A001

7. All–in–all, staff projects that real GDP growth will strengthen only gradually in 2003–04, with risks that weaker global activity and ongoing stresses in financial and oil markets could weaken or delay recovery. As past interest rate cuts feed through, earlier price shocks unwind, inventories are rebuilt, and flood reconstruction spending adds to demand, growth should pick up around the end of this year. But given tight macroeconomic policies, growth is not expected to exceed potential (about 2 percent) during 2003. Staff projects average growth will be 2 percent in 2003, and, provided that global demand firms, about 2   percent in 2004. Activity remains exposed to a more severe correction in global imbalances through a further strengthening of the euro, highly volatile asset and oil markets, and lower global growth. With an output gap (over 2 percent of potential GDP in 2002) persisting, and unemployment not expected to fall significantly below the current 4 million, inflation should remain at or below current levels of 1 to ½ percent—notwithstanding a pick up in effective wage increases to 2 ½–3 ½ percent for 2002–03, from around 2 percent in 2001. The official forecast calls for real GDP growth of 2 ½ percent in 2003.

uA01fig13

Price Inflation

Citation: IMF Staff Country Reports 2002, 239; 10.5089/9781451810363.002.A001

Germany: and Euro Area: Staff Projections, 2001-2007

(Growth rates, in percent, unless otherwise noted)

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Sources: Deutsche Bundesbank; and Fund staff estimates.

In percent of potential GDP.

Standardized rate.

III. Policy Discussions

8. The discussions focused on how macroeconomic and structural policies should be framed to foster a sustainable recovery. The authorities were confident that the conditions for recovery were in place and would not be defused by financial sector strains, the appreciating euro, or fiscal consolidation. Low credit growth was seen as foremost a cyclical phenomenon; to the extent that it reflected supply–side influences, it stemmed from better risk management rather than excessive risk aversion. The euro rise was welcome as it would strengthen confidence in the new currency, lower inflation, and support domestic demand; it had not gone far enough to be a significant drag on exports. Sticking to the planned fiscal consolidation would provide policy certainty and help underpin consumer and business confidence; this was all the more so since consolidation was an essential step in preparing for longer–term demographic strains. Achieving close to budget balance was thus a key policy commitment that the authorities intended to keep even if growth were to fall somewhat short of their expectations.

9. On structural policies, the authorities agreed that labor market reform had to be the next frontier. Even so, labor markets had demonstrated flexibility in recent years and wage moderation had not come to an end, notwithstanding more job–neutral settlements this year. The authorities stressed that it would take time to build consensus for reforms, particularly if it were to include the welfare system. But the high level of public debate generated by a committee of experts and representatives of the social partners (the Hartz Commission), which had been set up to recommend improvements in the Federal Labor Office (FLO), suggested that momentum for change was building.

A. Macro economic Conditions and Policies

10. Macro economic policies are tight given Germany’s cyclical position, but the authorities did not believe they would inhibit recovery. All agreed that monetary conditions were somewhat tighter than warranted given Germany’s relatively weak cyclical position. Taking into account banks’ reluctance to lend and the planned fiscal consolidation, staff noted that the authorities’ growth target for 2003 would be difficult to achieve.

11. The authorities were confident that the general government deficit would stay below 3 percent of GDP in 2002 and move close to balance in 2004. For 2002, expenditure at the federal level was being kept under tight control and almost all the Lander were operating under an expenditure freeze. Tax revenues in the first half of the year had been weak but the authorities expected income tax and VAT to pick up on account of the wage increases agreed on in May/June and the prospective revival in consumption. Similarly, corporate taxes would gain from recovering profits while nontax revenues would be boosted by larger–than–programmed transfers from the Bundesbank. Accordingly, they expected not to need further measures to stay below the 3 percent of GDP SGP ceiling.10 Looking forward, the authorities had agreed on an “internal stability pact” with the Lander, under which spending would be slowed relative to the path in the December 2001 Stability Program, implying savings of about   percentage point of GDP by 2004. The coordination of national fiscal policy objectives across the different levels of government was also being strengthened (Box 3). On the expectation that real GDP growth would accelerate to 2 ½ percent during 2003–04, the target of getting close to budgetary balance—interpreted as a deficit of around ½ percentage point of GDP—would be achieved.

Fiscal Transparency and Policy Coordination

A recent IMF staff assessment gives Germany very high marks for the openness and transparency of fiscal policy.1 An extensive, precise, and respected body of law prevails over all aspects of public policy. Statistics and reporting are comprehensive, including in the more arcane areas of contingent liabilities, guarantees, and tax expenditures. As in many other industrial countries, transparency problems tend to stem from complexity as opposed to a lack of public information or accountability. Although well–documented, Germany’s tax system and burden sharing arrangement between and across different levels of government are particularly complex. Staff recommends that simplification should remain an ongoing objective. There is also some scope to more clearly separate commercial and government activities undertaken by financial and non–financial public enterprises, although quasi–fiscal liabilities are estimated to be low.

A key area where the authorities are working to enhance transparency is in the clarification of plans at all levels of government to achieve national fiscal policy objectives, particularly given the growing importance of EU–wide obligations. Including for the federal government, staff recommends that more effort be devoted to identifying the costs of new initiatives, defining more clearly specific budget programs, and assessing structural trends in the budget. Better coordination and monitoring of plans across the federal and lower levels of government is called for, along with shorter reporting lags for the social insurance funds and sub–national governments to facilitate within–the–year analysis of developments at the general government level. Following the internal stability pact, the budget law has been amended to give the Fiscal Policy Planning Council (Finanzplanungsrat) a stronger coordinating role for national fiscal policy objectives.

1This box summarizes key findings from a draft Report on the Observance of Standards and Codes (ROSC) Fiscal Transparency module, which was prepared for the consideration of the German authorities in September 2002.

Germany: General Government Fiscal Accounts, 2001-2004

(in percent of GDP, unless otherwise noted)

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In percent of potential GDP.

Spending excluding expenditure on social programs.

12. Staff felt that reaching near–balance in 2004 would be difficult and could place an excessive strain on the economy. At the time, staff projected the deficit to come in below 3 percent of GDP in 2002, although with little room to spare: if growth failed to pick up in the second half of the year, weaker revenues could push the general government deficit up to around 3   percent of GDP. It would be important to ensure that any overshooting did not reflect lapses in expenditure control. Beyond 2002, the authorities’ plans embodied, according to staff calculations, large reductions in the structural deficit and cuts in real discretionary spending in 2003–04. However, even these would be insufficient to reach close to nominal balance in 2004 if, as staff assumed, annual growth fell short of the authorities’2 ½ percent target.

13. Staff stressed that, in pursuing fiscal consolidation, the quality and sustain ability of expenditure restraint was more important than the precise pace of reduction in the nominal deficit. To ensure steady progress in reducing the structural deficit, the expenditure/GDP ratio needed to be placed on a clear declining path. Expenditure restraint should aim to reduce the structural deficit relative to GDP by about ½ percentage point a year in order to achieve close to structural balance by 2004.11 Ideally, spending policies should be designed to have the most favorable impact on the supply side of the economy. With expenditures on a restrained medium–term path, automatic stabilizers affecting the deficit should be given free play. The advice on the stabilizers was symmetric as it was vital to avoid past problems with spending abundant tax receipts in good times. There would be no room for tax relief other than that factored into current plans.

14. The authorities argued that, at least for small shortfalls in growth, they did not intend to deviate from their nominal deficit targets. In contrast to measures of structural balance, nominal targets provided an indispensable and fully transparent discipline; fine tuning would be ineffective and undermine public confidence in the SGP. Staff was sympathetic to the problems of measuring structural deficits.12 But a very rapid adjustment might end up relying on unsustainable spending restraint, which would lack credibility. Since a key reason for pursuing fiscal consolidation was to prepare for the costs of population aging, a more credible approach might be to undertake fundamental reform of entitlements that contained future spending increases and accept a slower pace of deficit reduction.

Government Expenditure 1999 and 2001

(In percent of GDP)

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Excluding Germany

Source: OECD and WEO database.

Source: Eurostat; some figures are preliminary data.

15. On the quality of expenditure restraint, the authorities explained that the federal government’s medium–term budget protected productivity–enhancing outlays. The authorities elaborated that, as part of the internal stability pact, the federal government was committed to reducing nominal expenditure by ½ percent a year over 2003–04. However, spending on education, R & D, and infrastructure would be shielded from cuts. By contrast, some savings would be sought on spending on the jobless, particularly on labor market policies that had proven ineffective.

16. Staff was nonetheless concerned that spending plans relied too much on general restraint and were insufficiently targeted at reining in entitlements and inefficient spending. Investment and the wage bill had already borne a disproportionate share of the adjustment in spending during the 1990s, while social expenditure remained comparatively generous. The zero growth rate programmed for the federal government wage bill would encounter pressures for subsequent pay catch–up demands, and increases in federal investment spending were expected to be more than offset by investment cuts by the local governments; it was doubtful whether either would be sustainable. Staff called for a more aggressive elimination of spending on subsidies and active labor market policies than planned, as well as for cutbacks in entitlement spending, notably on the jobless. The authorities explained that subsidies were agreed on in the context of long–term programs. They hoped to manage some savings from a merger, which was under discussion, of unemployment and social assistance.

17. The authorities’ strategy to address the impending demographic challenge assumes that curbing government debt will avoid the need to make significant reductions in age–related benefits (Box 4). The official “Guiding Principles of Fiscal Policy” of November 2000, target a gradual move to a budget surplus of 1 percent of GDP for 2009–2012. This would reduce government debt to 38 percent of GDP in 2012, from around 60 percent in 2001, assuming nominal output growth averaged about 4 percent a year. The authorities noted that the associated lower interest payments would create significant room for age–related spending. Moreover, the 2001 pension reform would greatly help to slow spending, and the demographic outlook could be expected to improve as a result of more immigration following the recent adoption of a new immigration law. A consensus existed on the need for more measures to contain health care spending. These would be designed and implemented after the elections.13

Germany: The Fiscal Challenges of Aging

Germany’s old–age dependency ratio is projected to almost double over the next 50 years, raising age–related spending by over 6 ½ percent of GDP. Financing these additional outlays by social security contributions would require increasing rates to a quasi–confiscatory level of 60 percent, from just over 40 percent now.

The authorities’ strategy of moving to a general government surplus of 1 percent of GDP in 2009 only partly addresses this challenge. Assuming consolidation were brought about by permanent savings measures, compliance with SGP deficit and debt ceilings might be possible into the 2030s. But longer–term sustainability would require a larger fiscal effort.

Germany: Evaluation of Age-Related Government Spending, 2001-50

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source: German authorities; IMF staff projection

Offsetting the bulk of the demographic costs through reform of entitlement programs seems essential. The base for other public expenditure, at around 20 percent of GDP, is too small to efficiently buffer the projected increase in age–related spending. Even under the government’s strategy, the ratio of non–entitlement spending to GDP would have to fall by about 5 percentage points over the next ten years, despite savings on interest payments.

Staff analysis suggests that the reforms required to rein in the fiscal pressures from aging need not be drastic, provided they cover all dimensions of welfare spending and are implemented early. A Selected Issues paper examines an illustrative scenario in which the generosity of pensions, unemployment, and health programs are scaled back; future retirement ages are raised; and the length of education periods is reduced. Given the long time horizon, there would still be scope for significant real increases in benefits and pensions. The upfront fiscal consolidation would be smaller than currently envisaged by the authorities, but the permanent nature of the savings measures would ensure compliance with SGP limits though 2050. Moreover, reductions in non–entitlement expenditures would be more realistic (see Table).

Germany: General Government Operations, 2001-50 Entitlement Reform Scenario

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Sources: German authorities; IMF staff projections.

Unemployment benefits and assistance as well as other payments to the unemployed, excluding social security contributions on their behalf.

18. Staff questioned whether entitlement reform could be avoided. The pension reform had brought welcome institutional change but no significant savings. Relying only on medium–term fiscal consolidation to address the demographic problems would require a demanding compression of the relatively small share of public spending that is not demographically sensitive. Accordingly, staff advocated cutting high pension replacement rates further, raising the statutory retirement age, and shortening education periods.14 In addition, private households’ share in health care financing should be increased through co–payments. Given the lead time required to phase in reforms to entitlements, staff encouraged the authorities to build consensus for change well before the demographic strains began to be felt in earnest in 10–15 years. The authorities did not rule out further pension reforms and noted that higher surpluses than those targeted under the main guiding principles scenario might also be considered if previous efforts proved insufficient.

B. Labor Market Reforms and the East–West Divide

19. All agreed that labor markets had to be the focus of structural reforms after the elections. The authorities observed that the unemployment rate had declined by about 2 percentage points during 1997–2001, despite below–trend output growth. Moreover, it was not expected to move much above 8 percent in the current slowdown. By contrast, in the past, unemployment had ratcheted up during years with below–trend growth. Furthermore, much of the labor market problem related to unification, as the unemployment rate in the old Länder stood at about 6 ½ percent in 2001 (EU standardized). In their view, progress was due to: (i) more moderate wage demands since 1996, a trend they expected to continue, notwithstanding a job–neutral catch–up for past higher–than–expected inflation in the latest wage round; (ii) more wage and working time flexibility through the incorporation of opening clauses in traditional collective wage bargaining agreements or through wage setting outside the collective bargaining framework; and (iii) measures to encourage part–time and temporary work. Accordingly, they saw no need for major changes to the wage bargaining system or job protection legislation. Instead, they intended to concentrate mainly on job matching, where they saw obvious room for improvement, through a reform of the FLO.15

uA01fig14

Unemployment and the Output Gap

Citation: IMF Staff Country Reports 2002, 239; 10.5089/9781451810363.002.A001

20. Staff suggested that better job matching should be flanked by reforms to raise the payoff from work. Absent reforms, it was not clear how long wage moderation could be sustained—and, indeed, wage moderation was already being strongly questioned in some quarters because of its short–term depressing effect on demand. Ideally, reforms needed to be comprehensive. On the demand side of the labor market, high non–wage costs and burdensome regulations needed to be eased, notably those relating to part–time working and temporary working arrangements, where liberalization efforts had been less bold than in some other European countries. However, if efforts had to be prioritized, they should first focus on supply–side bottlenecks. Staff pointed out that, while data suggested that the bargaining system permitted a reasonable degree of wage flexibility for job stayers, few job losers appeared ready to concede wage cutbacks or to migrate to find a new job (Box 5). As a result, about one third of the unemployed had been without a job for one year or more, with both older workers and the less skilled bearing a disproportionate burden of job losses. Furthermore, relative to the high–employment countries, Germany compared poorly on the employment ratio of older workers.16 Staff argued that the root of these problems was overly generous benefits for the jobless: for the less skilled, these created poverty traps;17 for older workers, benefits had been designed with the aim of facilitating a transition from work into retirement. Better job matching alone would not address these crucial weaknesses.

Germany: Wage Flexibility

A forthcoming IMF Working Paper finds that the proportion of job stayers in the old Lander accepting wage cuts resembles that in the United States and the United Kingdom—although the typical wage cut is smaller.1 The implied downward flexibility reflects a collective bargaining system that sets wage floors that typically are significantly below actual wage levels and allows exemptions in roughly one fifth of all contracts. Moreover, if employers leave their association, they can set wages outside the collective bargaining framework without the constraint of a legal minimum wage: in 2000, collective bargaining no longer covered 37 percent of employees in the west. Wage flexibility at the level of the individual worker contrasts with the rigidity of the wage structure across broad categories of education, years of experience, and tenure.2 At the same time, few job losers make major wage concessions to find a job;3 and a disproportionate number of older persons are jobless. A key reason might be that the welfare system fosters a transition from work into de facto retirement: in 1985, unemployment benefit duration was increased from the standard duration of 12 months to a maximum of 32 months for those older than 53 years, after which somewhat less generous unemployment assistance becomes available indefinitely.

Nominal Wage Growth Statistics for Individual Job Stayers in Various Panel Data Sets

(In percent unless, otherwise noted)

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source: Fourthcoming IMF working paper, and studies reference in that paper.
1See Decressin and Decressin (2002), “On Sand and the Role of Grease in Labor Markets: How Does Germany Compare?,” forthcoming IMF Working paper.2See Prasad (2000), “The Unbearable stability of the German Wage Structure: Evidence and Interpretation,” IMF Working Paper No. 00/22.3See Burda and Mertens (2001): “Estimating Wage Losses of Displaced Workers in Germany,” Labour Economics (8).

Germany and U.K.: Employment by Age Groups, 2001

(In percent of corresponding population)

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Source: Eurostat.

Additional jobs if Germany had the same employment ratios for each age group as the U.K.

21. To foster labor supply, staff advocated benefit reform coupled with an earned income tax credit (EITC) for low–income earners, perhaps targeted to older workers. To this end, unifying the duration of unemployment benefits at 12 months and restricting a merged unemployment assistance and social assistance scheme to the truly needy should be considered. An EITC could help to reduce poverty traps, although experience elsewhere suggest that it would fail to provide a significant boost to labor supply absent cutbacks in benefits.18 At the same time, to facilitate the transition of the unemployed into the labor market, those who saw their level of assistance reduced as a result of welfare reform could be given the opportunity to earn supplements by taking on training and performing socially useful work. Such work should substitute for many of the current, ineffective active labor market policy schemes.

22. Savings from reform of welfare and the FLO could be partly used to help raise labor demand through reducing social security contributions. Total spending on unemployment, job creation, and social assistance not specifically related to sickness and disability amounts to over 3½ percent of GDP: depending on how much progress is made in improving the targeting of social welfare, budgetary savings are thus potentially significant. Efficiency considerations would suggest that cuts in contributions might, in the first instance, be limited to employers of older workers. Longer–term, sustainable cuts in contribution rates would require reform of pension and health benefits.

23. The authorities agreed that the generosity of welfare benefits might be holding back labor supply but were against general cutbacks in assistance. They would consider tightening eligibility for specific groups of unemployed who rejected job offers, notably the young. Also, a parliamentary commission was studying the merger of unemployment and social assistance with the main objective of removing inefficiencies. However, this would require changes in intergovernmental relations, as unemployment assistance was financed by the federal government, while social assistance was in the hands of the municipalities. If additional measures became necessary, the authorities believed the consensus would move in the direction of benefit reform. In this context, the Hartz Commission, which had initially been set up to look into the FLO’s poor record in job matching, had been instrumental in launching a public debate on broader reform.

24. Since the discussions, the Hartz Commission has published its proposals for labor market reform. The proposals aim mainly at improving job matching through restructuring the FLO and local labor offices and merging the administration of various benefits for the jobless. In addition, they advocate: (i) personal service agencies, operating outside the public sector but with its financial support, that would aim to place the unemployed with private companies under less–regulated fixed–term contracts; (ii) incentives for the jobless to become self–employed; (iii) subsidies or special loans to employers for hiring difficult–to–integrate unemployed; and (iv) for older workers, financial incentives to accept jobs and more scope for fixed–term employment. While the authorities intend to proceed rapidly with the implementation of some measures, notably the restructuring of the FLO and the special loans program, the cost effectiveness and budgetary implications of others require further analysis as well as new laws to be drafted in the new term. The special loans program is particularly controversial because it would involve public subsidies effectively provided by the development bank, Kreditanstalt fur Wiederaufbau (KfW), which is outside the general government sector.

25. The authorities argued that existing mechanisms to correct high unemployment in the new Lander were operating sufficiently. From various perspectives the catch–up of the new with the old Lander has been successful and is continuing (Box 6). However, as a result of overly rapid wage growth in the early 1990s, the new Lander now account for about one–third of Germany’s unemployed, with unemployment rates almost 2½ times as high as in the old Lander. In the authorities’ view, much of the initial job destruction had been unavoidable, owing to the lack of competitiveness of the manufacturing sector in the former East Germany. However, manufacturing had now turned into a vibrant sector accounting for about one–fifth of GDP in the new Länder, exports were booming, and unemployment had fallen despite the phase–out of various active labor market schemes. This partly reflected wages and working conditions that were much more flexible than in the old Lander, with a large majority of employees not covered by collective bargaining agreements. Staff agreed that mechanisms to correct imbalances in labor markets in the new Lander were operating but noted that unemployment was only adjusting slowly. High benefit replacement rates in the new Lander made it all the more important to pursue benefit reform.

Germany: The Catch–Up of the New Länder

Incomes in the new Lander have caught up rapidly with those in the old Lander. For a broad sample of countries, studies find that per capita incomes have historically converged at a rate of 3 percent per annum. For the new Lander, this would have meant that per capita GDP should have grown at least 2 percentage points a year faster over 1992–2001 than in the old Lander. In fact, it grew over 6 percentage points faster and now stands just 6 percent below the level in Portugal. Other Eastern European countries did not post similar growth. In manufacturing, productivity convergence has proceeded briskly. However, from the perspective of labor utilization, the catch–up has been disappointing, owing to the initial overly rapid convergence of eastern wages toward western levels. Wage moderation is now needed to cut unemployment and many of the new employers have left their associations to negotiate outside the collective wage bargaining framework.

Firms’ Membership in Employers’ Associations, 1993-2000

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Source: Burda and Hunt (2001), “From Reunification to Economic Integration, “Brookings papers of Economic Activity.
uA01fig15

GDP per Capital, PPP Based

Citation: IMF Staff Country Reports 2002, 239; 10.5089/9781451810363.002.A001

uA01fig16

Unemployment Rates

Citation: IMF Staff Country Reports 2002, 239; 10.5089/9781451810363.002.A001

uA01fig17

Manufacturing Value Added

Citation: IMF Staff Country Reports 2002, 239; 10.5089/9781451810363.002.A001

uA01fig18

Productivity and Wages

Citation: IMF Staff Country Reports 2002, 239; 10.5089/9781451810363.002.A001

26. The authorities noted that the current slowdown in activity in the new Lander was largely driven by construction, which had been artificially supported by inefficient investment subsidies. True, the overall envelope for investment by the local governments in the new Lander was programmed to decline under the pressure of fiscal consolidation. But they believed the quality of spending was more important, and they were considering a recent report on east–west convergence that proposed concentrating public support on rapidly growing clusters of activity in the new Lander, rather than spreading it thinly across the entire territory. Staff urged shielding public infrastructure from further cuts, noting that studies suggested that, on current plans, the per capita stock of eastern infrastructure covering schooling, transport, and communications would barely exceed two–thirds of the level in the old Lander by 2005.19

C. Product and Financial Markets

27. The authorities explained that they would continue to press for product market liberalization but were looking for a more level playing field in Europe. Germany had been at the forefront within Europe as regards liberalization of the telecommunications, energy, and postal sectors (the main network sectors); this had led to price declines and benefits for consumers. But while the authorities wanted to open their markets to more external competition, they were concerned that, absent better safeguards, key industries were exposed to takeovers by foreign state monopolies. This was particularly the case in energy and postal markets. Staff urged the authorities to intensify efforts with their European partners to keep the liberalization process moving forward. To foster more domestic competition in the energy sector, the introduction of specialized regulatory agencies might have to be considered as reliance on voluntary association agreements had been associated with less newcomer penetration of markets than expected. The authorities pointed out that they were currently strengthening the role of the Federal Cartel Office in ensuring competition and were considering making the association agreements legally enforceable under the Energy Industry Law. Ongoing steps to deregulate markets would be augmented by further divestiture of public assets.

28. Staff encouraged the authorities to resist pressures for public support to SMEs. The agreement with the EU to phase out public guarantees to the Landesbanken and savings banks and the coming changes from Basel H were seen in some quarters as exacerbating the cyclical problems of SMEs. With respect to Basel II, however, the authorities noted that they had reached agreement on lower equity requirements for small loans and lower risk weights on credits to smaller SMEs. This would effectively exclude many small enterprises from the new requirements, assuaging pressure for providing additional support to SMEs through subsidized loans offered by the KfW and the Deutsche Ausgleichsbank (DA). The focus of any measures would be to improve coordination and efficiency of SME support.

29. In the wake of domestic and international scandals, the authorities were taking steps to strengthen corporate governance. A voluntary corporate governance code establishing clear rules for the executive and supervisory boards of exchange–listed corporations had been introduced. It was expected to enhance transparency for investors and improve corporations’ access to international financial markets. Companies that do not comply with the code must issue a public declaration explaining their decision. Since the discussions, the authorities have tabled further proposals to strengthen governance. These include introducing personal liability for board members for the intentional dissemination of wrongful information and strengthening the supervision of accountancy firms and their liability for negligence.

30. The authorities viewed the financial sector as sound, with recent strains on profitability prompting improved risk management and faster consolidation. The performance of financial institutions has been weakening since 2001, in line with economic activity and a record number of corporate bankruptcies. The correction in equity markets has further eroded banks’ earnings, exposing structurally low profitability related to strong competition and high costs. While loan–loss provisions were rising and profitability was expected to continue to suffer in 2002, banks were responding by improving their risk management—a process also prompted by the phasing out of guarantees to public sector banks and the expected introduction of Basel H Moreover, consolidation was advancing among the mutually–owned credit cooperatives, and pressures for consolidation were building for the publicly–owned savings banks. Although exposures to potentially risky sectors and markets needed to be watched carefully, they were manageable, and reserves and capital were comfortable (Table 2). Like their European counterparts, German insurance companies have suffered from falling equity prices and—even before the recent floods—unusually high claims. While some insurers have been registering negative profits, the authorities expected the insurance sector to rebound, helped by higher premiums.

31. Staff argued that the present confluence of cyclical and structural weaknesses presented challenges for supervisors. The authorities acknowledged that restructuring in the financial sector was an ongoing process that would take several years. They were aware of a few problems in specific banks and insurance companies but stressed that systemic risks were low. They were strengthening the complex institutions group within BaFin—the single supervisory agency under the new Law on Integrated Financial Services Supervision—to take advantage of the synergies offered by integrated financial supervision. They also intended to hire 600 new staff to implement Basel II, although the public pay scale raised difficulties that needed to be addressed. Furthermore, they planned to review the regulatory framework to ensure comparable risk–adjusted capital requirements across financial institutions. Staff urged the authorities to make publicly available more information on financial sector risks, in line with other countries. All agreed that the upcoming Financial Sector Assessment Program (FSAP) presented a timely opportunity for supervisors to review the lines of defense against financial sector vulnerabilities.

D. Other Issues

32. The authorities reported that they were strengthening further the laws and regulations covering money laundering. Beyond the 40 recommendations of the Financial Action Task Force (FATF), the 8 special recommendations on terrorist financing had already been implemented. Moreover, a financial intelligence unit was being built up within the federal law enforcement authority; an automatic system offering access to information on all bank account holders was being developed; and tax consultants and accounting companies would be required to combat money laundering. Germany acceded to the OECD Convention on Bribery in International Business Transactions and adopted implementing legislation in 1999.

33. Germany’s statistics are generally of high quality, but to improve analysis and cross–country comparisons price deflators could better reflect changes in product quality; direct national accounts data on inventories should be constructed; data for the general government should be published with a higher frequency; and more comprehensive and timely data on financial sector vulnerabilities should be made available. Germany supports multilateral trade liberalization, notably the elimination of trade barriers for poor countries. Furthermore, it recently renewed its commitment to raising spending on ODA, which presently amounts to less than 0.3 percent of GNI.

IV. Staff Appraisal

34. The decade since unification has been one of difficult adjustments in Germany. The disappointing growth rate during the past 10 years should not disguise many distinct successes. Foremost among these was the integration of the new Lander with a remarkable degree of convergence of their income to western levels. But beyond this, Germany has steadily reduced its underlying fiscal imbalance, emerged as a leader within Europe in product market deregulation, and undertaken major tax and pension reforms. But the fact remains that growth for an entire decade has been low. And without a decisive break from past policies, particularly in labor markets but also in fiscal matters, Germany is at risk of another decade of painful fiscal adjustment against a backdrop of slow growth.

35. The new government has the opportunity to make this break. It must set its sights on putting more of the working age population to work so as to raise growth and revitalize the economy. Two priorities stand out from a macroeconomic policy perspective—increasing incentives to work and reducing entitlements, subsidies, and social transfers so as to deal with the fiscal imbalance permanently. Proceeding on both fronts will have powerful synergies: public expenditure reform will establish credibility, minimizing output costs of adjustment, and labor market reforms will raise growth, making fiscal adjustment more palatable. As the immediate outlook for growth is not strong—a stuttering recovery over the next year or so—the urgency for action is great.

36. The conditions for recovery have improved, but major domestic and global uncertainties cloud the growth outlook. With earlier price shocks having unwound, interest rate cuts feeding through and global activity firming somewhat, growth should begin to pick up toward the end of the year. But in view of domestic and global financial strains and a relatively tight macroeconomic policy stance, the economy is only projected to grow at the rate of potential next year. The current wide output gap and high unemployment are therefore likely to persist.

37. Fiscal consolidation is essential and needs to be implemented in a sustainable and credible manner. For 2002, the deficit will likely be close to the 3 percent SGP ceiling, and the authorities will need to continue to maintain firm expenditure control. Beyond this year, ensuring that the expenditure/GDP ratio is on a clear and sustainable downward path should be the priority. With that in place, a reduction in the structural deficit of ½ percent of GDP a year should be feasible. The automatic stabilizers should be given full play—in both directions—and postponing tax cuts to pay for one–time emergency flood relief would appear to be unnecessary. It is unrealistic, on current projections, to expect budget balance by 2004, and driving for that goal would likely place undue strain on the economy. That said, further tax relief beyond that already programmed should be postponed until expenditures and the deficit have been fully reined in.

38. It will be important to focus on the quality of expenditure restraint in order to provide the maximum boost to the supply side of the economy and reduce long–term spending pressures. Expenditure savings centered on pay compression and cutbacks in public investment are unlikely to be sustainable. Instead, industrial and agricultural subsidies should be curtailed more aggressively than planned, and spending on social transfers and labor market programs should be scaled back. In principle, broader entitlement reform that yielded significant future savings would be at least as effective in securing market confidence and ensuring that euro area–wide monetary policy strains do not develop as would meeting medium–term nominal deficit targets.

39. Looking ahead, the hardest fiscal task for Germany is to prepare for the costs of population aging. Although demographic pressures are not expected to bite for a decade or so, the new government needs to take the lead in building consensus for reforms. To avoid punitive increases in social contribution rates, budget surpluses will have to be run over a substantial period and be combined with measures to reduce the generosity of entitlements. In the area of pensions, the options largely come down to raising the retirement age and lowering the replacement ratio. In the area of health care, measures should encompass higher cost–recovery.

40. The current public policy debate on labor market reform offers a prime opportunity to push forward ambitious reforms. Some of the Hartz Commission recommendations, notably the setting up of private placement agencies, are good and should be implemented without delay; others, particularly the special loans program, are not. But a more comprehensive package that moves toward more flexible employment practices as well as stronger incentives to work is needed. This would provide the most effective signal to employers and workers about the orientation of policies and would reap the highest response in terms of investment and job creation. But if it takes time to build consensus for such a package, at a minimum, initial reforms need to address two critical problems: the low employment rate of older workers and the high unemployment rate of the low–skilled. Particularly for these groups, improving incentives to work through reform of the benefit system is a priority. This could be achieved by introducing an earned income tax credit for low–income earners, together with measures to target assistance for the jobless only to the truly needy. Those finding their level of assistance reduced could be given the opportunity to earn supplements by performing jobs that substitute for many of the ineffective active labor market policy schemes.

41. To meet the challenges of intensified global competition and improve productivity growth, Germany must remain committed to product market reform. While recognizing the difficulties of different speeds of market opening in Europe, Germany stands to benefit from remaining a leader in reform, as product market competition and productivity growth are closely related. Sufficient competition will have to be ensured in the network sectors, by carefully balancing self–regulation and intervention. The SME sector’s role as an engine of growth should not be compromised by special treatment or subsidies. Germany’s support for multilateral trade liberalization and the elimination of trade barriers for poor countries is highly welcome and the authorities are encouraged to raise ODA spending to the UN target of 0.7 percent of GNI.

42. Recent developments are setting the stage for a stronger banking system, but the confluence of cyclical and structural weaknesses requires supervisors to be particularly attentive. The phasing out of guarantees to public sector banks and the expected introduction of Basel II standards are welcome developments. These changes, together with banks’ efforts to raise profitability, are already driving the processes of improving risk management and bank consolidation. Allowing the latter to continue unhindered will be important to the future health of the banking system. Moreover, it is essential that the new Law on Integrated Financial Services Supervision be implemented to ensure the latitude and resources of the BaFin are sufficient to keep abreast of financial market developments. The forthcoming FSAP will provide a timely opportunity to review supervisors’ lines of defense.

43. Germany’s statistics are more than adequate for the purposes of effective surveillance. However, some improvements could facilitate cross–country comparisons as well as the monitoring of fiscal policy and financial sector vulnerabilities.

44. It is proposed that the next Article IV consultation be held on the standard 12–month cycle.

APPENDIX I: Germany: Fund Relations

(As of July 31, 2002)

I. Membership Status:

Germany became a member of the Fund on August 14, 1952. Germany has accepted the obligation of Article VIII, Sections 2, 3, and 4.

II. General Resources Account:

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III. SDR Department:

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IV. Outstanding Purchases and Loans: None

V. Financial Arrangements: None

VI. Projected Obligations to Fund: None

VII. Exchange Rate Arrangement:

Since January 1, 1999, Germany is a member of the European Economic and Monetary Union; the deutsche mark entered EMU at a value of DM 1.95583 per euro.

Germany maintains exchange restrictions against Iraq pursuant to U.N. Security Council Resolution No. 661, and against the Federal Republic of Yugoslavia (Serbia/Montenegro) pursuant to U.N. Security Council Resolution No. 757. These restrictions were notified to the Fund under Decision No. 144. In accordance with U.N. Security Council Resolution No. 022, the financial sanctions against the Federal Republic of Yugoslavia (Serbia/Montenegro) were suspended with effect from November 22, 1995. The sanctions against the areas of Bosnia and Herzegovina that were controlled by the Serbs were suspended on February 27, 1996.

VIII. Article IV Consultations:

Germany is on a 12–month consultation cycle. The staff report for the last Article IV consultation (SM/01/290) was discussed at EBM/01/108 (October 24, 2001).

APPENDIX II: Germany: Statistical Appendix

Germany has a full range of statistical publications and subscribes to the Fund’s Special Data Dissemination Standard (SDDS). The authorities make full use of the Internet to facilitate on–line access to data and press information.

Since the beginning of 1999, Germany’s monetary and banking statistics methodology has changed to reflect the standards of the European Monetary Union. The Bundesbank has also taken steps to further harmonize the presentation of the balance of payments data with the prescriptions of the fifth edition of the IMF’s Balance of Payments Manual.

Germany adopted the European System of Integrated Economic Accounts 1995 (ESA95) in 1999. Two significant gaps remain:

Statistics on inventories are unavailable, depriving Germany of a key economic indicator. In the national accounts statistics inventory accumulation is derived as a residual and lumped together with the statistical discrepancy.

Intra–annual ESA95 (national accounts) data on the general government are not available, as elsewhere in the euro area, depriving Germany of a key indicator to monitor fiscal developments. Relatedly, a bridge table between the general government data on a national accounts basis and the public sector data on an administrative basis is not published; this too hinders a full understanding of fiscal developments.

Following the adoption of the ESA95 standard for fiscal reporting by member countries of the European Union, Eurostat advised the IMF that the member countries would no longer report cash data for publication in the Government Finance Statistics Yearbook. The IMF Statistics Department is collaborating with Eurostat and the European Central Bank to develop a fiscal data reporting system that accords with the accrual methodologies of the ESA95 and the revised Government Finance Statistics Manual.

Germany: Core Statistical Indicators

(As of August 23, 2002)

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1

Discusion took place in Berlin, Frankfurt, and Bonn during July 1–8, 2002. Meetings were held with Bundesbank president Welteke, State Secretaries Koch–Weser, Overhaus (both Ministry of Finance), and Tacke (Ministry of Economics), and senior officials at the Chancellery, the Ministries of Finance, Economics, Interior, and Labor, the Bundesbank, and the Federal Office of Financial Supervision. The mission also met with the social partners, private financial institutions, and research institutes. The team comprised Ms. Schadler (Head), Messrs. Corker, Decressin, and Klingen, and Ms. Kodres (all EU1). Mr Bischofberger, Germany’s Executive Director, also took part in the discussions. The authorities released the misson’s concluding statement and intend to publish this staff report. Last year’s Article VIII, Sections 2, 3, and 4 (Appendix I).

2

For details, see the forthcoming Selected Issues paper.

3

See SM/0 07

4

Half of the gross tax relief for enterprises (totaling ½ percentage point of GDP) implemented in January 2001 was offset by lowering the general depreciation allowance from at most 30 percent (4 percent for buildings) to at most 20 percent (3 percent for buildings). This measure had been under consideration since end–1999.

5

Sachverstandingenrat, Jahresgutachten 2001/02 reports similar results.

6

See, for example, Edison and SløK: “Wealth Effects of the New Economy” and “New Economy Stock Valuations and Investment in the 1990”—IMF Working Papers WP/01/77 and WP/01/78. During most of the 1990s, financing by firms in the stock market is estimated to have accounted for less than 5 percent of the gross change in capital.

7

In 2001, the current account posted the first surplus since unification and the external sector made one of the largest contributions to GDP growth in the euro area. Although export growth declined sharply, it outstripped market growth by 4 percentage points. A Selected Issues paper reviews competitiveness in more detail, including within the euro area.

8

Conventional models suggest short–term fiscal multipliers close to unity for expenditure cuts.

9

SGP rule would be applied flexibly in the case of unanticipated emergency relief spending.

10

Since the discussions, the federal authorities have implemented a freeze on certain expenditures, the savings from which are to fund immediate flood–related repairs.

11

On staff projections, the general government would reach close to actual balance in 2006 with this adjustment.

12

Based on historical revisions, standard errors of real GDP growth (0.5 percentage point) and of staff estimates of output gaps (0.4 percent of GDP) in 1992–2001 are large and raise problems for targeting cyclically adjusted budget deficits.

13

Some measures are already programmed, namely the introduction of a positive list of reimbursable products in 2003 and diagnosis–specific lump–sum payments in 2004. Health policy issues are analyzed in a Selected Issues paper.

14

Under the 2001 pension reform, the minimum replacement ratio for a standard pensioner is to be cut from 70 percent to 67 percent by 2030. Each additional 1 percentage point. A one–year increase in the statutory retirement age (currently 65) would allow contribution rates to be cut by 0.8 percentage point.

15

Against about 4 million unemployed, some 0.5 million vacancies are recorded at the FLO. Employers estimate the total number of vacancies at 1.5 million.

16

The employment ratio of the young is also low, but this is related to the education system; the unemployment rate of 15–24 year olds is actually lower than U.K.(7.8 percent in 2001, compared with 10.3 percent in the U.K.). The overall employment ratio in Germany is above the EU average.

17

In the old Lander, social assistance for a single worker reaches about 70 percent of the wage paid in the relatively low–paid restaurant and hotel sector; for a married worker with one child, it can reach 100 percent, Replacement rates are higher in the new Lander (see Sachverständingenrat, Jahresgutachten 2001/02, page 377).

18

Research on the United States’ welfare reform credits cutbacks in benefits with raising labor supply and the EITC with reducing poverty, but also emphasizes that the reform has not yet been tested by a large downturn in the labor market. See Blank (2002) “U.S. welfare Reform: What’s Relevant for Europe?” CESFO Working paper No.753. The cost of the EITC might amount to ¼–½ percent of GDP (based on 2001 estimates) if schemes in either the United States or United Kingdom were taken as the model.

19

See DIW–Wochenbericht 24/00.