Front Matter Page

© 2002 International Monetary Fund

October 2002

IMF Country Report No. 02/240

Germany: Selected Issues

This Selected Issues paper for Germany was prepared by a staff team of the International Monetary Fund as background documentation for the periodic consultation with the member country. It is based on the information available at the time it was completed on October 9, 2002. The views expressed in this document are those of the staff team and do not necessarily reflect the views of the government of Germany or the Executive Board of the IMF.

The policy of publication of staff reports and other documents by the IMF allows for the deletion of market-sensitive information.

To assist the IMF in evaluating the publication policy, reader comments are invited and may be sent by e-mail to Publicationpolicy@imf.org.

Copies of this report are available to the public from

International Monetary Fund • Publication Services

700 19th Street, N.W. • Washington, D.C. 20431

Telephone: (202) 623 7430 • Telefax: (202) 623 7201

E-mail: publications@imf.org • Internet: http://www.imf.org

Price: $15.00 a copy

International Monetary Fund

Washington, D.C.

Front Matter Page

INTERNATIONAL MONETARY FUND

GERMANY

Selected Issues

Prepared by Jörg Decressin, Laura Kodres and Christoph Klingen (all EU1)

Approved by the European I Department

October 9, 2002

Contents

• Overview

• I. Growth and Adjustment in Germany: Perspectives and Prospects

  • A. Introduction and Summary

  • B. The Economic Performance

  • C. Supply-Side Developments

    • The contribution of labor

    • The contribution of capital

    • The contribution of total factor productivity

  • D. A Decade of Economic Adjustments

    • The demand side: public sector adjustment and the interplay with monetary conditions

    • The effects of changes in the sectoral composition of output

    • Integrating the new Länder

  • E. Economic Adjustment: The Road Ahead

• Appendix I Identifying Labor Supply and Demand

• Appendix II Macroeconomic Model Simulations

• References

• Text Box

• I. Taxation and Labor Supply

• Tables

• I-1. Germany’s Economic Performance, 1992-2001

• I-2. The Years Preceding German Unification, 1989-1991

• I-3. Germany’s Labor Market Performance, 1992-2001

• I-4. Growth Accounting, 1992-2001

• I-5. Labor Cost Developments

• I-6. Net Replacement Rates, 1999

• I-7. Labor Productivity Gaps and Capital Stock Growth, 1992-2001

• I-8. TFP Growth, 1981-2001

• I-9a. Regulatory Reform in Product Markets, 1978-1998

• I-9b. Detailed Indicators of Product Market Regulation, 1998

• I-10. R&D Expenditure, 1980-2000

• I-11. Employment Protection Legislation

• I-12. Education 1970-98

• I-13. Ranking Educational Achievement Based on 2000 PISA Study

• I-14. The Role of the Public Sector, 1992-2001

• I-15. Explaining the Per Capita Real GDP Growth Differences, 1992-2001

• I-16. The Size of Industry, Energy and the Construction Sectors

• I-17. Value Added Excluding Construction, Industry, and Energy

• I-18. Job Growth in Manufacturing

• I-19. Turbulence: Standard Deviation of Sectoral Growth Rates

• I-20. Public Sector Balances

• I-21. Primary Structural Fiscal Balances, 1991-2001

• Figures

• I-1. A Factor Decomposition of Business Sector Real GDP Growth, 1980-2001

• I-2. Labor Supply and Factor Proportions, 1980-2001

• I-3. Unemployment and Gross Replacement Rates, 1971-2001

• I-4. Taxes and Contributions, 1980-2001

• I-5. Labor Demand and Payroll Taxes, 1970-2001

• I-6. Fiscal Policy and Monetary Conditions, 1991-2001

• I-7. Government Revenue and Primary Expenditure, 1991-2001

• I-8. Value Added in Industry and Energy and the Real Exchange Rate, 1980-2001

• I-9. Economic Convergence Compared, 1991-2001

• I-10. East-West Convergence, 1991-2001

• I-11. East-West Unemployment and Labor Costs, 1991-2001

• I-12. Real GDP Growth and Asset Prices

• I-13a. Response to Innovation in US Real GDP Growth Rate, 1992:1-2001:4

• I-13b. Response to Innovation in Deviation of US Real GDP from US HP-Filtered Real GDP, 1992:1-2001:4

Overview

This selected issues paper focuses on two main themes; Germany’s growth record and how future performance might be enhanced; and the longer-term strains on the public finances.

Chapter I reviews Germany’s growth record in 1992-2001. During this period, per capita real GDP growth was both low and lagged behind that in other European countries. Some of the growth differential can be put down to Germany’s unique cyclical position following the unification-related boom at the beginning of the 1990s. However, correcting for the cycle, growth was still significantly lower than in the United Kingdom and the Netherlands. A crucial difference was Germany’s relative inability to create jobs, a failing that is linked to generous welfare systems, which tended to absorb displaced labor into long-term unemployment or early retirement, as well as to a rising burden of tax and social security contributions. The chapter stresses that the 1990s were a testing time for labor markets as the policies to integrate the new Länder into Germany’s economic system precipitated enormous shifts in the structure of output. While the growth record should in principle improve in the next decade, reducing the vulnerability of the economy to shocks and dealing with the legacy of high unemployment requires reforms to labor markets.

Chapters II and III complement this analysis. Chapter II reviews Germany’s external competitiveness, which deteriorated substantially in the wake of unification. It concludes that, by the beginning of the current decade, competitiveness had been largely restored. At a multilateral level, this partly reflected general euro weakness. But more fundamentally, the manufacturing sector responded to earlier real exchange rate appreciation by downscaling and improving productivity. Within the euro area, Germany’s competitiveness is more ambiguous, but export market share has begun to recover in recent years. Chapter III examines the recent slowdown in credit, which has gone beyond what might be expected on cyclical grounds. While identifying supply-side factors is problematic, the unexplained credit weakness is consistent with the need for restructuring in the banking system and ongoing efforts to improve credit-risk management.

Chapters IV and V address fiscal sustainability issues. Chapter IV analyzes the impact of population aging on the fiscal accounts. Pulling together all age-sensitive expenditures in a consistent macroeconomic framework, it highlights the need for additional reforms to entitlements. Various scenarios show that the huge long-term costs of aging cannot be absorbed in a fully sustainable manner under current plans to run modest budget surpluses in the medium term. Indeed, given the limited scope to shrink non-entitlement spending, it is hard to see how such surpluses can be generated or sustained without entitlement reforms. Chapter V puts an additional spotlight on the health care system. Public spending on health as a share of GDP is the highest in the world and future health care costs will likely come under pressure from medical advancements as well as from demographics. The chapter notes that health care reform is a contentious issue in all countries and there are few ready-made answers. However, a strong case for increasing copayments can be made as this should at least begin to correct the lack of incentives to curb demand for and supply of health services.

Contents

• II. Is Germany Competitive?

  • A. Real Exchange Rate Trends and Profitability

  • B. The Macrobalance Approach

  • C. Export Market Shares

  • References

• Figures

• II-1. Real Effective Exchange Rates Against 19 Industrial Countries 1960-2002

• II-2. Nominal Real Effective Exchange Rate, 1988-2002

• II-3a. Nominal Effective Exchange Rate and Selected Bilateral Rates Against Euro Area, 1988-2002

• II-3b. Real Effective Exchange Rate CPI-Based Against Euro Area, 1988-2002

• II-4a. Real Effective Exchange Rate Based on Unit Labor Cost in Manufacturing, 1988-2002

• II-4b. Real Effective Exchange Rate Based on Unit Labor Cost in Business Sector, 1988-2002

• II-5. Index of Employment in Manufacturing

• II-6. Selected European Countries: Business Sector Profitability, 1/, 1988-2002

• II-7. SI Norm and Underlying Current Account, 1984-2001

• II-8. Export Market Shares within Various Regions, 1980-2001

• III. The Slowdown in Credit Growth

  • A. Introduction and Summary

  • B. Background

  • C. Modeling Credit Growth

    • The structural model

    • A less-structured model

    • Alternative definitions of credit and activity

  • D. Conclusions

  • Appendix Data Sources and Definitions

  • References

• Tables

• III-1. Structural and Non-Structural Equation Results

• Figures

• III-1. Growth of Private Domestic Credit to Non-Banks in Germany and the Euro Area

• III-2. Actual vs Projected Credit Growth

• III-3. Net Interest Rate Margins for Selected Bank Types

• III-4. Model Projections of Credit Growth

• III-5. Total Liabilities of Non-Financial Enterprises

• IV. The Fiscal Challenge of Aging: What Needs to Be Done

  • A. Introduction and Results

  • B. Assumptions

    • Demographic developments

    • Macroeconomic environment

  • C. The Outlook in Detail

    • Public pensions

    • Civil service pensions

    • Health care expenditure

    • Long-term care insurance

    • Remaining aspects of public finances

  • Appendix

    • Expenditure of Public Pension Fund (GRV), 2000-2050

    • Expenditure for Civil Service Pensions, 2000-2050

    • Health Care Expenditure, 2000-2050

    • Long-term Care Expenditure, 2000-2050

  • References

• Tables

• IV-1. General Government Operations, 2001-50

• IV-2. Summary of Macroeconomic Developments, 2001-07

• IV-3. Labor Force Participation Rates

• IV-4. Health Expenditure By Age Group

• Figures

• IV-1. Development of Age-Related Public Expenditure, 2000-50

• IV-2. Evolution of Fiscal Deficits and Public Debt, 2000-50

• IV-3. Evolution of Baseline and Required Social Security Contribution Rates, 2000-50

• IV-4. Population Dependency Ratios, 1980-2050

• IV-5. Public Pension Fund Expenditure, 2000-2050

• IV-6. Demographic Indicators, 2000-50

• IV-7. Per Capita Health Expenditure by Age Group

• V. Health Care Reform in Germany

  • A. Introduction

  • B. The German Health Care System

  • C. Reform Efforts and Proposals

  • D. Possible Reform Priorities

    • Patient co-payments

    • Regulatory options

  • References

• Tables

• V-l. Health Care Expenditure, 1970-2000

• V-2. Health Care Expenditure by Type

• V-3. Health Care Expenditure by Type, 1970-2000

• V-4. Evolution of Per Capita Expenditure of Public Health Insurance Funds, 1992-2002

• V-5. Indicators of Health Care Resources

• V-6. Indicators of Health Care Utilization

• V-7. Health Status Indictors

• Figures

• V-1. Health Care Expenditure by Sponsoring Agency, 2000

• V-2. Social Contribution Rates for Health Care and Pensions, 1970-2002