Long abstract

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Following a prolonged period of stagnation, Germany has been enjoying a vigorous recovery. Business and government finances are robust, laying a solid foundation for a continuation of the upswing provided that headwinds from the global financial market turmoil do not become overwhelming. Nevertheless, for high economic growth to last beyond the cyclical upswing, it will be necessary to raise the growth rate of potential output. Past reforms, especially in the labour market, have helped to raise the potential growth rate recently, but there is still much scope to increase hours worked per capita and to increase productivity, notably in certain network industries. Improving education outcomes, including by reducing the impact of socio-economic background on outcomes, will be important for sustaining high economic growth in the long run.
Past achievements in fiscal consolidation need to be preserved. With the structural budget now in balance, the challenge is to avoid pro-cyclical policies and to deal with the long-term fiscal challenges of ageing. Replacing the current fiscal rule, which has proved to be ineffective, with the requirement of a structural budget balance in line with the Stability and Growth Pact should be considered. In addition, securing future tax revenues requires shifting more of the tax burden from mobile to immobile tax bases. The lowering of corporate tax rates is a step in the right direction but more could be done. Finally, the tax collection process should be made more efficient.
Reform momentum in the labour market needs to be maintained to achieve lasting improvements. The focus should be on increasing the low number of hours worked per person employed, notably of women. This could be achieved by lowering financial disincentives for second-earners to work longer and increasing the supply of childcare to allow more mothers to work. Long-term unemployment also remains a problem and while the increase in work incentives implemented with the Hartz IV reform has been a first step to improve labour supply of this group, more could be done. On the labour demand side, lowering the strict employment protection legislation for regular job contracts and avoiding too high minimum wages are important challenges. Plans to further phase out early retirement options are welcome in order to raise employment rates for older workers and should be implemented soon.