Germany's healthier economy

Reforms in areas like healthcare can make Germany's good times last much longer.
Economics Department

©David Rooney

Is the German Wirtschaftswunder back? The tide has obviously turned for the better in what for most of the post-war period was indeed Europe's “wonder economy”: after years of very slow growth at the beginning of the decade, the EU’s largest economy has been experiencing a strong upswing since 2005. The reforms of recent years, notably on the labour market, are showing positive results with the unemployment rate falling to a seven-year low of around 7.5%.
The share of older workers in employment has risen dramatically–thanks to a combination of the phasing out of early retirement options and strong demand for qualified labour. The government has balanced the budget for the first time since 1989, the year the Berlin Wall fell. Four years ago the deficit reached 4% of GDP, and the improvement since then has been achieved almost exclusively by textbook-style expenditure cuts under the Stability and Growth Pact as well as a shift from direct to indirect taxation. This has all given Germany the strength it has needed to better withstand the headwinds from global financial turmoil, high commodity prices and an appreciating euro.But while these are relatively good times in Germany, there is still quite a bit of catching up to do. Though still the world’s third largest economy, GDP per capita trails in just 16th place, well behind the US. Luckily, the environment for the kinds of structural reforms needed to close the gap has seldom been more favourable. The challenge is to use the good times to drive through the most pressing reforms. Berlin is dubbed “the city of change” and this spirit can now lead the country as a whole to lift its performance.The biggest danger would be to become complacent or, worse, backtrack on reforms already in place. Apart from some recent decisions by the government, for instance, to prolong unemployment benefits for older workers and another to grant ad hoc pension increases, there is fortunately enough consensus to maintain successful reform elements and even preserve some enthusiasm for new and necessary reforms.
                   Back to strength?
Germany's GDP real growth (left axis) and
unemployment rate (right axis), 2003-2008*
*Data are from the Economic Survey of Germany (2008 is a forecast)
and may be revised for the OECD Economic Outlook No 83 June 2008,
which was forthcoming when this OECD Observer went to press.


The 2008 OECD Economic Survey of Germany advances three sets of recommendations to help keep up momentum. First, there are those which are designed to safeguard the achievements of past policy, and include replacing the current fiscal rule with a balanced structural budget requirement, modelled on the Stability and Growth Pact, to safeguard the budget. The report also urges the government to resist the introduction of sectoral minimum wages, as that may impede competition and job creation, especially for workers on the margin of the labour market.Second, the report makes a number of suggestions to give a boost to reforms in some currently under-performing areas. These include the need to remove fiscal disincentives for second-earners to go out to work—in Germany the number of hours worked by married women is low by OECD standards as many of them work in so-called mini-jobs that are exempted from social security contributions; freeing up employment protection legislation for regular job contracts; and strengthening competition in network industries, such as energy and railways. It also urges stepping up efforts to improve education performance.The third set of recommendations focuses on how to make current reforms more effective. Prominent among these is healthcare financing, which is a major concern for most countries. True, spending per capita has risen in Germany by just 1.3% per year in 2000-05, but German healthcare remains one of the OECD’s costliest, with public spending higher only in France. However, on health outcomes, performance fares less well, despite high capacity in terms of hospital beds, the number of health professionals, and so on.Population ageing, but also technological progress, which leads to better, but more expensive treatment, will drive up healthcare costs by 3.6 percentage points until 2050, and costs for long-term care will rise by an additional 1.9 percentage points of GDP. Around 0.5 percentage points of this increase is due to pure demographic effects, as more older citizens demand ever better healthcare services. Ageing strengthens the argument that additional costs will simply have to be pre-funded in the government’s budget today if it is to be able to maintain the same level of healthcare services. However, the argument does not necessarily hold for the larger part of the rise in costs due to technological progress. The benefit of ever better treatment will accrue only to the next generation, and the present generation may not want to contribute to financing advances it may not itself be around to use.Public current expenditure on health
                   % of GDP

Source: OECD Economic Survey of Germany, 2008
Currently, healthcare coverage is provided through a mix of social health insurance for about 90% of the population and primary private health insurance for eligible individuals who opt out of the system. Labour-income dependent social health contributions are set by insurers, who have incentives to direct their efforts at attracting high income members with a low morbidity risk, rather than improving the cost-effectiveness and quality of their services.A second problem for effective competition relates to the collective contracts between insurers and associations of providers, which alongside the likes of national fee schedules for physicians and hospitals, leave little room for insurers to compete on quality. Segmentation of the market hampers competition further. Little wonder the government's healthcare reform started out mainly by aiming to increase competition to make financing more sustainable and reduce its burden on labour costs. The central idea to be launched in 2009 is to channel healthcare insurance contributions and general tax money into a central health fund. Contribution rates would be uniform rather than set by insurers according to labour income, and would then be distributed back to insurers with capitations already adjusted by income and risk. The onus will then be on insurers to cover their costs by finding savings and possibly levying surcharges. Insurers with surpluses can grant refunds while cost overruns will have to be billed to members at the end of the year.In theory, this new system can bring about higher quality treatment for all their members, rather than having insurers chasing after wealthier low risk ones. Competition across a wider market will encourage this shift to quality and efficiency and will be enhanced by further reform measures, including greater freedom for insurers to shop among different providers, and more freedom to enhance price competition in the pharmaceutical market. There will also be a drive to make health insurance mandatory, and more affordable as well.And because general health services will be financed more from the budget, the system will reduce distortionary taxation of labour income as well. It is a promising reform, and the Economic Survey of Germany lists a score of recommendations to ensure it actually delivers. For instance, any surcharges made by insurers should also be flat and not income dependent, and aid for low earners should be tax financed and not cross-subsidised by high-earners.Also, private health insurers should be included in the new financing system based on the central health fund to improve the risk selection process and make it more efficient. The government should monitor closely whether new tariffs do generate savings, as well as keeping an eye on medicine rebate agreements and the like. In short, the OECD’s underlying message is that the German economy is very much back on its feet, and with more effort on reforms, can look forward to an even cleaner bill of health in the years ahead.
ReferenceOECD (2008), OECD Economic Surveys: Germany, OECD, Paris.©OECD Observer No 267 May-June 2008


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