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...long to embark on reforms? What is the economic outlook today? It argues that two factors were responsible for falling growth: the end of the post-World War II economic catch-up and a failure to reform the economy in response to shocks. Because of Germany's political system, economic reforms require broad popular support. However, this support changes constantly due to frequent elections, which makes it difficult for governments to push through ambitious reforms that typically have payoffs stretching beyond electoral cycles. Nonetheless, the depth of the 2001-05 economic downturn and Germany's comparatively poor economic growth performance in Europe have by now forged a general agreement on the need for change. The European Union, notably with its policies that combat state aid and that call for sound fiscal positions, has played an important role in forging this agreement. Accordingly, Germany's economic outlook has by now improved noticeably, although significant challenges remain.
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For many years after World War II, Germany's economic output grew very rapidly--a period commonly referred to as the "Wirtschaftswunder," or economic miracle. It came to an end in the 1970s, and Germany has found it difficult to adjust to the change ever since. From the 1970s onward, Germany's economic performance has been mixed and, in the decade following unification in 1991, mostly disappointing as shown in Figure la. The policy response to the oil price and other economic shocks, including those related to unification and a rapidly aging population, has been reduced labor utilization and increased welfare payments. This has become unsustainable, and today there is broad agreement on the need for reform although not on its precise course.
Whether reform will be carried forward to decisively tackle a looming demographic shock is not clear, but a strong start has been made with the launch of the German government's Agenda 2010 in 2003 and subsequent policy changes. Also, the European Union and its institutions have played a significant role in prompting adjustment. This paper addresses three questions:
* Why did growth decline after the 1970s?
* Why did it take so long to embark on reforms?
* What is the economic outlook today?
Why Did Growth Decline?
Trend growth slowed from 4 1/2 percent a year in the 1960s to 1 1/2 percent in the 1990s. Two factors were key: the end of the post-World War II economic catch-up and a failure to reform in response to shocks. The symptoms of slowing growth were declining productivity growth, capital accumulation, and labor input.
First, Figure 1b shows that total factor productivity growth has...
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