Front Matter

Front Matter Page

© 2004 International Monetary Fund

November 2004

IMF Country Report No. 04/340

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 8, 2004. 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.

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Front Matter Page

INTERNATIONAL MONETARY FUND

GERMANY

Selected Issues

Prepared by Jörg Decressin, Allan Brunner, Benedikt Braumann and Louis Kuijs (all EUR)

Approved by the European Department

October 8, 2004

Contents

  • Overview

  • I. Investment Trends and Business Capital Stock in OECD Countries: Long-Term Developments and Future Prospects

    • A. Introduction

    • B. Stylized Facts and Possible Explanations

      • Long-run determinants of capital accumulation

      • Capital stock convergence

      • Lending rates

      • Excessive wage growth

      • The role of labor and capital taxation

    • C. Econometric Results

      • The econometric approach

      • Decomposition of long-run developments

    • D. Summary and Policy Conclusions

    • Appendix: Capital Accumulation in a Neoclassical Growth Model

    • References

  • Figures

  • I-1. Investment Trends, 1960-2002

  • I-2. Business Capital Growth Trends, 1960-2002

  • I-3. Business Capital Stock Growth and Neoclassical Fundamentals, 1965-2000

  • I-4. Capital Accumulation and Per Capita GDP, 1960-2000

  • I-5. Capital Accumulation and Per Capita GDP, 1965 and 2000

  • I-6. Government Ownership of Banks and Lending Spreads, 1995-2000

  • I-7. Capital Accumulation and Efficiency Wage Growth, 1960-2000

  • I-8. Business Capital Stock and Efficiency Wage Growth, 1965-2000

  • I-9. Capital Accumulation and Taxation of Capital and Labor, 1960-2000

  • I-10. Business Capital Stock Growth and Taxation of Capital and Labor, 1965-2000

  • Tables

  • I-1. Determinants of Business Capital Growth Rates, 1960-2000

  • I-2A. Germany: Decomposition of Capital Stock Growth Rates, 1961-2000

  • I-2B. Sweden: Decomposition of Capital Stock Growth Rates, 1961-2000

  • I-2C. United States: Decomposition of Capital Stock Growth Rates, 1961-2000

  • I-2D. Spain: Decomposition of Capital Stock Growth Rates, 1961-2000

Overview

1. A cyclical recovery is underway in Germany, but the longer-term growth prospects remain a concern. A combination of fiscal adjustment and structural reform is needed to improve the longer-term growth outlook, and this Selected Issues Paper illuminates different aspects of the challenges confronting Germany and the associated policy requirements.

2. In a cross country study involving 21 OECD economies, Chapter I investigates the steady decline in capital accumulation in Germany in recent decades. It finds that capital accumulation was very strong in the early years after World War II, consistent with rebuilding. With marginal benefits diminishing as the capital stock was restored to levels comparable with other advanced countries, part of the more recent slow down could thus have been expected and is commonly referred to as “convergence”. However, the path along this convergence has had wide swings, which are related to wage booms in the 1970s and immediately following unification in the 1990s, and to increases in taxes on capital and wages. Sharp wage increases are found to boost capital formation in the short run as employers substitute capital for labor at a rate that adjusts to the higher relative price for labor (thereby boosting unemployment and causing an underutilization of labor). Higher taxes on factor inputs, be they capital or wages, are both seen to lower capital accumulation. In the long run, capital formation is seen to depend on the growth of total factor productivity and labor supply. Hence policies should aim at keeping factor price distortions to a minimum, and especially promote flexibility in labor markets together with proper incentives for a higher degree of labor utilization.

3. Chapter II focuses on the German labor market, assessing participation rates, employment, and unemployment from a cross country perspective. Participation is found to be low among elderly workers (who are bridging into retirement with generous unemployment facilities), women (in the West), and youth. Employment rates are especially low among the elderly, notably in the East, where lower productivity workers were essentially priced out of the market through high wage floors (high reservation wages) linked to the adoption of generous entitlement provisions from the West following unification. Moreover, while the overall unemployment rate is higher than in comparator countries, the gap in participation (i.e. labor utilization) is larger than in unemployment, suggesting that policies directed at increasing participation rates offer the greatest potential for increased labor supply and output growth. Labor market and entitlement reforms in Agenda 2010 are estimated to boost steady state employment by some 1½ percent. In light of the impending demographic changes, especially the decline in the working-age population, additional steps will be needed to boost longer-term participation rates and labor utilization. The paper concludes with several options to deepen reforms in this direction.

4. Chapter III considers the link between pensions and growth. The key to this link is embedded in German law, which generally requires that social transfers need to be financed with payroll taxes. Higher payroll taxes, however, reduce labor supply, and therefore reduce growth. Staff simulations show that the coming demographic shifts are likely to reduce GDP growth below what is currently expected because of an adverse cycle of rising nonwage labor costs and low incentives to work. The Agenda 2010 reforms to begin addressing the pressures from aging are a step in the right direction, but are not expected to be enough to contain payroll taxes sufficiently and prevent a growth slowdown. An important policy option to lessen the pressure from aging is to increase the effective retirement age—thereby supporting growth and enhancing the distributional equity between generations.

5. Chapter IV offers perspectives on Federalism and Germany’s Political Economy of Fiscal Adjustment. It shows that the evolution of the structural fiscal balance is closely linked to the support for the government in the upper house of parliament (the Bundesrat—representing the Länder governments). Also, it explores the course of structural reforms, which are key to boosting growth and redressing long-term fiscal imbalances, and finds that these are subject to frequent policy reversals. In order to limit the political economy biases to fiscal policy, the chapter explores options to strengthen budgetary institutions, notably more transparency; stronger budgetary rules; and more room for Länder governments to mobilize revenue and tailor spending to local circumstances—thereby inducing a degree of competition in the federalist framework that is now dominated by the need for consensus.

6. Chapter V examines whether purchasing power parity (PPP) holds over the long run in Germany and Switzerland. Using data for the past century, it finds that PPP, characterized by a relatively stable REER, holds for Germany but not for Switzerland. The Swiss trend appreciation reflects high equilibrium private and public saving rates and a degree of pricing power in monopolistic domestic markets that is not present in Germany. Calculations of the German fundamental equilibrium exchange rate suggest that the current REER is close to its equilibrium level. How to reconcile this external, and quite competitive, equilibrium in Germany with dormant domestic demand and low labor utilization is a challenge that requires further research.

Contents

  • II. Employment, Unemployment, and Labor Supply in Germany

    • A. Introduction

    • B. Labor Force Participation, Employment, and Unemployment: an Overview

    • C. The Role of Labor Market Institutions

    • D. Recent Reforms and Their Possible Impact

    • E. Labor Supply and Employment Prospects with Further Reforms

    • F. Conclusions

    • References

  • Figures

  • II-1. Germany and Selected Countries: Labor Market Institutions, 1960-2000

  • II-2. Negotiated and Actual Pay Increases, 1992-2003

  • II-3. Dynamics of Working Age Population, 1950-2050

  • Tables

  • II-1. Utilization of Labor Resources in International Perspective, 1970 and 2003

  • II-2. Disaggregated Labor Market Data in International Comparison, 2003

  • II-3. Participation and Unemployment Rates

  • II-4. Unemployment Rates, 2003

  • II-5. Reasons for Not Participating in Labor Market (15-64)

  • II-6. Net Replacement Rates for Unemployed Persons

  • II-7. Net Replacement Rates for Long-Term Unemployed Persons

  • II-8. Statutory Tax Wedge on Labor and Its Components in International Comparison, 2003

  • III. Pensions and Growth

    • A. Introduction

    • B. The Model

    • C. Economic Effects of aging Without Reforms

    • D. The Reform of 2004

    • E. Raising the Effective Retirement Age

  • IV. Perspectives on Federalism and the Political Economy of Adjustment

    • A. Introduction and Summary

    • B. The Political Economy Infrastructure

    • C. The Role of the Political Economy Infrastructure in Fiscal Adjustment and Structural Reform

      • Insights from the political economy literature

      • Indicators of the political economy in Germany

      • Government ideology, support, and the deficit

      • Government ideology, support, and structural reforms

    • D. The Role of Budgetary Institutions

      • Budgetary institutions: The status

      • Budgetary institutions: Scope for reform

    • E. Reforming Bund-Länder Economic Relations

      • Interregional redistribution

      • Tax policy coordination versus competition

      • Region-specific expenditure policy

      • Potential avenues for reforming Bund-Länder fiscal relations

    • Appendix: Indicator of Structural Reforms

    • References

  • Figures

  • IV-1. Central Government Margin in Bundestag

  • IV-2. Central Government Margin in Bundesrat

  • IV-3. Central Government Overall Margin

  • IV-4. Government Margin, Structural Balance

  • IV-5. Structural Revenue and Expenditure

  • IV-6. Government Margin, Structural Reforms

  • IV-7. Convergence

  • Text Boxes

  • IV-1. The Political Economy of Fiscal Adjustment

  • IV-2. The Political Economy of Structural Reforms

  • IV-3. Intergovernmental Redistribution

  • Tables

  • IV-1. Chronology of Reforms, 1970-2004

  • IV-2. General Government Balance and Public Investment, 1992-2003

  • IV-3. Distribution of Cash Deficit, 1992-2002

  • IV-4. Revenues Before and After Redistribution and GDP, 2001

  • IV-5. Tax Receipts of Bund and Länder, 2002

  • IV-6. Bund-Länder Repartition of Tax Revenue, 1992-2001

  • V. Does Purchasing Power Parity Hold in the Long Run? Evidence from Germany and Switzerland

    • A. Introduction

    • B. German and Swiss Real Exchange Rates—Some Stylized Facts

    • C. Time-Series Properties

    • D. Why PPP May Not Hold in the Long Run

    • E. Equilibrium Real Exchange Rates: Competition, and Inflation

    • Appendix: Data Sources

    • References

  • Figures

  • V-1. Germany: Real Effective Exchange Rate

  • V-2. Switzerland: Real Effective Exchange Rate

  • V-3. Germany: Autocorrelation

  • V-4. Switzerland: Autocorrelation

  • V-5. Unit Root Tests

  • V-6. Relative Employment Ratio

  • V-7. Relative Fiscal Surplus

  • V-8. Net Foreign Assets

  • V-9. Switzerland: Relative Markup

  • V-10. Mexico: Inflation and Real Exchange

  • Tables

  • V-1. FEER Estimation Results (OLS)

Germany: Selected Issues
Author: International Monetary Fund