Strong domestic demand and exports are driving growth. Record-low unemployment and real wage gains have underpinned consumption. Low interest rates and immigration boost residential construction. Exports benefit from a goods mix suited to investment needs in high-growth emerging economies and the recovery of the euro area economy. Business investment is picking up with the strong exports. Credit growth remains modest.

Wages are growing moderately. Recent collective bargaining outcomes points to some acceleration in wage growth. Unions have increasingly negotiated non-wage benefits to ensure a better work life balance. However, rising inflation, primarily due to higher oil prices, is eroding real wage gains to some extent (Figure A).

Economic growth will slow somewhat, due to capacity constraints (Table A). The recovery in the euro area will sustain exports and investment in equipment, while private consumption and housing investment may decelerate somewhat due to slower employment and real wage growth. Consumer price inflation may rise modestly, as firms can absorb the impact of higher wages in profit margins. The fiscal stance is projected to be somewhat expansionary, as the new government plans tax reductions and higher spending on education, digital infrastructure and social transfers. Nonetheless, strong tax revenue growth and low interest rates are projected to raise the budget surplus to 1.5% of GDP.

The current account surplus remains large. Saving exceeds investment in the public and private sectors, notably in the corporate sector, where domestic investment has not kept pace with profitability. Exchange rate and energy price movements also mattered. Structural reforms to boost long-term, inclusive green growth and the use of fiscal space to support such reforms could reduce the current account surplus, by strengthening investment and reducing household saving.

Germans enjoy high living standards, especially in areas like jobs and earnings, and work-life balance. Disposable household income is more equally distributed than in other large OECD economies. However, inequality in wealth and market income is relatively high. Relative poverty risks relate to a high incidence of low-wage employment among low and middle-skilled workers as well as part-time working women.

The strong fiscal position provides room in the near term to fund spending priorities, such as increasing provision of high-quality childcare and full-day schooling, adult skills, or investing in infrastructure and new technologies, as argued below. Fiscal leeway should be used in a prudent manner, taking capacity constraints into account. In the medium term, higher interest rates and ageing-related spending will reduce fiscal space. Additional structural reforms will be needed to maintain sustainability in the long run. Further room for prioritising spending can be identified by more extensive use of spending reviews.

Labour productivity growth in recent years has been subdued (Figure B), which poses challenges in raising incomes and wellbeing. Slower productivity growth partly reflects strong employment performance, subdued investment, rising skill shortages and slower adoption of new technologies, including in the public sector. Productivity growth has been weaker among small and medium sized firms. Productivity can be boosted by encouraging more firms and individuals to seize opportunities new technologies provide, improving also inclusiveness.

Entrepreneurship is key to faster technology diffusion and higher productivity among SMEs. Firm creation has been declining partly due to strong employment growth. The lower income security associated with self-employment could hold back entrepreneurship. The period during which failed entrepreneurs must repay debt can last up to six years, discouraging firm creation. Women are under-represented among entrepreneurs, especially in technology-intensive sectors. R&D tax incentives may boost innovation if designed carefully to benefit fully young firms which have not generated profit. Well-developed e-government services can reduce the administrative burdens on start-ups.

Government ownership in business sector activities holds back reallocation of resources and the development of new business models. Privatising government stakes in businesses, including in the Landesbanken, could reduce risk of incumbent bias, for example in lending.

Improving competition and boosting investment in digital networks would allow to better harness new technologies. A larger number of mobile communication operators would result in more innovative services at lower prices. The upcoming radio spectrum auction for 5G networks should be used to promote competition in the mobile market. This would also stimulate demand for highest-speed broadband services, boosting roll-out. More investment is needed to expand high-speed broadband in rural areas where unsubsidised provision is unlikely.

Automation, digital platforms, and other technological changes are altering the nature of work. Jobs with routine tasks are at risk of automation. They are concentrated in middle-skill occupations. The share of jobs with high risk of being automated or of undergoing substantial changes is high (Figure C).

New forms of work, such as digital platforms, involve more workers in flexible arrangements such as “solo” self-employment. This reinforces the case for extending social safety nets to the self-employed.

Technological change increases the demand for cognitive and non-cognitive skills. Cognitive and digital skills of German adults are above the OECD average, but fall short of leading countries (Figure D). The vocational education and training system ensures excellent integration of young people in the labour market (Figure E).

More than a quarter of vocational graduates earn more than academic graduates. However, their earnings increase little with experience. Strengthening general education within the vocational education system and stronger incentives to participate in life-long learning could enhance adaptability of German workers to technological change.

More modular training offers, combined with opportunities to formally recognise skills acquired on-the-job, can boost life-long learning, as experience in Denmark and Portugal suggests.

Impressive progress has been made in reducing the impact of socio-economic background on education outcomes, as improved PISA scores and a steep rise in childcare enrolment show. There is scope to further improve education outcomes among children with weakest socio-economic background. Ensuring high-quality childcare and early childhood education as well as that high-quality full-day primary schooling is available everywhere would allow making progress in this direction.

Better opportunities for women to develop their careers would boost productivity and reduce poverty risk. Women are overall as highly educated as men but their skills are used less, in part because they often work fewer hours, limiting professional choice and career prospects. Further developing full-day childcare and reducing the tax and social security disincentives for second earners, mostly women, to work longer hours and further strengthening fathers’ incentives to take care of their children would improve gender equity.

Emissions from transport have increased despite substantial gains in efficiency, leaving a weak spot in the overall climate policy mix. Transport infrastructure plans needs to be made consistent with CO₂ emission reduction targets, including by expanding the electric charging infrastructure for automobiles. Policies to deploy ICT-based ride sharing, coupled with congestion charging, facilitate the low-carbon transport transition, help deploy effective public transport at lower cost, and can boost competitiveness of cities by reducing congestion.