Germany
2007 Article IV Consultation: Staff Report; Staff Supplement; Public Information Notice; and Statement by the Executive Director for Germany
Author: International Monetary Fund
Publication Date:
27 Feb 2008
eISBN:
9781451810547
Language:
English
Keywords:
ISCR; CR; government; deficit; Bundesbank; labor productivity growth; staff recommendation; exchange rate; labor market; current account; core inflation; General government; Global; government expenditure
Download PDF (748.6 KB)

The German economy has made major strides, helped by wide-ranging reforms. Greater transparency and stronger incentives for prudent action will support crisis prevention and management. The immediate priorities are preserving the integrity of the financial system and maintaining economic confidence. Policy on banking sector restructuring should be mindful of, and consistent with, the forces of international financial integration. Stepping up productivity is the key to sustaining growth. Further efforts are needed to bolster and reinforce commendable gains in fiscal outcomes.

Abstract

The German economy has made major strides, helped by wide-ranging reforms. Greater transparency and stronger incentives for prudent action will support crisis prevention and management. The immediate priorities are preserving the integrity of the financial system and maintaining economic confidence. Policy on banking sector restructuring should be mindful of, and consistent with, the forces of international financial integration. Stepping up productivity is the key to sustaining growth. Further efforts are needed to bolster and reinforce commendable gains in fiscal outcomes.

I. The Context

1. The economy has made major strides, helped by wide-ranging reforms. From the doldrums of 2001-03, strong external competitiveness generated a robust recovery, with beneficial spillover effects for Europe. With strong performance in 2006 and much of 2007, a welcome decline in unemployment is ongoing. These developments have been aided by extensive reforms, including in labor and capital markets. Determined fiscal consolidation has enhanced policy credibility.

Reform Initiatives and Implementation

article image

Different reforms.

Phased in over time.

2. Germany, however, faces key challenges, with a growing risk that these may interact in insidious ways:

  • The rescue of two German banks in the summer of 2007 raised concerns that the problems may be more widespread. With the international subprime fallout still ongoing, the drip of bad news has continued, generating appreciable risks to economic confidence and short-term prospects.

  • These developments come at a time when—despite progress—a sustainable increase in potential growth has not yet been secured and German consumers remain ambivalent about future prospects.

  • The hard-won competitiveness gains could be eroded without an impetus to productivity growth. Wages remain high for unskilled labor and low returns to human capital contribute to skilled emigration. Aging costs remain a threat to fiscal sustainability.

  • The prospects for further reforms have dimmed with no major policy proposals in the pipeline. And recent labor market measures motivated by “fairness” create distortions and incentives inimical to employment and output growth.

3. Pressing ahead with reforms, therefore, remains crucial. The immediate priorities are preserving the integrity of the financial system and maintaining economic confidence. However, significant medium-term challenges remain (Box 1). These include further efforts to foster employment and growth, while confronting the pressures from global movement of labor and capital and also achieving regional balance within Germany. This, in turn, will require a continued reorientation of traditional, corporatist institutions—wage bargaining, relationship banking, insider-dominated corporate governance, and federal decision making. Preserving solidarity through shared gains, while accommodating the forces of global competition, is the overarching challenge.

uA01fig01

Germany’s relative decline

Citation: IMF Staff Country Reports 2008, 080; 10.5089/9781451810547.002.A001

1/ EU-15 Excluding Germany, Ireland, and Luxembourg.

Past Fund Policy Recommendations and Implementation

Following much progress in implementing policies recommended by Directors, the reform momentum has slowed noticeably:

Foundations for employment and growth. The authorities regard rationalization of programs under Hartz IV as a priority, but implementation has lagged. There has also been no progress in reforming employment protection legislation. Despite Directors’ urging to refrain from introducing minimum wages, a sectoral minimum wage has been instituted for postal workers.. The proposed extension of unemployment benefits for elderly workers also goes against the Directors’ advice to increase the incentives for work. Initiatives for cutting red tape are, however, proceeding through the Normenkontrollrat.

Financial sector efficiency. Directors have underscored the importance of an efficient financial sector. To date, bank restructuring initiatives have been limited, as has been the role of private capital—which Directors have seen as vital. The authorities are exploring rationalization of banking supervision. Following the introduction of real estate investment trusts, a push on capital market development is not imminent; indeed, risks are associated with some proposed measures.

Fiscal consolidation and reforms. Directors have welcomed the authorities’ strong expenditure-based measures for fiscal consolidation and the substantial progress in reducing long-term aging costs. But they have cautioned that fiscal sustainability will not be assured even if the structural deficit were to be eliminated by 2010. Accordingly, they have encouraged the authorities to pursue a broad-based approach, encompassing both fiscal adjustment and growth-enhancing reforms.

II. Recent Economic Developments

4. The upswing maintained traction in 2007. From the cyclical trough in 2004, GDP growth accelerated to 2.9 percent in 2006, the highest rate since unification (except in 2000). Output grew by 2.5 percent in 2007, with an unexpectedly strong third-quarter performance, despite the onset of the financial turbulence. Output is now close to potential. Growth in 2007 was not dented by high oil prices, fiscal consolidation, or first-quarter contraction in consumption (following purchases in 2006 in advance of the VAT hike). Reductions in social contributions and a boost in investment driven by the impending elimination of a depreciation allowance in 2008 helped temper the contractionary effects.

Comparison of Real GDP Projections

(percent)

article image

5. The external competitive position remained strong. Price competitiveness (helped by decade-long wage moderation) has permitted sustained export growth (Figure 1). Export earnings and their stimulative effect on investment have contributed to growing corporate profitability (Figure 2).

Figure 1.
Figure 1.

Germany: Exports and Competitiveness

Citation: IMF Staff Country Reports 2008, 080; 10.5089/9781451810547.002.A001

Sources: IFS, WEO, OECD, Direction of Trade Statistics, and IMF staff calculations.1/ Excludes Belgium and Luxembourg.
Figure 2.
Figure 2.

Germany: Corporate Profitability Trends1/

Citation: IMF Staff Country Reports 2008, 080; 10.5089/9781451810547.002.A001

Source: Bundesbank1/ Nonfinancial corporate sector.2/ Debt over depreciation plus corporate savings and transfers.

6. Employment—especially full-time employment—started picking up in mid-2006. Protracted labor shedding and wage moderation were instigated by the pressures to remain competitive. With wage moderation legitimized and reinforced by the Hartz IV reforms, short-term unemployment has fallen. Indeed, the labor market has shown signs of tightening with increasing vacancy rates and a pick up in wage growth (Figure 3). Collective wage agreements imply an average gross wage increase of about 2 percent in 2008.

Figure 3.
Figure 3.

Germany: Labor Market Developments

Citation: IMF Staff Country Reports 2008, 080; 10.5089/9781451810547.002.A001

Source: Federal Statistical Office, Federal Labor Office, and Bundesbank1/ Difference between actual and negotiated wage rate.

7. A balanced budget is the result of sustained effort. From 4 percent of GDP at the trough of the cycle in 2004, the general government deficit reached balance in 2007. Although this adjustment coincided with the upswing, substantial policy effort contributed to a structural adjustment of about three percent of GDP between 2003 and 2007. Much of this adjustment reflected cuts in discretionary, aging, and welfare expenditures. In 2006, the structural balance improved by more than one percentage point, meeting the target set under the excessive deficit procedure ahead of schedule. The adjustment continued in 2007 with the VAT hike, reduction in the deductibility of interest income, expenditure restraint, and increase in healthcare premiums.

uA01fig02

Nominal Compensation Per Employee

Citation: IMF Staff Country Reports 2008, 080; 10.5089/9781451810547.002.A001

uA01fig03

German Fiscal Adjustment

(Percent of GDP)

Citation: IMF Staff Country Reports 2008, 080; 10.5089/9781451810547.002.A001

8. Inflation has remained moderate despite domestic and global pressures. In the first 11 months of 2007, headline inflation was 2.2 percent at an annualized rate, and core inflation was 2.0 percent. The sizable VAT hike in January 2007 (from 16 to 19 percentage points) had a relatively benign effect, pushing up core inflation smoothly by 0.7 percentage point rather than the expected 1.1 percentage points (Box 2). Renewed energy price inflation and a jump in food prices raised year-on-year headline inflation to 3.3 percent in November but core inflation was 2.4 percent.

uA01fig05

HICP Annual Inflation Rate

(Percent)

Citation: IMF Staff Country Reports 2008, 080; 10.5089/9781451810547.002.A001

9. International financial turbulence hit Germany with force, casting a cloud on the sustainability of the gains achieved. Last summer, IKB (a private bank, but with a one-third ownership by the government-owned KfW) and Sachsen Landesbank (a state-owned bank) had to be rescued after they were unable to meet their liquidity commitments to their off-balance-sheet “conduits.” German banks were placed under close market scrutiny, with credit default spreads rising sharply (text figure and Figures 4 and 5). Thereafter, concerns about the German financial sector softened, especially relative to the magnitude of the problems revealed in the United States. In November, the German share of main and longer-term ECB refinancing operations fell below 50 percent from about 55 percent in the first seven months of 2007. However, revelations of further write-downs have continued and German banks—notably West LB, another state-owned bank—remain under watch (text table below). Moreover, many banks have not released year-end statements and further negative surprises seem likely.

Figure 4.
Figure 4.

Germany: Financial Indicators

Citation: IMF Staff Country Reports 2008, 080; 10.5089/9781451810547.002.A001

Source: Thomson Financial/DataStream.
Figure 5.
Figure 5.

Germany: Corporate Spreads, Money Market Rates, and Lending Standards

Citation: IMF Staff Country Reports 2008, 080; 10.5089/9781451810547.002.A001

Source: DataStream and Deutsche Bundesbank.
uA01fig06

Changing perspectives on crisis centers

Citation: IMF Staff Country Reports 2008, 080; 10.5089/9781451810547.002.A001

Exposure of Select European Banks to Conduits and Special Investment Vehicles

(SIVs)

article image
Source: Fitch Ratings.

Majority ownership.

Maximum commitments.

Funding defined as deposits plus senior and subordinated debt as of end-December 2006, or end-March 2007.

The Smoothing of the VAT Increase

The smaller-than-anticipated inflation spike following the January 1, 2007 VAT hike was the consequence of a long announcement period—13 months. Consumers made advance purchases, and retailers raised prices prior to the VAT-hike implementation. An econometric analysis of sectoral inflation trends shows that 0.3 percentage point of the increase in core inflation in 2006 can be attributed to the anticipated VAT hike.1 Advance price increases were higher for durable goods and commodities with less competitive markets.

1/ See Selected Issues, Chapter I. The model controls for common price shocks within the euro area, seasonal factors, and onetime effects

III. Outlook And Risks

A. Short-Term Outlook

10. In the currently evolving situation growth is projected to slow with the weakening global cycle. In the first half of 2007, forecasters presumed that the German and U.S. economies were “decoupling” (text figure). However, the fourth-quarter signals presaging a slowing German momentum (Figure 6) are now tied to weaker U.S. growth (Box 3). Both sides agreed that the weaker U.S. economy—through slower world trade—would be the primary factor pulling down German GDP growth, given its strong external dependence. Growth would be more modestly dampened by the stronger euro—cushioned by the reliance on imported inputs. On the positive side, employment gains are projected to fuel the beginning of a consumption recovery, holding GDP growth up at 1.7 percent in 2008 (text table).1

Figure 6.
Figure 6.

Germany: Sentiment, Orders, and Production

Citation: IMF Staff Country Reports 2008, 080; 10.5089/9781451810547.002.A001

Source: Bundesbank, IFO institute, and GfK.
uA01fig08

Consensus forecast of 2008 growth

Citation: IMF Staff Country Reports 2008, 080; 10.5089/9781451810547.002.A001

Comparison of the 2008 Forecasts

(Percent Change)

article image

Germany’s Growth Linkages1

U.S. and European growth impulses have a significant bearing on German growth. A vector autoregression (VAR) of real GDP growth in the U.S., Japan, Germany, the rest of the euro area, and new EU members finds that changes in U.S. GDP growth affect activity in Europe but not vice versa.2 Growth impulses from other euro area countries translate almost one for one into higher growth in Germany and the rest of Europe.

Growth spillovers from Germany were limited in the past but are more prominent now. Estimates for the most recent period (1998-2007) indicate that a ½ percent increase of German GDP raises growth in the rest of the euro area by ¼ percent and by about ½ percent in the new EU member countries after three quarters. These effects point to increasing economic integration especially with the new member states (e.g., offshoring).

uA01fig09
Source: Response of GDP growth (DY) to one S.D. Innovation based on Cholesky decomposition. The top six panels refer the period 1993q1-2007q2, the bottom two panels refer to 1998q1-2007q2.
1 See Selected Issues, Chapter 2.2 For similar results see WEO April 2007, Chapter 4.

11. However, the uncertainties have increased considerably and risks are firmly on the downside. A sharper-than-anticipated slowdown in the United States would have a potentially sizeable impact on German growth, all the more so if it undermined confidence. Strong external production linkages imply significant spillovers from Germany to the rest of Europe, especially emerging Europe (text figure). Euro appreciation associated with a disruptive unwinding of global imbalances and, hence, sharply lower world growth would also amplify the consequences of a strong euro (Box 4). Higher-than-expected oil prices would act directly and, by dampening sentiments, weaken the consumption recovery; the oil-price effect, however, would be mitigated if the euro also appreciates.

Growth Consequences of the Euro Appreciation

Real exchange rate movements have limited growth effects during periods of robust global growth. The current real appreciation of 3.9 percent (between January 2006 and October 2007) is moderate compared with past fluctuations. Staff econometric analysis suggests that this adjustment could dampen annual growth by less than 0.2 percentage point.

The negative effects can, however, increase significantly in a global downturn. Staff estimates show that a real exchange rate appreciation in Germany has up to twice the direct effect when the global output is well below potential. Although such events have been rare, the risks to global growth raise the possibility of a more significant negative growth effect of a euro appreciation.

uA01fig11

Real effective exchange rate appreciation

(yoy growth rate)

Citation: IMF Staff Country Reports 2008, 080; 10.5089/9781451810547.002.A001

uA01fig12
Source: Staff estimates. Global output gap measured as percent deviation from HP filtered trend.
1 Measured in CPI terms based on the IMF methodology: http://www.imfstatistics.org/imf/IFSExcha.htm.

12. The authorities are acutely conscious that the greatest uncertainty arises from the unfolding international financial developments. In this context, they have taken valuable steps to assess the exposures of German banks. Consistent with their preliminary conclusion that the exposures are limited and have not impaired capital positions, credit flows thus far have remained relatively unaffected. Banks came into the crisis well capitalized and with cyclically strong profits. Moreover, the reliance of German businesses and households on financial credit is relatively modest and apparently declining (text figure). However, the authorities recognize that the turmoil has proved to be a moving target and, hence, the findings from bank examinations and stress tests can become quickly outdated. Recent indications are that lending standards have tightened, although less than elsewhere in the euro area. The continuing turbulence could further impact asset valuations and capital levels—with adverse and cascading consequences for credit availability and growth.

uA01fig13

German credit demand has been low relative to euro area.

Citation: IMF Staff Country Reports 2008, 080; 10.5089/9781451810547.002.A001

13. Inflation should slow somewhat, to 2.1 percent in 2008, but the risks are on the upside. The price increase following the 2007 VAT hike will exert a dampening base effect. Oil and food price inflation are projected to add an inflationary bias, though the effects are expected to ease slowly. Higher outcomes from the new wage bargaining create risks of second-round spillovers, which, however, are likely to be mitigated by slower growth.

B. Competitiveness

14. Germany’s competitiveness is adequate, with some evidence of a modest undervaluation. This conclusion, which the authorities broadly agreed with, is based on several considerations:

  • The current account surplus is largely structural and is expected to contract in the medium term. Despite strong investment trends, the current account surplus widened to an estimated 5.6 percent of GDP in 2007 (Tables 1 and 2). The surplus was, however, boosted by temporary factors, in particular, the increase in the VAT rate that increased private and public savings. Stripping out these and other temporary factors from long-term trends, staff’s estimate of the current underlying surplus is about 4¼ percent of GDP.

  • For Germany, the CGER exercise estimates a medium-term current account norm (reflecting long-term trends in a multilateral setting) of 3.3 percent of GDP. This norm is higher than that of other major European countries, reflecting mainly savings for old age and European financial integration that generates capital flows from Germany to the less advanced European economies. The authorities’ estimates show that about half of Germany’s current account surplus derives from within the euro area, with a surplus on the trade account, reflecting competitive strength in manufactured goods, and a deficit on the services account.

  • According to CGER estimates, the real exchange rate is close to equilibrium. These estimates show that the valuation of the real effective exchange rate (REER) to range from 3 percent overvaluation (equilibrium real exchange rate approach) to a 10 percent undervaluation relative to equilibrium (external sustainability approach, see text table), with large standard errors. The mid-point of the range—suggesting a 3-5 percent undervaluation—is normally considered a reasonable benchmark and also coincides with the estimate from the macroeconomic balance approach.

  • The implication is that the depreciation during the late 1990s and early this decade has mainly corrected the overvaluation of the mid-1990s. As that overvaluation declined, Germany gained market shares; these shares have now begun to stabilize. The authorities emphasized the uncertainties in measuring equilibrium exchange rates. Their favored approach—treating the average over the past three decades as the “equilibrium”—also finds a small undervaluation.

Table 1.

Germany: Basic Data

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

2007 estimate, 2008 IMF staff projections.

Growth contribution.

National accounts definition

Eurostat definition.

Deflated by the national accounts deflator for private consumption.

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 (2.5percent 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 2007 refer to December.

Data for 2007 refer to the change from December 2006 to December 2007.

Data reflect Germany’s contribution to M3 of the euro area; data not shown for 2002 because of a series break.

Data for 2007 refer to December.

Data for 2007 refer to December.

Based on relative normalized unit labor cost in manufacturing. Data for 2007 refer to December.

Table 2.

Germany: Medium-Term Balance of Payments, 2005-13

article image
Source: WEO.

Comparison of the Real Exchange Rate Assessment and Current Account (CA) Positions and Current Account Norm Contributions for the Three Largest Euro Area Countries 1/

article image

CGER (Consultative Group on Exchange Rate Issues). Values between -10 and +10 means the real exchange rate (RER) is close to balance. International Monetary Fund, 2006, Methodology for CGER Exchange Rate Assessments (available at www.imf.org).

Macroeconomic balance approach.

Equilibrium real exchange rate approach.

External sustainability approach.

The underlying CA/GDP balance is calculated as ratio of Hodrick Prescott filters of current account balances and for nominal GDP for 1970 until 2013.

Oil balance to GDP, and dummies for the EMU creation and if the country is a financial center, etc.

uA01fig14

German Real Exchange Rate 1/

(Percentage deviation from long-term average=100 of real exchange rate index using export sales deflators)

Citation: IMF Staff Country Reports 2008, 080; 10.5089/9781451810547.002.A001

1/ Lower values denote an increase in competitiveness.

C. Medium-Term Outlook

15. Growth is projected to slow to the potential rate of 1¾ percent annually, unless measures are taken to step up total factor productivity growth. The strength of the current upswing has not clearly surpassed previous ones (although it is notable in its unusual composition—buoyant investment and lagging consumption) (Figure 7). The output gap, created following the poor performance earlier in the decade, is just about closed. Looking ahead, productivity growth—crucial to maintaining the growth momentum—is difficult to predict, but recent trends are not comforting. Labor productivity rose by about 2½ percent in 2006 from a substantial fall earlier in the cycle (text figure), but increased by less than 1 percent in 2007. Moreover, productivity has been sustained mainly in the manufacturing sector, which accounts for a quarter of value added (Figure 8). The much larger services sector—with two-thirds of the value added—has shown little improvement, this being especially true for real estate and financial services. German firms are highly innovative, measured, for example, by the production of patents (Figure 9). However, the translation of the innovation into productivity increases has been weak (text figure).

Figure 7.
Figure 7.

Germany: Comparison of Business Cycles, 1990-20071/

Citation: IMF Staff Country Reports 2008, 080; 10.5089/9781451810547.002.A001

Sources: Federal Statistical Office; and IMF staff calculations.1/ All values relative to trough equal to 100. The trough of the current cycle is Q4 2004. Average of previous cycles is an unweighted average of cycles with troughs in 1993Q2, 1996Q1, and 1989Q4. Troughs identified using largest negative distances between real GDP and trend GDP (HP filter).
Figure 8.
Figure 8.

Germany: Labor Productivity Growth, Contributions From TFP, and Capital Deepening

Citation: IMF Staff Country Reports 2008, 080; 10.5089/9781451810547.002.A001

Source: Federal Statistical Office and staff calculations.
Figure 9.
Figure 9.

Selected Countries: Patent Developments

Citation: IMF Staff Country Reports 2008, 080; 10.5089/9781451810547.002.A001

Sources: European Patent Office; OECD; and IMF staff calculations.
uA01fig15

Labor Productivity Growth (2000-06) and Patents Granted, 2000

Citation: IMF Staff Country Reports 2008, 080; 10.5089/9781451810547.002.A001

Medium-Term Projections, 2003-13

(Percentage change from the previous period, unless otherwise indicated)

article image
Source: Fund staff estimates.

In percent of GDP.

IV. Policy Discussions

16. Against the background of short-term uncertainties and medium-term challenges, the discussions focused on:

  • strengthening employment and growth;

  • safeguarding financial stability and reforming the financial sector; and

  • consolidating fiscal progress to deal with near-term uncertainties and aging pressures.

17. The authorities were cautious about the likely pace of further reforms. They emphasized that recent policy measures had entailed sacrifices, generating a demand for “dividends.” Staff cautioned against policy reversals and suggested that an appropriate balance was possible between efficiency and inclusiveness—to support growth, equity, and stability. Fairness is better achieved by continuing in the spirit of the Hartz IV reforms to focus on people rather than on specific labor market outcomes. Also, while maintaining their commitment to the Soziale Marktwirtschaft (social market economy), the authorities had allowed more options outside the framework of traditional institutions. Both sides agreed that striving for this balance would continue to prove fruitful.

A. Strengthening Employment and Productivity

18. Skills shortages need to be addressed. With a stronger labor market, a paradoxical phenomenon has emerged. While vacancies have increased, especially in skilled occupations, the inflow of immigrants to fill these positions has remained subdued, and highly trained Germans have chosen to seek employment elsewhere in Europe (Figure 10). The reasons for German emigration are complex and often specific to particular professions, but include a search for lower tax rates, higher returns to expertise, and more robust economic opportunities. These shortages are expected to increase rapidly with aging. The authorities agreed that a two-pronged strategy is necessary: invigorating education and training, and encouraging skilled immigration (Box 5). Immigration is politically sensitive, but restrictions for engineers from the new member states have been relaxed.

Figure 10.
Figure 10.

Germany: Labor Market and Migration Trends

Citation: IMF Staff Country Reports 2008, 080; 10.5089/9781451810547.002.A001

Source: Federal Statistical Office; and IMF staff calculations.1/ Inward migration less outward migration of foreigners.

Alleviating Shortages of Skilled Labor1

A dynamic general equilibrium model was used to simulate the long-term effects of increasing the labor force by 100,000 persons a year (a 0.3 percentage point increase). The model incorporates demographics, life-cycle earnings, and savings dynamics. Skilled labor can be increased through domestic measures (such as retraining) or by increasing immigration. The two experiments lead to similar consequences for growth, but increased immigration also increases the size of the population and mitigates the aging problem; hence the focus on the latter scenario here.

This annual increase in immigration of 100,000 adults compared with the baseline could raise real GDP by 0.2 percentage point a year. With more adults joining the workforce, investment and capital stock would rise. A virtuous cycle of increases in income and consumption would then follow. The current account would deteriorate initially, but improve later as individuals start saving for retirement and older cohorts become more numerous.

uA01fig17

Effects of Relaxing Immigration Restrictions: Allowing 100,000 More Young Adults Per Year

(Deviations from baseline)

Citation: IMF Staff Country Reports 2008, 080; 10.5089/9781451810547.002.A001

Source: Dynamic general equilibrium model with demographic and life-cycle earnings dynamics calibrated for Germany. Based on Blanchard-Yaari-Weil framework. Faruqee, Hamid (2002) Population Aging and Its Macroeconomic Implications: A Framework for Analysis, IMF Working Paper 02/16.
1 See Selected Issues, Chapter III.

19. Staff cautioned that the remarkable turnaround on the labor market was jeopardized by a misplaced focus on minimum wages to pursue social objectives. The authorities viewed the minimum wage for postal workers and extended unemployment benefits for the elderly as measures to achieve “fairness.” Staff cautioned that wage floors were not an efficient instrument for social goals. The minimum wage for postal workers was already having unintended consequences: with competitors unable to match these wages, competition in postal services could be undermined. Additional sectoral minimum wages would raise the costs of, and reduce the demand for, low-skilled labor, especially in regions with endemic unemployment. Also, extension of the unemployment benefit period for older workers could open more such demands and signal a weakening commitment to improving incentives for work.

uA01fig18

ILO unemployment rate 1992-2007 1/

Citation: IMF Staff Country Reports 2008, 080; 10.5089/9781451810547.002.A001

Source: Federal Statistical Office1/ Revised series Oct. 2007
uA01fig19

Unemployment Rate by State1/

Citation: IMF Staff Country Reports 2008, 080; 10.5089/9781451810547.002.A001

1/ Percent of civilian labor force; not seasonally adjusted; national accounts definition.Source: Haver Analytics.

20. Perspectives on other labor market initiatives converged more. Staff supported the authorities’ intent to rationalize job training and placement programs and urged more vigorous implementation. Staff also noted that the proposed child care programs will help increase the participation of women in the labor force, although care will be needed to keep them well targeted.

21. The authorities agreed that a broad range of measures are needed to boost the investment climate. They reported progress in the efforts of the national Normenkontrollrat as part of the government’s program to reduce red tape and simplify regulations. They recognized that reducing the corporate tax rate (which remains one of the highest in Europe) and tax wedge on labor would eventually be desirable, but noted that, following the measures recently undertaken, a further fiscally responsible reduction in capital and labor taxes was not feasible in the short run. They were clear that any amendments to the Foreign Trade and Payments Act would be undertaken in a manner that preserves Germany’s long-standing reputation for openness to foreign capital. Staff also noted that a financial sector that efficiently finances innovation can complement the high patent rates to spur growth while also improving economic welfare by allowing greater consumption smoothing than recently achieved (text figure).

uA01fig20

Consumption-Income Correlations and the Financial Index, 1985–2005

(Correlations between quarter-on-quarter growth rates)

Citation: IMF Staff Country Reports 2008, 080; 10.5089/9781451810547.002.A001

Note: The financial index ranges between 0 and 1 for each country, with a higher value representing a greater arm’s length content in the financial system.

B. Financial Sector Stability and Efficiency

22. The ongoing turbulence has served as a wake-up call. Despite the progress achieved, long-standing concerns about the relatively low profitability of the still-fragmented banking system have—by creating incentives for excessive risk taking—intersected with new concerns about financial stability (Tables 3 and 4).2 The size of the capital market and its ability to enhance efficient allocation of resources and improve consumption smoothing leave room for considerable progress.

23. Against this background, the mission held extensive discussions on financial sector issues, with emphasis on:

  • banking sector restructuring;

  • crisis prevention and management;

  • supervision; and

  • continued strengthening of capital markets.

Banking sector restructuring

24. Both sides were concerned that, absent further banking sector restructuring, systemic and fiscal risks could rise. In line with international trends, the number of banks has fallen sharply in recent years and the number of employees per bank has increased (Table 5 and text table). The sector’s fragmentation contributes to low interest rate margins and still modest income from nonbanking services (Figure 11). Banks unable to generate adequate profits are likely to take on greater risks. The recent turbulence has again raised the question of whether many banks, especially the Landesbanken, have viable business models. Although the banking and financial system faces major challenges, the authorities stressed that it had nonetheless proved to be stable and functionally viable, even in a clearly stressful operational setting. They recognized, however, that the domestic banking system could come under further pressure with the globalization of finance and the framework set by European competition policies. Besides creating wider systemic concerns—as it briefly did this past summer—staff noted that the fragility also generates contingent fiscal liabilities, which can turn only too real as in the case of the State of Saxony, Sachsen LB’s owner.

Table 3.

Germany: Core Set of Financial Soundness Indicators for Banks, 1998-2006

(In percent)

article image
Source: Deutsche Bundesbank. The authorities provide annual data only and disseminate them once a year.

According to Capital Adequacy Regulation, Principle I.

Limited comparability of 2006 data with prior years

2005-06 data in accordance with IMF’s FSI Compilation Guide.