Emerging from the crisis: Laying the foundations for a balanced recovery in Germany

 

Remarks by Angel Gurría, OECD Secretary-General, for the launch of the Economic survey of Germany 2010

26 March 2010, Berlin, Germany

Ladies and Gentlemen,
It is a pleasure to present our 2010 Economic Survey of Germany.
The state and evolution of the German economy is an extremely important variable for the recovery of the global economy; Germany is a heavyweight in the European Union and thereby in many ways an indicator of the strength and speed of the recovery in Europe. Without a solid recovery of Germany the state of European economies will remain fragile. A credible exit strategy for the fiscal stimulus in Germany is an essential ingredient for a return to fiscal solidity across Europe. The global importance of the German economy is highlighted by the current controversial discussion about its current account surplus. What we want to share with you today is a report, which shows that reforms in Germany will not only make the German economy stronger, but also reduce global imbalances.

As many other OECD countries, the German economy is now emerging from the deepest crisis in the post-war period. Real GDP growth resumed already in the second quarter of 2009. Actually, faster than many had projected. For 2010 and 2011, we are expecting GDP to increase by 1.3 and 1.9%, respectively.

While we can say that the worst of the crisis is behind us, this is certainly not the time for complacency. Growth rates remain very low. The pre-crisis production levels will only be reached again by 2013. And there remain several policy challenges that have to be addressed to consolidate the recovery and build a brighter future. Let me highlight four major policy avenues to pursue in this respect:


1. Adjusting labour market policy

German labour markets have weathered the crisis remarkably well. While the average OECD unemployment rate in this recession rose by around 3 percentage points, the increase amounts to only ½ percentage point in Germany. Some international commentators have referred to this fact as “the German miracle”.

Rather than a miracle, this is the positive outcome of more flexibility due to previous reform efforts and the pragmatic strategies of the social partners who should be congratulated. German firms have become much more flexible over the past years. This has allowed them to reduce working time at the company level instead of laying off employees.

The government’s timely decision to extend the short-time working scheme (“Kurzarbeit”) also deserves recognition. Around one fifth of the reduction in working time in 2009 can be attributed to this measure.
Short-time work schemes are very useful tools for preventing “excessive layoffs” during a crisis. However, if made too generous or provided for too long, such a scheme may hamper necessary structural change. This is why we recommend to gradually phase out the generous extension of the scheme and not to prolong it beyond the end of this year, now that Germany has started to recover from the crisis.


2. Bring fiscal policy back to sustainability

Fiscal policy is another area where Germany is facing a delicate balancing act. On the positive side, as a result of extensive consolidation efforts during the years preceding the crisis, the size of Germany’s deficit is smaller than in many other large economies. On the not so bright side, the budget deficit has widened to 3.3% in 2009 and is set to rise well above 5% this year. Consequently, net borrowing has ballooned.
Just like in other OECD countries, there is a clear need to bring fiscal policy back to a sustainable path. This is the most difficult challenge as fiscal consolidation will need to be achieved in a context of rising unemployment.

Germany has managed to define and communicate its exit strategy from high deficits better than other countries. This helps a lot. Including a fiscal rule aiming at a balanced budget over the medium term into the constitution is a strong statement which should be acknowledged. It is also a strong, positive signal to the markets.

Thus, the structural budget deficit needs to be under 0.35% of GDP by 2016 for the federal government, with consolidation starting already in 2011. For the "Länder" balanced structural budgets are required by 2020. Such a concrete consolidation target is not only in the interest of the sustainability of public finances in Germany, it is also part of the broader picture of stability and fiscal sustainability in the euro area.

The immediate challenge is to put in place the policies that will allow both meeting the rule and contributing to long-term growth. In the coming months, cutting unnecessary expenditures and increasing spending efficiency will be of paramount importance. As in other OECD countries, increasing revenues from those taxes that are least harmful for growth would also help the German government achieve their 2016 consolidation target.

Any plan to lower taxes will inevitably raise future consolidation needs. We are confident that the German government is very much aware of this trade-off. I still remember Chancellor Merkel’s reference to the "Schwäbische Hausfrau" in 2008 while talking about the bursting financial crisis, to remind us that one cannot live beyond one’s means for an extended period of time. Let me stress that the "Schwäbische Hausfrau" is still very relevant today in a context of fiscal consolidation.


3. Ensuring stability in the banking sector

The German banking sector still needs some adjustment. It is crucial that the government ensures adequate capitalization of German banks. There are also long-term structural challenges pending, such as reforming the Landesbanken.

So far, only a very small number of banks have used the government’s bail out institutions like the “Bad Banks” scheme. This can be both a good and a bad sign for the state of banks’ capitalization. If banks’ capital buffers are too low, there is a clear risk that a lack of credit supply will hamper the recovery.

Therefore, the German government needs to continue ensuring that banks are adequately capitalized, including through the use of stress tests, and provide (if needed and as a last resort) public capital to those banks that cannot attract private funds.

Some say that the German business model was to “sell Porsches and buy Lehman Brothers certificates” (quoting Prof Hans-Werner Sinn, President of the Ifo Institute). Implicitly, this suggests a link between the current account surplus and banks’ investments in foreign toxic assets. However, this is only one part of the story.

Microeconomic factors in the German banks also weakened the financial sector. Excessive risk-taking of several banks and weaknesses in banking supervision and regulation as well as the role of the state-owned Landesbanken which lacked a viable business model and low capitalization, are all part of the explanation. Going forward, reforms need to take place in these areas.

The last policy challenge that I will touch upon is of crucial importance, mainly for a more balanced German economy. And it can also contribute to a more balanced global economy.


4. Remaining top exporter while boosting domestic investment

The German current account surplus is a major issue in worldwide economic policy discussions. Some commentators are openly questioning an assumed over-reliance of the German economy on an export-led growth pattern – implicitly arguing that the export sector is too strong to the detriment of other countries.
We believe the real policy challenge lies elsewhere.

First, the success of the export sector over the past years needs to be made sustainable by relying less on price-competitiveness and more on innovation. Second, the success of the export sector needs to be broadened to the whole economy which implies strengthening the role of the service sectors.

Reforms are needed to make Germany a more attractive place for investment. Structural reforms to raise the long-term potential growth rate would help in this regard. They would stimulate domestic investment, thereby contributing to domestic demand and helping to reduce the current account surplus.

According to our survey, Germany needs to implement structural reforms in three main areas to benefit more from its domestic investment potential:

a) Continuing the reduction of the excessive regulation of product markets. Further effort should, for example, be devoted to easing regulation in professional services sectors. This would not only strengthen the respective sectors themselves through increased firm entry; it would also help other areas of the economy, since these services are an important input factor for other sectors.

b) Improving the framework conditions for innovation. While German firms are still very innovative, their lead vis-à-vis other countries appears to be shrinking. This can endanger the country’s competitive advantages in the long run. Some high technology sectors and in particular services sectors receive only a below average share of the total funds spent on R&D activities. One reform option in this area is to introduce tax incentives for R&D. Tax incentives tend to be more effective in stimulating private R&D and have the advantage that winning projects are more likely picked by the market rather than the government.

c) Continuing the reforms of the education system. Germany still has a very low number of tertiary graduates in comparison to other OECD economies. Only a quarter of those aged 25-34 attain a tertiary degree; in contrast to more than half in Japan, or an average one third in the OECD.

A larger share of the young Germans needs to be equipped with sufficient skills to pursue university education. University education must be made more attractive. In addition, it needs to be ensured that those without tertiary education – namely those with apprenticeships – are equipped with skills that allow them to adapt to a changing economic structure throughout their working live. We know that education reform takes time to have full economic effects. Thus it is imperative to start now. In the meantime, immigration of high-skilled labour should be made easier.

Ladies and Gentlemen:
This crisis has left deep scars in the world’s economy. But it has also provided us with a big opportunity to reform. It is time to revise our economic concepts; it is time to reset our economies according to new values of trust, inclusiveness and sustainability. It is now clear that the reality of economic interdependence leaves no other route than multilateral cooperation and solidarity.

Germany will come out stronger from this crisis, and based on this renewed economic strength it will help its European partners to face their challenges, just as it will contribute to a faster global recovery. The OECD is here to help. We hope that this survey makes a solid contribution to defining German policy priorities and efforts to turn this crisis into a historic opportunity.
Thank you very much.

 

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