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European Economy. Economic Papers. Germany's Growth Performance in the 1990'S EUROPEAN COMMISSION DIRECTORATE-GENERAL FOR ECONOMIC AND FINANCIAL AFFAIRS ECONOMIC PAPERS http://europa.eu.int/comm/economy_finance N° 170 - May 2002 Germany’s growth performance in the 1990’s by Directorate General for Economic and Financial Affairs Germany’s growth performance in the 1990’s ECFIN/292/02-EN This paper only exists in English. ©European Communities, 2002 Editorial The European Commission’s Directorate-General for Economic and Financial Affairs regularly monitors economic developments in all Member States as part of its general duties. Out of this work, occasionally a more in-depth analysis of an individual country is published. The study on Germany presented here takes the form of a Working Paper. This means that it does not reflect the official position of the European Commission. Rather it mirrors exclusively the views of DG ECFIN, and should be interpreted as a contribution to the ongoing academic and political discussion in Germany and Europe about how the economic growth potential could be increased. The study is subdivided into three chapter. A first chapter presents stylised facts about growth in the German economy. This chapter contains two sections. One on Germany’s business cycles in the 1990s was written by H. Jansen. P. Weiss contributed the section on longer-term trends. The study does not contain a separate section on eastern Germany, because the problem of re- unification is pervasive throughout the study. However, partial aspects are presented in separate boxes. Two of them, one on the economic performance of the New Länder and one on economic policies in the New Länder were written by M. Hallet; a box on the construction sector was contributed by S. Webers. The chapter on the macro-economic policy mix also contains two sections. Monetary policy was analysed by O. Dieckmann, public finances by U. Jochheim. A final chapter analyses structural factors impacting on output growth. The first section on competitiveness, trade and FDI was co- authored by O. Dieckmann and H. Jansen. B. Döhring contributed a section on the German labour market. H. Jansen provided the brief section on product markets. The overall supervision of the study lay with P. Mills and P. Weiss who also wrote the executive summary. They are grateful to H. Jansen for editorial assistance and to K. Gradinger and C. Hallberg for technical assistance. Special thanks are also owed to W. Roeger for various simulations with the QUEST II model. iii Table of Contents 0. Executive summary................................................................................................... 1 1. Growth of the German economy in the 1990s: stylised facts ................................... 6 1.1 After the re-unification boom: Germany’s business cycles in the 1990s ............. 6 1.1.1 Output growth ................................................................................................. 6 1.1.2 The recovery of 1995/98................................................................................. 6 1.1.3 The recovery of 1999/2001............................................................................. 9 1.1.4 An econometric analysis of the short-term response of growth to exports .. 11 1.1.5 The dependence of the business cycle on trade ............................................ 13 1.1.6 Conclusions................................................................................................... 14 1.2 The growth performance in the 1990s in a longer-term perspective .................. 15 1.2.1 Output and employment growth ................................................................... 15 1.2.2 Population growth......................................................................................... 15 Box 1: The economic performance of the New Länder....................................... 17 B1.1 Output growth and production structure .................................................. 17 B1.2 Competitiveness and the labour market ................................................... 19 1.2.3 Labour market developments........................................................................ 22 1.2.4 Labour input and labour productivity ........................................................... 23 1.2.5 Growth accounting........................................................................................ 24 1.2.6 Demand components of output growth......................................................... 26 1.2.7 Conclusions................................................................................................... 29 Box 2: Developments in the German construction sector ................................... 30 B2.1 Large differences between West and East Germany................................ 30 B2.2 Residential construction ........................................................................... 30 2. The macro-economic policy mix ............................................................................ 32 2.1 Monetary policy in the 1990s ............................................................................. 32 2.1.1 Developments in the 1990s........................................................................... 32 2.1.2 Measuring monetary policy .......................................................................... 34 2.1.3 Assessment.................................................................................................... 36 2.2 Budgetary policy in Germany in the 1990s ........................................................ 38 2.2.1 Immediate impact of re-unification .............................................................. 38 2.2.2 Composition of revenues .............................................................................. 39 2.2.3 Composition of expenditure.......................................................................... 40 2.2.4 The year 1996 as a turning point?................................................................. 41 2.2.5 Conclusions................................................................................................... 42 Box 3: Economic policies in the new Länder ..................................................... 43 B3.1 The size of fiscal transfers........................................................................ 43 B3.2 The efficiency of regional policy ............................................................. 44 2.2.A Annex: The effects of German fiscal policy in the 1990s: .......................... 50 iv 3. Structural issues ...................................................................................................... 52 3.1 Competitiveness, trade and FDI.......................................................................... 52 3.1.1 Development of competitiveness indicators in the 1990s............................. 52 3.1.2 Trade developments...................................................................................... 57 3.1.3 Developments of foreign direct investment.................................................. 64 Box 4: FDI as an indicator for Germany’s attractiveness as a business location 71 B4.1 Different FDI definitions in the 1990s ..................................................... 71 B4.2 Statistical discrepancies might distort analysis ........................................ 71 3.1.4 Some concluding remarks............................................................................. 72 3.1.A Annex: The real exchange rate and economic performance in Germany.... 74 3.2 The functioning of the labour market ................................................................. 75 3.2.1 Overview....................................................................................................... 75 3.2.2 Wage formation: how flexible can it be?...................................................... 79 3.2.3 Labour demand: Does job creation pay? ...................................................... 83 3.2.4 Labour supply: Does work pay? ................................................................... 87 3.2.5 Concluding remarks...................................................................................... 89 3.2.A Annex: Simulation of Germany's potential growth rate .............................. 92 3.3 Product markets: Obstacles to growth in individual markets ............................. 93 3.3.1 Network industries........................................................................................ 93 3.3.2 Inefficiencies in spending public money ...................................................... 94 3.3.3 Capital markets ............................................................................................. 94 3.3.4 Restrictions to market access........................................................................ 95 3.3.5 Conclusions................................................................................................... 96 References....................................................................................................................... 98 v 0. Executive summary Economic growth in Germany has been lacklustre since the mid-1990s … Since the mid-1990s, output growth in Germany has been lacklustre: between 1995 and 2001 growth averaged 1.6% per year. This is almost 1 percentage point below that of its partner countries in the EMU/EU area, even if the faster growing cohesion countries (i.e. Spain, Ireland, Portugal and Greece) are excluded from the comparison. The only year where this gap was notably smaller was 2000 when an unprecedented
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