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Reforms move Germany forward

World Affairs Talk | Jan 28, 2007

After a long five year adjustment crisis, Germany is getting the rewards of its strenuous efforts. Germany, once derided as the "sick man of Europe", has bounced back with its economy booming and budget overspending slashed after long & painful reforms.

Despite having a big economy, Germany had the lowest growth and one of the highest deficits in Europe in the past few years. But the recent data showed that Germany's economic condition improved dramatically in 2006 when growth hit a six-year high point and the public deficit was chopped back by one third. Growth of German gross domestic product (GDP) nearly tripled to 2.5 percent in 2006, from 0.9 percent in 2005, the federal statistics office ‘Destatis’ calculated. It was the third-biggest increase in annual GDP since re-unification in 1990. In 2006, agriculture, forestry, and fishing accounted for only 1.1% of the gross domestic product and employed only 2.2% of the population, down from 4% in 1991. However, agriculture is extremely productive, and Germany is able to cover 90% of its nutritional needs with domestic production.

By tradition, Germany’s financial system is bank-oriented rather than stock market-oriented. One of the reasons that banks are so important in German finance is that they have never been subject to a legal separation of commercial and investment banking. Instead, under a system known as universal banking, banks have offered a wide range of services from lending to securities trading to insurance. Another reason for the strong influence of banks is that there is no prohibition of interlocking ownership between banks and their client companies. German Finance minister Peer Steinbrueck proclaimed that the country's public deficit which has exceeded EU limits every year since 2002 had been cut by more than a third, and now measured only 1.9 percent of GDP, down from 3.2 percent in 2005.

The upturn, traditionally driven by exports, had broadened much more powered by a boost in domestic demand. Unemployment fell to 10.8 percent in 2006 from 11.7 percent in 2005. And the German trade surplus hit a record high in November 2006, putting it in line to become the world's champion exporter for the fourth year in a row. Temporary factors, such as the World Cup soccer championships, had distorted the country's economic performance to the upside in 2006.

This has been possible through tough economic reforms, initiated by the previous Social Democrat-led government under Gerhard Schroeder and carried on by the current left-right coalition administration under Angela Merkel. Pronounced wage restraint, some structural reforms, as well as cuts in taxes and government expenditure have led Germany to become a better place to invest for the foreign multinationals.

The German government is confident to keep this momentum going. It feels the favorable 2006 provided a good basis for a continuation of the upturn in 2007. German economy minister Michael Glos said, he expects the deficit ratio to fall to 1.2 percent in 2007. If German administration achieves this, its economy will be in a much stronger position to urge its Euro-zone partners to consolidate their budgets as well. However, structural impediments to growth, sustained budget consolidation, and age-related spending pressures, still present considerable fiscal challenges in the years to come.

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