Rolf Breuer expands on how Europe's largest economy can regain sustained and vigorous economic growth.

For years, Germany's international competitiveness has been in decline. Rising unemployment, growing public deficits, social security systems which are stretched to their financial limit and the lowest economic growth in the eurozone are the visible symptoms of this development.

Though both the causes of the problems and the measures required to solve them are well known, Germany has not yet succeeded in creating the environment necessary for strong and sustained economic growth. Germany's economic policy must be more resolute in implementing radical change. Only sufficiently vigorous economic growth can enable the country to master the impending challenges posed by demographic developments and global competition.

Self-improvement

Until now, Germany has been all too ready to rely on the economic success of other countries to pull it out of periods of weak growth, failing to meet its responsibilities of eliminating the causes of weak growth itself. To regain its former strength, Germany must generate its own growth.

Granted, the last 10 years have seen some errors of commission and omission in Germany's economic policy. However, no other country in the industrialised world has had to master a challenge on the scale of the integration of the former East Germany with West Germany. Critics of the current weakness of the German economy should bear in mind that this is, in some measure, the price for the successful transformation of a planned economy into a market economy.

The underlying strength of the German economy has not been damaged by this unprecedented achievement. It remains in an excellent position to make a success of the necessary reforms.

An internationally competitive economy requires a strong state, where regulation is based on the principles of a market economy. Germany's economic policy has failed to meet these requirements for some time now.

An unmistakable sign of this is total government outlay, which is currently only slightly under 50% of GDP. The high level of state intervention in the mechanisms of the market economy has often curbed, or even prevented, necessary economic change. Germany needs economic policies that will motivate its citizens, induce firms to take investment risks and encourage society as a whole to do more to meet the challenges of the new age.

The division of political responsibility between federal, regional and local governments is increasingly proving an obstacle. Since the end of the 1960s, the dividing lines between these spheres of responsibility have become increasingly blurred. At the same time, the financial autonomy of regional and local governments has been steadily eroded. It is, above all, this development that is responsible for the fact that Germany's economic policy now lacks a clear direction. On too many decisions a political majority can only be achieved at the cost of minimum consensus.

If the state is to regain its ability to act on economic issues, the division of responsibilities, revenue raising and spending powers between federal, regional and local governments needs to be more clearly defined once again. The upcoming reform of local finances will provide an opportunity to start rectifying the situation.

Joint financing by federal and local governments must be phased out and local authorities given clear-cut powers and independent, stable and adequate sources of revenue. The proposal to introduce a tax on income and profits in the form of a local surtax on federally-set rates of income tax and corporation tax seems a promising solution.

Corporate competitiveness

Fiscal policy has a key influence on the competitiveness of the economy. Germany's tax reform in 2000 represented a step in the right direction, but was unable to eliminate all the system's shortcomings. Tax reform must remain on the political agenda.

Germany's fiscal policy should also be guided by the principle that companies in good financial health are the basis of a competitive economy. At present, the country's small and medium-sized firms, in particular, are suffering from a distinct shortage of capital. To remedy this problem, sustained cuts in taxes and non-wage labour costs are indispensable.

But an internationally competitive tax regime is not, in itself, enough to boost economic growth. Both growth and the competitiveness of a country's economy are also influenced by the number of business start-ups. To improve Germany's weak position in this area, it is essential to eliminate the existing bureaucratic hurdles and encourage a new culture of self-employment.

Reforming the welfare state

Germany's social security systems are currently under enormous strain. One of the main reasons is that Germans are getting older. It is therefore important to carry out a thorough reform now so that they will be able to meet the far greater challenges facing them in the future.

The state healthcare system is in most urgent need of reform. Both the insured and the providers of healthcare services will have to accept changes. Reform will not be possible without restrictions on the services offered, more flexibility and more competition between the statutory health insurance funds.

There is also a need for further reform of Germany's public pension insurance scheme. The relief provided up to now to the statutory pension scheme by private and occupational retirement provision is not enough in the long term to stabilise compulsory pension contributions at a maximum of 20% of gross wages.

Legislation was introduced in the last parliament to supplement the statutory pension insurance system with urgently needed funded private and occupational schemes. This is a good basis for a further strengthening of the pension insurance system.

Labour market deregulation

All these reforms will have little impact unless Germany succeeds in freeing up its labour market. The strict regulation of the labour market impedes structural change and restricts the economy's growth potential. Too few new jobs are being created in Germany while inefficiency and a lack of incentives mean too few jobless people are finding their way back into employment.

Labour-market reform must therefore take a multi-track approach. Reforms to tackle the unemployment problem have already been introduced by implementing the Hartz Commission's proposals. To create new jobs, however, a completely different approach is required.

The special practice of wage negotiations leads to rigid wage agreements, a major impediment to the creation of new jobs. Such a practice ignores the fact that economic conditions vary greatly from one region to another and from one company to another. Also, the numerous rules and regulations governing the labour market, the German Labour-Management Relations Act and protection against dismissal can be considerable obstacles to employment. The overregulation of the labour market in Germany prevents the creation of new jobs; employment adjustments in shrinking markets take place too slowly, acting as a curb on the potential for new companies to develop.

Education and training

If Germany is once again to achieve the sustained and vigorous economic growth that is a prerequisite for full employment, it needs a high level of investment in real capital and workers with professional qualifications of above-average quality. In education and training there is considerable ground to be made up.

Germany's performance in education has slipped in the league table of industrialised countries, both for schools and universities. Unless this trend is reversed, there is a danger that, in the long term, the country's human capital will no longer have the high quality needed by a high technology country.

The German education system's main problem is not a lack of money but too little autonomy and an under-developed service mentality in schools and colleges of higher education. More competition is needed. Closer links between the academic and business communities would improve the quality of vocational-oriented education.

Germany is therefore starting 2003 with its share of problems. Yet it must tackle these problems with confidence, and embark on the urgently needed reforms. Some painful adjustment will be inevitable. Fortunately, there is growing awareness among the German population that radical change is unavoidable, particularly in the area of social security, as well as an increasing readiness to accept such change. This is an important prerequisite for the success of the reforms and for a return to Germany's former strength. If the reforms are planned and implemented correctly, this adjustment will represent a crucial investment in the future of Germany as a business centre - a centre which will then regain its traditional attractiveness for international firms.

Dr. Rolf E. Breuer is president of the Association of German Banks and chairman of the Supervisory Board of Deutsche Bank.

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