EUROPEAN COMMISSION Brussels,7.3.2018 SWD(2018) 204 final COMMISSION STAFF WORKING DOCUMENT Country Report Germany 2018

Including an In-Depth Review on the prevention and correction of macroeconomic imbalances Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE COUNCIL, THE EUROPEAN CENTRAL BANK AND THE EUROGROUP 2018 European Semester: Assessment of progress on structural reforms, prevention and correction of macroeconomic imbalances, and results of in-depth reviews under Regulation (EU) No 1176/2011 {COM(2018) 120 final}





Contents Executive summary 1.Economic situation and outlook 2.Progress with country-specific recommendations 3.Summary of the main findings from the Macroeconomic Imbalances Procedure in-depth review 4.Reform priorities 4.1.Public finances, fiscal frameworks and taxation* 4.2.Financial sector* 4.3.Labour market, education and social policies 4.4. Beyond the aggregate: ageing, inequality and savings* 4.5. Investment 4.6. Sectoral policies Annex A: Overview table Annex B: Macroeconomic Imbalances Procedure Scoreboard Annex C: Standard tables References LIST OF Tables Table 1.1:Key economic and financial indicators – Germany

Table 2.1:Summary table on 2017 CSR assessment Table 3.1:MIP assessment matrix – Germany Table 4.2.1:Financial soundness indicators, all banks in Germany Table B.1:The MIP Scoreboard for Germany (AMR 2018) Table C.1:Financial market indicators Table C.2:Headline Social Scoreboard indicators Table C.3:Labour market and education indicators Table C.4:Social inclusion and health indicators Table C.5:Product market performance and policy indicators Table C.6:Green growth LIST OF Graphs Graph 1.1: Demand components of GDP growth Graph 1.2: Contributions to headline inflation Graph 1.3: Sectoral net lending Graph 1.4: Determinants of household disposable income Graph 1.5: Current account and component balances Graph 1.6: Balance of goods by broad economic category Graph 1.7: Current account balance and components of the financial account Graph 1.8: Factors explaining the current account surplus

Graph 1.9: General government budget balance and gross debt Graph 1.10: Tax wedge - 2016 Graph 2.1: Overall multiannual implementation of 2011-2017 CSRs to date Graph 4.1.1: Government balance and trends in selected revenues and expenditures Graph 4.1.2: Taxes by economic function Graph 4.2.1: Mortgages and corporate loans in billion EUR and in % of GDP Graph 4.2.2: Annual change of different household loan categories Graph 4.2.3: Funding sources of non-financial corporations Graph 4.3.1: Phillips curve in Germany: compensation growth and unemployment rate Graph 4.3.2: Trends in labour costs and its components Graph 4.3.3: Employment rate by citizenship Graph 4.3.4: Gini coefficient and poverty risk Graph 4.4.1: Dependency ratios (2036 population forecast) and savings rates of DE Graph 4.4.2: Savings rates by age groups – measured in 2015 Graph 4.5.1: Capital stock Graph 4.5.2: Gross fixed capital formation in the private sector Graph 4.5.3: Potential growth and contributions Graph 4.5.4: Productivity developments Graph 4.5.5: Housing overvaluation gap Graph 4.5.6: Gross fixed capital formation in the public sector

Graph 4.5.7: Net public investment by level of government Graph 4.5.8: Net capital stock by type of activity Graph 4.6.1: Business expenditure on R&D (BERD) performed by SMEs Graph 4.6.2: Venture capital investment (market statistics) in 2016 LIST OF Boxes Box 2.1: Tangible results delivered through EU support to structural change in Germany Box 3.1: Euro area spillovers Box 4.3.1: Monitoring performance in light of the European Pillar of Social Rights Box 4.3.2: Policy highlights: The introduction of the general minimum wage Box 4.5.1: Investment challenges and reforms in Germany Box 4.6.1: Collaborative economy Executive summary Germany’s enduring economic upswing offers an opportunity for policy action aimed at fostering higher potential growth, which can prepare the country for future challenges. Boosting public and private investment, where gaps have been clearly identified, can help maintain the efficiency of the capital stock and raise productivity to prepare for future challenges such as new digital business models, low-emission transport and decentralised (renewable) energy production. Better involvement of the underrepresented groups in the labour market can help address the looming shortage of skilled labour stemming from demographic change. Boosting investment and expenditure in education, including lifelong learning, and in research and development are also key in raising long-term growth potential.( ) The German economy showed robust growth in 2015-2017, driven by domestic demand. Real GDP growth was at 1.9 % in 2016 and 2.2 % in 2017. In 2017, private consumption grew for the second year running by 2 %. Underpinned by the continued economic expansion, unemployment fell to a record low of 3.6 % by the fourth quarter of 2017, despite the growing labour force. Employment growth continued, with the employment rate reaching 79.1 % in the third quarter of 2017, as both demand for labour and the labour supply increased. Despite record low unemployment and high job vacancy rates, wage growth remains moderate. The positive output gap and high capacity utilisation are expected to spur investment. Inflation rose from 0.4 % in 2016 to an average of 1.7 % in 2017 on the back of rising energy prices. The budget balance continues to improve, while government debt remains on a downward path. In 2016, the government surplus reached 0.8 % of GDP, higher than in 2015, rising further to a record high of 1.2 % of GDP in 2017, partly due to lower interest payments on public debt. The budget is expected to remain in surplus in headline and structural terms in 2018 and 2019 as well. The gross debt-to-GDP ratio is set to fall further from 68.1 % in 2016 to below the 60 % Maastricht threshold over the next couple of years, possibly by 2019. Given its economic importance and strong integration in EU value chains, Germany is a source of potentially significant spillovers to other EU countries. A further rise in domestic demand, including through higher public investment in R&D and education, would increase Germany’s actual and potential growth. It would also stimulate demand and GDP growth in other EU countries, including those that need to bring debt down. Germany has made limited progress in addressing the 2017 country-specific recommendations. Limited progress has been made towards achieving a sustainable upward trend in public investment, including public spending on education, research and innovation. Some progress has been made in addressing capacity and planning constraints on infrastructure investment. There has been limited progress towards stimulating competition in the business services and regulated professions, reducing disincentives to work for second earners and helping them to move into standard employment, promoting higher real wage growth, and reducing the high tax wedge for low-wage earners. No progress has been achieved in making the tax system more efficient and conducive to investment.

Regarding progress in reaching the national targets under the Europe 2020 strategy, Germany is performing well on the employment rate, early school leaving and poverty, improving tertiary education attainment, investment in research and development (R&D), and increasing the share of renewable energy. However, it is unlikely to reach its national indicative energy efficiency and climate targets by 2020. Germany performs relatively well on the indicators of the Social Scoreboard supporting the European Pillar of Social Rights. It has very low unemployment but a large gender employment gap. Strong social dialogue and a relatively advanced welfare model underpin Germany's competitive economy. The main findings of the in-depth review set out in this report, and the related policy challenges, are as follows: ·The current account surplus is expected to edge down further in the future, but to remain high. Strong domestic demand is expected to keep import growth above export growth, further easing the current account surplus. The domestic saving-investment imbalance, which has been growing since 2008, may have reached a turning point in 2016. However, the factors keeping investment low relative to savings remain in place. ·Demographic change and rising income inequality up to 2014 partly explain the rise and persistence of the current account surplus. Rising income inequality, linked to demographic and labour market changes, may have constrained private consumption and increased the trade balance. In addition, population ageing and concerns about the adequacy of future pension levels and old-age poverty could explain a rise in domestic savings. According to economic theory and model estimates, the demographic transition is currently pushing up the current account surplus by a substantial amount, but should lower savings in the long run. ·Private investment has picked up, but business investment remains subdued as a proportion of GDP, suggesting that obstacles to investment persist. Housing seems to account for most of the increase in private investment, while investment in non-residential construction is slow to pick up. Though investment in machinery and equipment has increased to pre-crisis levels, as a share of GDP it remains subdued. On average, investment in intangible assets, such as R&D, has grown in importance. However, it is largely concentrated in medium-high tech sectors and in larger firms, while small and medium-sized enterprises and the services sector in general are tending to under-invest. This explains large productivity gaps between manufacturing and services, which are likely to dampen potential growth. Despite favourable financing conditions, non-financial corporations remain net lenders. Barriers to investment include demographic trends resulting in shortages of skilled labour, taxation and administrative burden, regulatory restrictiveness in the services sectors and the shortfall in very-high-capacity broadband. ·While public investment increased recently, the public investment gap remains large, particularly as regards investment in infrastructure and education. Real public investment growth turned positive in 2015, after showing negative growth rates in the years before. This improvement reflects government efforts to boost investment. The accumulated investment backlog at municipal level fell to some extent in 2016, but remains large at an estimated 4 % of GDP. The biggest shortfalls are in education, where the national spending target has not been met, and in infrastructure. While the Federal Government and the Länder kept their construction investment stable, such investment by municipalities fell steadily, with negative net investment also in 2017. Investment in public infrastructure is still held back by capacity and planning constraints at municipal level. Measures to overcome these have yet to show results. In addition, there is scope for enhancing digital public services and improving public procurement. ·Germany is lagging behind on very-high-capacity broadband deployment, and the digital divide between urban and rural areas remains a particular challenge. Only a comparatively small proportion of German territory is covered by fibre-based access networks. Instead, upgrading existing copper cable networks continues to be the dominating incumbent's preferred technological solution. However, many services rely on very high connectivity. Lack of such connectivity holds back investment, especially by small and medium-sized businesses, many of which are located in semi-rural and rural areas. ·Germany's tax and social security systems are not particularly progressive or supportive of employment and private investment. There is a relatively strong emphasis on more distortive direct taxes, notably on labour income, while revenues from consumption and environmental taxes are lower. Household income and consumption are restrained by the high tax wedge on labour, especially for low earners. The statutory corporate tax rate is among the EU's highest. Taxes on inheritance and gifts allow large-scale transfer of wealth from one generation to the next and preserve the high wealth inequality. Healthcare efficiency could be improved by better integrating primary, ambulatory specialist and in-patient care and making better use of eHealth. ·The banking sector is not very profitable, but the equity and leverage situation remains acceptable. Nationally aggregated profitability seems low, and ongoing consolidation is improving efficiency relatively slowly. Still, capitalisation ratios are satisfactory, and the non-performing loans' ratio is low, in the context of a relatively small loan stock, particularly for non-financial corporations. While the housing market continues to be buoyant, overall house price developments are not causing macro or financial stability risks. The venture capital market remains less developed than that of other international innovation leaders. ·Wage growth remains moderate, despite record low unemployment and high job vacancy rates. The German labour market is performing well on aggregate, with strong employment growth and low unemployment. However, the prevalence of part-time work especially among women, and a large low-wage sector present structural challenges. Moderate recent wage growth is partly attributable to slow productivity increases in services, weak inflation expectations, low collective bargaining coverage in some sectors, and a reduction in structural unemployment. ·Despite growing skilled labour force shortages, the labour market potential of certain groups remains underused. Disincentives to work persist, particularly for second earners and the low-waged; they include the substantial tax wedge, tax rules, and the lock-in effects of the mini-job earning threshold. Long-term unemployment, though falling, remains sizable. An ageing population poses further challenges to the labour market, social policy and education in the medium to long term. Improvements in family and education policies, adult learning and in the integration of people with a migrant background into education and employment could reduce inactivity and in-work poverty, improve social cohesion and potential growth alike. ·Germany has a solid social protection system overall, but there are concerns about the future. In 2015, the rise in the risk of poverty and inequality has halted and the income position of low income households improved. Nevertheless, future deterioration of pension adequacy in the statutory first pillar is expected to increase the risk of poverty in old age, especially for low-wage earners or people with atypical work and interrupted employment history. The gender pension gap is one of the highest in the EU. Social outcomes for migrants and their children remain a concern. Other key economic issues analysed in this report which highlight particular challenges facing Germany’s economy are as follows: ·Germany's electricity networks are adapting to renewables production at a slow rate, and significant investment in transmission and distribution grids is still lacking. Substantial delays in carrying out many projects have incurred considerable costs to German and European electricity networks and electricity markets. The lack of north-south internal lines strains the electricity trade with Germany's neighbours, as domestic congestion tends to be pushed to the borders. Moreover, there is scope for higher energy efficiency in transport. ·Progress on emissions reduction has been slow. Germany is expected to miss its Europe 2020 Effort Sharing Decision target for greenhouse gas emissions. The transport sector has been particularly slow to cut emissions of both greenhouse gases and local air pollutants. 1. Economic situation and outlook GDP growth The German economy continued to grow strongly in 2017. Germany’s real GDP growth rate was a solid 2.2 % driven by private consumption and investment. Export growth picked up amid a strengthening euro area recovery while the strong domestic demand caused imports to accelerate. On balance, foreign trade had a small positive contribution to growth. Economic sentiment continues to improve across sectors, suggesting continued expansion in the coming quarters. Survey data show expectations of improving orders, higher output and greater demand. Capacity utilisation has continued to increase, which bodes well for investment. The strong labour market, favourable world trade developments the expansion in the euro area should help to sustain the enduring upswing. Overall, real GDP growth is expected to strengthen to 2.3% in 2018 and remain above 2% in 2019 (see Graph 1.1).

Graph 1.1:Demand components of GDP growth Source: European Commission Potential growth is benefiting from the sustained rise in labour supply and total factor productivity while capital accumulation is lagging behind. Potential GDP growth has strengthened in recent years reaching around 2 % in 2016 (see Graph 4.5.3). It was driven by expanding labour supply on the back of improving participation and recent high net migration. The number of foreign nationals in the labour force increased from 3.5 million in 2011 to 4.8 million in 2016. In addition, total factor productivity growth has been strong, consistently exceeding the euro area average (see ‘Labour market’ below and Sections 4.3 and 4.5). Capital accumulation, on the other hand, has made a relatively small contribution to potential growth. In the medium to long term, labour input is unlikely to grow as strongly along the extensive margin. Therefore, to sustain potential growth, it will be important to enhance capital accumulation by stepping up productive investment. Investment The positive demand outlook and high capacity utilisation are expected to boost investment. Private investment in equipment has been recovering since the soft patch of 2016; it has grown strongly last year, returning to the pre-crisis levels. Further increases are likely amid favourable demand prospects, not least from the euro area and the rest of the EU. Consistently rising capacity utilisation should also boost the efforts to renew and expand the capital stock. Housing investment grew strongly in the first two quarters of 2017 and is expected to continue growing, though more slowly. This booming sector is sustained by ample order book backlogs and a steady flow of building permits. Non-residential construction has continued to stagnate to some extent, casting doubt on firms' long-term expansion strategies. Public investment in 2017 increased by around 5.1 % nominally and 2.9 % in real terms posting robust growth for a third year in a row (see Section 4.5). Labour market Employment growth continued, spurred by increased labour demand and supply. Employment grew by 1.3 % in 2016 and 1.5 % in 2017, and by the third quarter of 2017 the employment rate climbed to 79.1% for those aged 20-64. This brought the unemployment rate for the age group 15-74 down further to a new post-unification low of 3.8 % in 2017. Youth unemployment at 6.7% in 2017 was one of the lowest in the EU. Despite population ageing, the labour supply increased mainly driven by increasing labour market participation of women, older workers and incoming workers from other EU countries. Although the labour market tightens and the output gap closes, wages continue to grow at a moderate pace. Although nominal compensation per employee increased by 2.4 % in 2017, slightly above their growth rate of 2.2 % in 2016, real compensation growth decelerated from 1.8 % to 0.7 %. Several factors have kept wage increases moderate so far. These include increased labour supply; relatively limited collective bargaining coverage in some sectors; and a stronger role of non-wage components in collective bargaining (see Section 4.3). The large proportion of part time work, particularly among women, prevents the full use of workers’ labour market potential. Despite high employment rates for women (74.5 % in 2016), the equivalent in full-time employment is only 58.1 % as part-time employment remains among the highest in the EU. Women with a migrant background and women with caring responsibilities are more often in part-time work. The current arrangement of joint taxation of income for married couples (Ehegattensplitting), non-contributory health insurance coverage for non-working spouses, and the high marginal tax rates just above the earnings threshold of a mini job, create disincentives to work more hours. This lower labour market attachment is combined with a large gender pay gap (22.0 % compared to an EU-average of 16.3 % in 2015). In addition, the labour market potential of people with a migrant background is not being fully used. In the third quarter of 2017, the employment rate of non-EU nationals (aged 20-64) was 54.6 %, just slightly below the EU average for non-EU nationals (58.0 %) but 27.2 pps. lower than the rate for German nationals. Women with a non-EU nationality had an employment rate of 45.4 % 32.9 pps. lower than for women of German nationality. Social developments Income inequality has begun to decline (see Annex C). This reverses a decade-long trend of increasing inequality of disposable income distribution, which peaked in 2014 at close to the EU average. The latest figures show a modest reduction in the S80/S20 ratio, which measures the income of the richest 20 % of households in relation to that of the poorest 20 %. For Germany, the share fell to 4.6 in 2016, owing to an improvement in the incomes of poorer households. This trend is believed to have continued in 2017. The improvement reflects rising wages, which have also reduced the amount of in-work poverty. The share of income of the richest 20 % has fallen slightly. This may reflect a slowing of the wage premium on skills, as the incomes of the low and medium-skilled rose faster in 2016 than those of the highly skilled. However, wealth inequality in Germany is high in international comparison. In 2014, the Gini coefficient for net wealth in Germany at 0.76 was the second highest in the euro area (whose Gini coefficient, calculated on the basis of data from the second wave of the ECB’s Household Finance and Consumption Survey, was 0.69). ( ) For Germany, the P90/50 ratio was 7.7, meaning that a person who fell just within the richest 10 % of the population had roughly 8 times the wealth of a person in the middle of the wealth distribution. Like wealth as a whole, financial and real assets were distributed unevenly. Inequality of opportunity also remains a concern. While overall the risk of poverty has begun to decline modestly (see Section 4.3 on social policy), the poverty risk faced by the children of low-skilled parents has continued to rise reaching 64.7 % in 2016. PISA results also showed a strong link between socioeconomic status and educational performance, partly explaining the underperformance of children with a migrant background. (see Section 4.3). Inflation Inflation is expected to remain moderate. HICP picked up from 0.4 % in 2016 to an average of 1.7 % in 2017 on the back of rebounding energy prices and related second round effects (see Graph 1.2). Core inflation (excluding energy and unprocessed food) has increased from just above 1 % over 2015-16, to 1.5 % in 2017 and is expected to rise to 1.7 % over this year and next, in the context of strong demand and higher wage growth. Overall headline inflation dynamics are projected to be in line with the euro area’s and to oscillate around 1.6 %. Dampened by the expected stable energy prices, this moderate inflation should support household purchasing power. Graph 1.2:Contributions to headline inflation Source: European Commission Sectoral balances The widening of domestic saving-investment balance, reflected in the increasing current account surplus, may have reached a turning point in 2016. Private borrowing increased further in 2016 slightly above GDP growth and the rate of net asset accumulation by the private sector stabilised. Nominal corporate investment increased in 2016, with a further significant rise in 2017, while corporate savings are set to fall slightly as a share of GDP. As a result, corporations, whose indebtedness is among the lowest in the euro area, contributed to the slight reduction in the savings surplus. The household savings rate increased to 17.1 % in 2016, propped up by low consumer price inflation, but is forecast to have declined to 16.6 % in 2017, as consumer demand remained robust and inflation rose. Still, the household savings rate will likely remain the highest in the euro area (which averages 12.3 %). After rebounding in 2016, household investment is expected to have grown strongly in 2017, lowering the net lending balance further. A further fall in public sector indebtedness is expected, thanks to the favourable macroeconomic outlook (see ‘Public finances’ below). Graph 1.3:Sectoral net lending Source: European Commission However, the consumption share of GDP remains relatively low, as the high household saving rate is being sustained. The GDP share of labour income has increased since 2011, but so have the shares of income tax and social security deductions. The share of property income has been falling as a result of less generous dividend pay-outs by corporations and lower interest income. The saving rate has nevertheless remained stable, while consumption has declined in parallel with household disposable income as a proportion of GDP. Nonetheless, real consumption has actually increased as purchasing power has been boosted by low inflation. Even so, the consumption share of GDP (53 % in 2016 and 2017) has remained low from an historical perspective.

Graph 1.4:Determinants of household disposable income Source: European Commission External position The current account surplus has edged down from a historically high level and is expected to decline slowly in the coming years. In 2016, it fell to 8.2 % of GDP, from a peak of 8.5 % in 2015, while it stood at 7.8 % for the year ending in November 2017. The trade surplus stayed largely stable at 8.5 % in 2016, but fell to 8.2 % for the year ending in November 2017. Between 2013 and 2016 cheaper energy and other commodity prices drove the widening of the trade balance by 2 pps. of GDP, but since then terms-of-trade effects have gone into reverse. The trade balance is also contracting in real terms. The export outlook is expected to be favourable and to fuel German exports. At the same time, strong domestic demand is expected to keep import growth above export growth and to further ease of the current account surplus ratio. Nevertheless, the current account is expected to remain above the MIP threshold of 6% of GDP for a number of years. Graph 1.5:Current account and component balances Source: Deutsche Bundesbank, European Commission The current account surplus with respect to the rest of the euro area stabilised at 2.4 % of GDP in 2016-17. Recovery in the euro area goes hand-in-hand with stronger German exports and a growing export ratio with respect to the region. At the same time, the ratio of euro area imports to Germany remains robust, although imports from other regions are growing at a faster rate. Graph 1.6:Balance of goods by broad economic category Source: European Commission The trends behind the widening trade balance may have started reversing. The balance of trade in intermediate goods widened by 2 pps. of GDP in the course of 2012-2016, largely in parallel with the widening of the overall trade balance. Since mid-2016, imports of intermediate goods have become relatively more important, and the balance has been coming down. In addition, net exports of passenger cars peaked in 2015 and have been declining since, as more foreign cars are making their way onto the German market. Graph 1.7:Current account balance and components of the financial account Source: Deutsche Bundesbank In addition, there has been a shift in a composition of the financial account. Portfolio investments, in particular in foreign debt instruments, which typically are of a relatively short-term and speculative nature, have been the main foreign investment outlet, accounting for the bulk of net capital exports. Following the 2009 financial crisis, German portfolio investment abroad tended to significantly exceed portfolio investment in the country by non-residents. However, since mid-2015 German residents have been scaling down portfolio investment. In parallel, a wave of repatriation of German securities has set in, from investors for whom the safe haven motive for holding German government bonds no longer counterbalances their low returns. Thus, a significant part of the current account surplus in recent years reflects disinvestment by non-residents, rather than German capital exports as it was the case in the past (Graph 1.7). This disinvestment by non-residents has also been related to the increased purchases of German government bonds by the Bundesbank in the context of ECB's Public Sector Purchase Programme and has coincided with an increase of Germany’s Target 2 surplus. Nonetheless, the current account surplus remains considerably above what fundamentals suggest. According to the Commission current account 'norm' calculations, fundamental savings-investment determinants currently suggest a surplus of +2.5 pp, which is mostly due to ageing, but also due to the manufacturing intensity of German exports. ( ) Yet most of the surplus and its dynamics is explained by non-fundamental factors. Private-sector deleveraging since 2000 explains a large part of the surplus, along with the fiscal stance, and an increasing net international investment position (NIIP) giving rise to a sizeable positive income balance. Overall, the sustained current account surpluses have led to a NIIP somewhat above what fundamentals suggest. Graph 1.8:Factors explaining the current account surplus Source: European Commission Public finances The general government budget balance continues to improve, while public debt continues to fall. In 2016, the headline surplus reached 0.8 % of GDP, higher than in 2015, rising further to a record high of 1.2 % of GDP in 2017. The surplus would have been even higher (by around 0.2 %), as it already included the repayment in 2017 of a nuclear fuel tax ruled invalid by the German Constitutional Court. From its recent peak in 2010, with a government deficit at 4.2 % of GDP, Germany has consistently improved its government balance, turning it into a surplus from 2014 on. What made this improvement possible was the fact that government revenue rose from 43.0 % of GDP to 45.0 % between 2010 and 2016. At the same time, public spending fell from 47.3 % of GDP to 44.2 %. Since 2015, all levels of government (federal, state, municipalities and social security) have been making a positive contribution to the budget surplus. The positive government balance is also reflected in falling government debt, which reached 70.9 % in 2015, falling further to 68.1 % in 2016. According to the Commission’s 2017 autumn forecast, the debt ratio can be expected to fall below the 60 % Maastricht threshold in the next few years, possibly by 2019. Graph 1.9:General government budget balance and gross debt Source: European Commission The tax wedge ( ) remains substantial and has been a major source of increasing government revenue over the last few years. The increase in government revenue by around 2.0 % of GDP between 2010 (43.0 %) and 2016 (45.0 %) is based mainly on income taxes, which contribute 1.3 % to the rise. According to 2016 data, Germany’s tax wedge is one of the EU’s largest at 49.4 % (average of 22 comparable European OECD countries: 41.7 %) for a single earner earning 100 % of the average wage without children. Graph 1.10 shows that, as in other countries, income tax accounts only for about one third of the tax wedge. It is rather social security contributions that account for the biggest share. However, unlike in most other European countries, that the German employers pay a smaller share (16.2 %) than employees (17.3 %). The employees’ share is one of the largest in Europe (the average, for 21 comparable European OECD countries, is 10.1 %). (See also Section 4.1). Graph 1.10:Tax wedge - 2016 Source: OECD Table 1.1:Key economic and financial indicators – Germany Source: Eurostat and ECB as of 30 Jan 2018, where available; European Commission for forecast figures (Winter forecast 2018 for real GDP and HICP, Autumn forecast 2017 otherwise)

2. Progress with country-specific recommendations Progress with implementing the recommendations addressed to Germany in 2017 has to be seen in a longer term perspective since the introduction of the European Semester process in 2011. ( ) Looking at the multi-annual assessment of the implementation of the CSRs since these were first adopted, 38 % of all the CSRs addressed to Germany have recorded at least 'some progress'. 62 % of CSRs recorded 'limited' or 'no progress' (see Graph 2.1). Overall, for every Semester cycle, multi-annual implementation in Germany has remained relatively weak, remaining below the average of the progress made by other Member States. Moreover, the gap in reform implementation between Germany and other countries has widened over time, despite the fact that since 2014 Germany has been subject to in-depth monitoring under the Macroeconomic Imbalances Procedure (MIP). Graph 2.1:Overall multiannual implementation of 2011-2017 CSRs to date Source: European Commission A sound fiscal position masks missed fiscal and structural reform opportunities. Germany has managed to preserve a sound fiscal position since 2011, ensuring compliance with its medium-term budgetary objective and keeping debt on a downward path. It has also taken some first steps to improve fiscal governance, which involves matching fiscal capacity and responsibilities better at federal and Länder level. Reforming efforts to make the tax system more efficient and modernise the tax administration have however remained limited in scope, and no measures have yet been taken to comprehensively review corporate taxation and the local trade tax (Gewerbesteuer). While the effects of some recent measures such as steps to increase funding and planning capacity at municipal level will be visible later, public investment has expanded only to a small extent, despite the good financial situation. This may have meant missing out on possibilities to improve potential growth, especially given the low-interest-rate environment. The good labour market outcomes result mainly from earlier reforms and institutional strengths, rather than recent measures. High employment growth and low unemployment reflect the strong cyclical upturn combined with the favourable impact of past labour market reforms, employment friendly social dialogue, and a competitive export industry. Between 2011 and 2016, the tax wedge for workers earning two-thirds of the average wage was cut by only 0.3 pps., to 45.3 %. During the same period, the EU-28 average fell by 0.9 pps. to 36.8 %. While the 2014 pension reform facilitated earlier retirement, it is not yet clear whether measures to incentivise later retirement through greater flexibility will have the intended effect. In addition, fiscal disincentives for second earners and people with mini-jobs remained largely unchanged. Policy inertia contributes to some lock-in of productive capacity, thus hindering further increases in productivity and potential growth. Even if the introduction of the statutory general minimum wage in 2015 had an impact, wage increases remained moderate. This also reflected that, despite some government efforts to improve bargaining coverage, coverage of collective agreements stagnated. Education spending has remained subdued. Education spending remained well below the EU average as a share of GDP (2011 4.3 %, 2015: 4.2 %, against an EU average of 4.9 %). While availability of full-time childcare facilities and all-day schools improved, the attendance of children under 3 years of age remained slightly below the Barcelona objectives. It even fell by 0.2 pps. to 32.7 % in 2016 as demand expanded as a result of immigration. Despite some measures, the education system remains marked by socioeconomic inequalities, and across the Länder significant performance differences persist. To date, there is no comprehensive strategy to modernise the regulated professions and to boost competition in the service sector. Extensive regulatory restrictions and administrative formalities apply to firms providing services in Germany, especially where business services are concerned. Germany submitted an action plan to the European Commission in January 2016, including a range of measures, such as modifying the legal provisions governing certain specific professions: lawyers and patent attorneys, tax advisers, and auditors. Yet, it has only partially adopted or implemented the measures described. Overall, progress is limited. Overall, Germany has made limited progress in responding to the 2017 country-specific recommendations (CSRs) ( ). Limited progress has been made towards achieving sustainable growth in public investment, a CSR closely related to the euro area recommendation about strengthening domestic demand and growth potential. This is done by stepping up investment in infrastructure and boosting the funding available under the Municipal Investment Promotion Fund for modernising school buildings, including digital infrastructure. At the same time, there has been limited progress with stepping up public expenditure on education, research and innovation which even if increasing in absolute terms, has remained largely stagnant as a share of GDP. Some progress has been made with tackling capacity and planning constraints on investment in infrastructure. No progress has been made with making the tax system more efficient and investment-friendly. Progress was limited in promoting competition in the business services and regulated professions. Progress was limited on issues also related to the euro area recommendation on labour market, including on reducing disincentives to work for second earners, facilitating transition to standard employment and reducing the tax wedge for low-wage earners. Similarly, limited progress has been made with creating conditions for higher real wage growth. Table 2.1:Summary table on 2017 CSR assessment Source: European Commission Box 2.1: Tangible results delivered through EU support to structural change in Germany Germany is a beneficiary of significant European Structural and Investment Funds (ESI Funds) support and can receive up to EUR 28 billion until 2020. This represents around 4% of public investment ( I ) annually over the period 2014-2018. By 31 December 2017, an estimated EUR 14.9 billion (53 % of the total) was allocated to projects on the ground. These investments help creating 1 500 new research jobs in supported public and private research facilities. Another 8 100 researchers benefit from investments in their institutions. More than 100 interactive innovation partnerships have been launched boosting the innovation culture in the agricultural and forestry sector in Germany. 1 600 children enjoy improved childcare facilities or schools in North Rhine-Westphalia. In rural areas, more than 20 million rural inhabitants benefit from supported investment in basic services and infrastructures. ESI Funds help address structural policy challenges and implement country-specific recommendations. Investments in research and development in the private sector are stimulated, among others, by the enhanced use of financial instruments such as loans, grants or guarantees for public interventions. The Funds invest in coaching for people with a distance to the labour market which in turn helps enhance the overall labour market participation with specific measures aimed at improving the job prospects of older workers. Various reforms were undertaken already as precondition for ESI Funds support ( II ). For example, all German regions developed or updated Smart Specialisation Strategies for research and innovation. Remarkable in a European context is the strong focus of the strategies on the productive environment and materials, reflecting the structure of the German economy. Germany is advancing the take up of the European Fund for Strategic Investments (EFSI). As of December 2017, overall financing volume of operations approved under the EFSI amounted to EUR 5 billion, which is expected to trigger total private and public investment of EUR 21.9 billion. More specifically, 53 projects involving Germany have been approved so far under the Infrastructure and Innovation Window (including 26 multi-country projects), amounting to EUR 4.4 billion in EIB financing under the EFSI. This is expected to trigger about EUR 17 billion in investments. Under the SME Window, 21 agreements with financial intermediaries have been approved so far. European Investment Fund financing enabled by the EFSI amounts to EUR 632 million, which is expected to mobilise approximatively EUR 4.9 billion in total investment. Over 28 800 smaller companies or start-ups will benefit from this support. RDI ranks first in terms of operations and volume approved, followed by energy, transport and SMEs. Funding under Horizon 2020, the Connecting Europe Facility and other directly managed EU funds is additional to the ESI Funds. By the end of 2017, Germany has signed agreements for EUR 2.1 billion for projects under the Connecting Europe Facility. https://cohesiondata.ec.europa.eu/countries/DE European Structural and Investment Funds help address challenges to inclusive growth and convergence. Notably, they contribute by coaching people so that they can re-enter the labour market thereby enhancing overall labour market participation. For example, they offer specific measures for older workers in order to improve their job prospects. Investments in R&D in the private and the public sector are stimulated, also through the use of financial instruments (see Box 2.1). 3. Summary of the main findings from the Macroeconomic Imbalances Procedure in-depth review The in-depth review for the German economy is presented in this report. In spring 2017, Germany was identified as having macroeconomic imbalances, in particular relating to its large current account surplus reflecting excess savings and subdued investment. The 2018 Alert Mechanism Report (European Commission, 2017d) concluded that a new in-depth review should be undertaken for Germany to assess developments relating to identified imbalances. Analyses relevant for the in-depth review can be found in the following sections: public finances in section 4.1; the financial sector in section 4.2; the labour market and social policy, in the respective subsections of section 4.3; inequality and demographics in section 4.4, public and private investment, the housing market and public procurement in the respective subsections of section 4.5. ( ). Imbalances and their gravity Germany's large and persistent current account surplus stems from the successful export performance of its manufacturing sector not being matched by corresponding domestic investment and consumption, despite a pick-up since 2015. Although a surplus on the current account is consistent with the German economy's structural characteristics, its current high level and persistence are not attributable to fundamental factors alone (see section 1 on current account 'norm' discussion). Rather, it has resulted from the interaction of various domestic and external factors. Chief among these are the two negative private investment shocks, which ensued from the bursting of the dotcom and financial market bubbles, and the relative disadvantage of German debt securities in terms of returns coupled with the limited flexibility of households' investment strategies. Also, it cannot be ruled out that concerns about pension adequacy push up the aggregate saving rate that would be expected in view of the strong age cohorts approaching retirement age (‘baby boomers’). Moreover, significant positive terms-of-trade effects - in view of cheaper imports and despite the depreciation of the euro and low inflation - have served to amplify the surplus in nominal terms in 2014-2016. Over time, these various factors have pushed up net savings across all sectors of the economy, while at the same time depressing the consumption and investment ratios. Given its size and strong trade and financial linkages with the rest of the euro area, the existing economic challenges of the German economy also have wider implications for the euro area. Thus, implementing policies that increase potential growth in Germany can help to support the ongoing euro area recovery and, in turn, ease debt reduction needs faced by highly indebted Member States. Box 3.1 illustrates the effects on domestic and foreign GDP of an increase in spending on R&D and education. The two simulations presented therein follow the spirit of the euro area recommendation 1(), in particular as regards improving growth potential and supporting the creation of quality jobs. Evolution, prospects, and policy responses The current account surplus has been falling since 2015 but remains above the rate suggested by fundamental factors and is expected to remain above the MIP threshold. For the 12 months ending in November 2017, it stood at 7.8 % of GDP, suggesting a further decline compared to 2015 (8.5 %) and 2016 (8.2 %). This correction was mainly driven by the trade balance, which declined to 8.2 % for the 12 months ending November after hovering at around 8.5 % in 2015 and 2016. In particular, imports have strengthened in line with domestic demand benefitting all major trading partner areas, including the euro area. In addition, contributing to a gradual correction of the current account surplus, the negative secondary income balance has widened (from 1.3 % of GDP in 2016 to 1.6 % for the 12 months ending in November 2017) as a result of higher private sector transfers (notably remittances) abroad. However, net capital exports have remained high although their composition has changed. In recent quarters, they have been driven by recalling German bonds rather than by acquiring foreign debt securities. The former has also coincided with a mounting TARGET 2 balance. Outward foreign direct investment abroad saw some recovery in comparison to 2016. All in all, accumulated current account surpluses have resulted in a large positive net international investment position, which reached 55.1% in 2016, somewhat above what fundamental factors would suggest. The private saving-investment balance did not widen further in 2016. Private borrowing rose further in 2016 slightly above GDP growth, while the rate of net asset accumulation by the private sector stabilised. Nominal corporate investment increased in 2016 and further in 2017, while corporate savings are projected to have fallen slightly as a proportion of GDP. This implies that companies, which are among the least indebted in the euro area, have helped bring down the savings surplus. The household savings rate rose to 17.1 % in 2016, propped up by low consumer price inflation, but is projected to have fallen to 16.6 % in 2017, in line with robust consumer and rising inflation. However, the household savings rate is likely to remain the highest in the euro area (whose average is 12.3 %). In 2016, the household investment growth rebounded and households’ net lending position weakened marginally. Household investment is expected to have grown strongly in 2017, lowering the net lending balance further. Until recently, corporate investment has been held back, despite the low interest rate environment. While private investment has recovered to pre-crisis levels, business investment has remained largely flat as a share of GDP. Moreover, in view of the favourable financing conditions and low interest rate environment, a more forceful pick-up could have been expected. Uncertainty over long-term business prospects is often mentioned as a probable contributory factor in domestic investment restraint in recent years. In terms of its components, non-residential construction (e.g. infrastructure) investment has stagnated after years of decline before the crisis. By contrast, investment in residential construction has recently seen strong growth, partly reflecting a sizable accumulated housing supply shortage. While private infrastructure investment continued to stagnate in 2017, foreign direct investment (reinforcing foreign production locations) picked up. This suggests it may be useful to review potential obstacles other than uncertainty to private investment. They include: inefficiency in corporate taxation; the high administrative burden; the less developed venture capital market compared to international innovation leaders; regulatory restrictiveness in the services sector; and delays in implementation of electricity and broadband infrastructure projects.

Public investment, which has been muted, has fallen short of depreciation. As mentioned in Section 4.5, net public investment turned negative in 2003. This outcome reflects a gradual scaling back of investment in maintaining and expanding public infrastructure. The design of federal fiscal relations may also have contributed to protracted underinvestment, especially at municipal level, where net investment has been markedly negative since 2003. It is also partly a reaction to the post-unification investment boom in eastern Germany and the consolidation needs in western Germany, notably at municipal level. An additional annual public investment of 0.3 % of GDP over the next decade would be needed to close the investment backlog at the municipal level. The latter is estimated at EUR 126 bn in 2017, according to the yearly survey conducted by the public development bank KfW (2017a). Years of restrained growth in consumption have also dampened domestic demand and contributed to the building up of the external surplus. High unemployment, a long period of wage moderation and a fall in the total number of hours worked in the first half of the 2000s resulted in low growth in disposable incomes, even if consumer price inflation was supportive of purchasing power. Wage growth picked up from 2014, but not to the extent the tightening labour market situation and unit labour costs in relation to the euro area average would suggest. Since 2014, nominal wage growth remained roughly stable even as inflation picked up in 2017, resulting in the slowing down of real wage growth. Disincentives to work for certain groups are constraining labour participation, disposable income and consumption opportunities. These include a high tax wedge for low-wage earners, disincentives for second earners to increase working hours and the fiscal treatment of mini-jobs that creates lock-in effects. The adjustment of the current account surplus is expected to be only gradual in the medium term. Both export and import growth is expected to remain strong, while terms of trade effects are set to have an only limited impact. Stronger import growth is expected to be driven by a pick-up in equipment investment and demand for foreign inputs along the value chain amidst stable domestic and foreign demand growth. As a result of stronger growth of imports as compared to exports, Germany’s trade surplus should continue to ease leading to a gradual decline in the current account surplus. Over a longer period of time, the large-scale demographic shift from working to retirement age is expected to start to lower the aggregate savings rate and thus the current account surplus. However, in the medium term, the current account surplus is expected to remain above the MIP threshold and to decline only gradually. (European Commission, 2017b) The policy response to address the imbalances has remained limited so far. Although the federal fiscal reform and the relieving of municipalities from certain social spending obligations will strengthen the fiscal position of the Länder and municipalities, it remains to be seen to what extent this additional fiscal space will actually be used for additional public investment. The consultancy and the federal transport infrastructure company, set up in the context of the reform of fiscal relations to support the local governments in planning and implementing investment projects, can be expected to accelerate public investment. Yet, this reform falls short of increasing the tax autonomy of the Länder and municipalities, which could have further increased the scope for public investment. Efforts to improve the business environment for private investment have remained limited. The same holds for efforts to reduce the high tax wedge for low earners and work disincentives for second earners, with a view to supporting labour market participation, disposable income and consumption. Overall assessment The German economy displays a persistently large current account surplus, which reflects a subdued level of investment relative to saving. The size and persistence of the surplus can only be partly explained by the country's industrial structure (e.g. the highly competitive manufacturing sector) and other characteristics of the German economy and society. Hence, it is significantly higher than empirical benchmarks, taking into account these factors in explaining cross-country differences, and much above the level that would be required to stabilise the already high net international investment position (i.e. above the NIIP benchmark) ( ). Subdued investment and private consumption, resulting in an excess of saving over investment, have also contributed to the build-up of the external surplus. This can be partly explained by necessary adjustments in the aftermath of the post-unification boom, including prolonged wage moderation, labour market reforms and significant scaling back of construction activity. While there is currently a clear and robust shift towards more domestic demand-driven growth, both consumption and investment remain relatively low, given the favourable cyclical, labour market, financing conditions and infrastructure investment needs. Continued relatively subdued investment as a share of GDP also undermines Germany’s future growth potential, and has implications for the euro area. While private consumption has picked up, private investment has remained restrained, despite favourable financing conditions. Public investment has picked up, though budget projections indicate scope under EU and national fiscal rules for further increases. Persistently low investment could hamper Germany’s economic growth in the long term. Stronger capital accumulation would be needed to sustain potential growth in the future, especially if population ageing intensifies and immigration slows down. Given Germany's size and strong trade and financial linkages with the rest of the euro area, expanding investment could also ease deleveraging needs faced by highly indebted Member States. Overall, the policy response to address the imbalances has so far remained limited. The federal fiscal reform and associated measures led to a moderate improvement of fiscal space and investment capacity for municipalities. Efforts to improve the business environment for private investment have remained limited. The same holds for efforts to reduce the high tax wedge for low earners and work disincentives for second earners. Box 3.1: Euro area spillovers Based on the European Commission’s QUEST model ( III ), this box compares the effect of an increase in expenditure on R&D and education ( IV ). These scenarios specifically aim at improving potential growth, thereby addressing long-term challenges of the German economy and complementing earlier simulations that aimed at a more immediate economic boost, including an increase in public investment and a reduction in personal income tax (European Commission, 2017c). Not surprisingly, the overall effects are relatively limited in the short-run. Based on model assumptions, education reforms lead to only very gradual changes in aggregate skill levels due to cohort effects, as it takes time for the new, better-skilled cohorts to enter to the labour force ( V ).R&D subsidies may be even accompanied by a slight decline of GDP, as stronger R&D activity detracts high-skilled labour from other sectors of the economy. Fostering R&D should therefore ideally be combined with policies that increase the supply of high-skilled workers, e.g. investment in tertiary education, in order to dampen the competition for high-skilled labour. While the reforms already generate certain positive spillovers in the short run, their impact increases considerably over time. Both simulated reforms together positively contribute to GDP and employment in the rest of the euro area in the longer term. For an identical amount of fiscal spending, the long-term positive spillovers are particularly high for the R&D expenditure, while also being significant for the education measures. It is estimated that increasing R&D expenditure by 1 % of GDP will raise GDP in the rest of the euro area by about 0.4 % in 15 years and by 0.6% in 20 years. This will be achieved through increased domestic output and thanks to knowledge spillovers, resulting from the international dissemination of innovations that foster intangible capital formation and productivity gains abroad. Increasing education expenditure by 1 % of GDP across-the-board of education institutions is expected to increase the GDP of the rest of the euro area by 0.15 % after 20 years through the trade channel; spillovers in the form of cross-border knowledge dissemination are absent in the scenario of higher domestic spending on education. Spillovers are further mitigated by the fact that domestic competitiveness gains (more net exports) partly offset positive demand spillovers (more net imports) to the rest of the euro area. Table 3.1:MIP assessment matrix – Germany Source: European Commission 4. Reform priorities 4.1. Public finances, fiscal frameworks and taxation*( ) Public finances Germany’s public finances are robust, and the debt-to-GDP ratio is improving. Since its bottom in 2010 (-4.2 % of GDP) in the aftermath of the financial crisis, the budgetary balance has consistently improved, becoming positive in 2014, and rising to +0.8 % in 2016 and to 1.2 % in 2017. Likewise, overall government debt, which peaked at 81.0 % of GDP in 2010, has fallen continuously, reaching 68.1 % in 2016. According to the Commission's 2017 autumn forecast, it is expected to fall below the 60 % Maastricht threshold by 2019 (European Commission, 2017b). While government revenues increased by 2.0 pps. of GDP between 2007 and 2016, mainly owing to higher income taxes and social security contributions (see graph 4.1.1), government expenditure increased by only 1.3 pps. of GDP. Graph 4.1.1:Government balance and trends in selected revenues and expenditures Source: European Commission Taxation The overall level of taxation corresponds to the average among the Member States, but the tax wedge is high. The overall level of taxation at 39 % of GDP in 2016 lies between the euro area average of 40.1 % and the EU average of 38.9 %. The tax wedge for low earners (at 50% of the average wage) is high and only 9.2 pps. lower than the tax wedge for high wage earners (at 167% of the average wage), indicating relatively low progressivity compared to other EU countries. Social security contributions account for about two thirds of the tax wedge, while income tax accounts for only one third. Importantly, employees contribute well above average to the security systems, while employers' contributions are still below average (see also Box 4.1 which displays various possible scenarios to remedy this state of affairs). Graph 4.1.2:Taxes by economic function Source: European Commission, 2017c

By comparison with other EU countries, Germany places a relatively strong emphasis on more distortive direct taxes, notably on labour, to raise revenues. Taxes on income from employment amounted to 19.3 % of GDP in 2015, the 6th highest figure in the EU-28. By contrast, revenue from taxes on consumption and capital fall at the lower end of the distribution, ranking 23rd and 15th out of 28 countries. In 2015, revenues from recurrent property taxes came to 0.4 % of GDP, which is well below the EU average of 4.3 %. All in all, taxes on labour contribute above average to government revenue in Germany, by comparison with other EU countries, while capital taxes are much lower. Over the past ten years, transfer property taxes have become increasingly important in the financing of states' budgets. All the Länder, except Bavaria and Saxony have increased their tax rates on property transfers since 2007. In a number of cases, the rate almost doubled. Overall, almost all Länder now apply rates between 5 % and 6.5 %, up from a uniform 3.5 % in 2007. In combination with higher real estate prices, the increased rates have boosted tax revenue considerably. This trend is expected to continue (IW Köln, 2017). There is potential for shifting taxation from labour to other tax bases less detrimental to growth, including environmental taxes. At 1.9 % of GDP, the overall level of environmental taxes is quite low in Germany compared with the EU average of 2.4 % of GDP.( ) In 2004, the level was still at the EU average, but since then it has fallen steadily. This decrease was driven mainly by a decrease in transport fuel taxes. The tax rates on motor fuels have not been adjusted since 2003. As a result, they have been eroded by inflation to the level before the ecological tax reform. The tax advantage on marginal rates on diesel compared to petrol is among the highest in the EU, although diesel has a more harmful impact on ambient air quality than unleaded petrol. Exemptions from the energy tax for specific energy-intensive processes were introduced in 2006, when the energy tax law was introduced. In recent years, no measures have been taken to broaden the tax base by reducing environmentally harmful tax incentives, such as energy tax reductions and the favourable taxation of company cars. Such measures would allow a shift to tax sources less detrimental to growth and help to resolve environmental issues (see also Section 4.6). Germany's tax system is still not very conducive to investment. Its statutory corporate tax rate of 31 % is among the EU's highest and it is also high in comparison with other major economies (ZEW, 2017a).( ) Apart from inefficiencies arising from the inclusion of some non-profit elements in the local trade tax base, the system is susceptible to special tax planning to minimise tax payments.( ) Similarly, the effective average tax rate stands at 28.2 %, significantly above the EU average 20.9 %. Moreover, the debt bias in corporate taxation also remains high 7th highest in the EU. This is because debt financing costs are deductible from the corporate income tax base, whereas the same treatment is not extended to equity financing costs. In the ‘International Tax Competitiveness Ranking’ of 35 OECD countries (Pomerlo, 2017), Germany’s system ranks 21st overall and 14th as regards corporate tax. The low ranking, in 29th position of personal income taxation, also applicable to transparent entities as partnerships, is a result of the system's complexity and the high tax rates. Moreover, loss-carry forward provisions are relatively strict, limiting the amount to 60 % of the taxable income for a given year. Finally, Germany also ranks very low (31st out of 33 countries examined,) as regards attractiveness to businesses engaged in digital activities (ZEW, 2017b). In the past few years, a number of targeted measures have been taken to make the tax framework more conducive to investment. The INVEST grant programme, set up in 2013, supports private investors wishing to acquire a stake in innovative new companies. Under this programme, investors in start-ups receive a tax free grant worth 20 % of the sum invested. The programme was expanded as of January 2017 (see section 4.6 on venture capital) and the maximum grant was doubled. An exit grant for individuals selling their shares was introduced, amounting to 25 % on the capital gains, which roughly covers the tax due on the sale. ( ) A recent study notes that some of the INVEST scheme's features constitute good practice, such as the use of upfront relief administered outside the tax system, and the scheme's transparent cost and impact monitoring of the scheme (PWC and IHS, 2017). Other measures taken in 2016 include: simplified taxation of investment funds, revisions to the rules for tax loss carry forwards and measures to modernise tax administration procedures (see European Commission, 2017c). Reducing tax exemptions from inheritance tax can help address the highly unequal distribution of wealth and broaden the tax base to allow reducing the burden on smaller family businesses. With 0.16 % of GDP inheritance tax accounts for only 0.41 % of total tax revenue, according to 2012 data. Estimates suggest that a total of about EUR 200 to 300 billion (around 6-10 % of GDP) is given as a gift or inherited in Germany every year (Bach and Thiemann, 2016). These capital transfers are highly concentrated at the top of the wealth distribution: one third of the total amount of inheritances and gifts is transferred to just 1.5 % of beneficiaries, who receive inheritances of over EUR 500 000. The 0.08 % of cases involving transfers exceeding EUR 5 million received 14 % of the transfer volume and more than half of corporate transfers, which are currently largely exempt from inheritance tax. The 2016 reform of the inheritance tax is expected to change little in this regard. A reduction of the tax exemptions would significantly broaden the tax base, which would make it possible to reduce tax rates and lower the burden on smaller family businesses (Bach and Thiemann, 2016). Low recurrent taxes on property and inheritance should be seen in the context of substantial wealth inequality. At 0.76, the 2014 Gini coefficient for net wealth in Germany was the second highest in the euro area (whose overall Gini coefficient was 0.69, based on data from the second wave of the European Central Bank's Household Finance and Consumption Survey). The wealthiest 10 % of the population hold about 60 % of total wealth, while the lower half of all households holds only around 1 %. Real estate ownership and business assets were strongly concentrated among the wealthier households, with only 10 % holding shares or business assets, and 13 % holding mutual investment funds. In the absence of a wealth tax, higher and more targeted inheritance taxes applied to the wealthiest strata of society could help reducing wealth inequality. In a recently published report on wealth and poverty by the German government (Federal Ministry for Labour and Social Affairs, 2017a), two thirds of respondents said inheritances were their main source of wealth, rather than savings. Healthcare The German health system is performing well, although it is costly and there is scope for efficiency gains. Health expenditure as a percentage of GDP, 11.3 % in 2016, is the highest in the EU and the ratio has increased by 1.2 pps. However, over the period 2016-2070, the expected increase of 0.7% in the public expenditure on health care (7.4% of GDP in 2016 excluding expenditure on long-term nursing care but including capital formation), appears moderate compared to 0.9% for the EU also in light of the ageing population in Germany (European Commission, 2018). Germany provides 813 beds per 100 000 population, the highest ratio in the EU (515). However, bed capacity has been reduced by 3.9 % since 2005, which is less than the EU average of 11.9 %. The average length of a hospital stay in 2015 (9 days) was among the EU's highest. France, for instance, is at the lower end of the distribution with only 5.5 days. High rates of avoidable hospital admissions for chronic diseases also suggest over-provision of hospital care and room for better integration of primary care, ambulatory specialist care and in-patient care (OECD and European Observatory on Health Systems and Policies, 2017). Expenditure on pharmaceuticals is high and growing. Germans spend the most per capita on retail pharmaceuticals in the EU. The consumption of prescribed defined daily doses rose by over 50 % between 2004 and 2015. Overall, pharmaceutical expenditure has increased by about 70 % since 2000 — more than any other cost item covered by statutory health insurance (SHI). The main reason for this is patent-protected new originator products, though generics account for a substantial share of the total (81 % in 2016). The daily treatment costs of patented medicines are on average 16 times higher than for generics. (Schwabe et al, 2017) The legal framework for statutory health insurance (SHI) and private health insurance (PHI) creates inefficiencies and challenges the solidarity principle in health care. The SHI is based on the principle of ability to pay (risk- and income based solidarity), while the PHI is financed through risk-related premiums. SHI contributions are independent of risk and based on income up to a certain threshold, and non-earning spouses and children are covered without any surcharges. PHI premiums are risk dependent and separate premiums have to be paid for spouses and children. Although several reforms have been made, the current legal framework, which allows people on higher incomes, civil servants and the self-employed to opt out of SHI, undermines the risk- and income-based solidarity principle in health care (Busse et al., 2017). Moreover, doctors can charge PHI patients more than those covered by SHI. This creates inequalities in waiting times and accessibility for medical services, as well as incentives for overprovision of health services to PHI patients (see also Chapter 4.3). Fiscal framework The Federal Government has implemented an endorsement process to guarantee the independence of the macroeconomic forecast underlying the budgetary projections. The Commission's Opinion on Germany’s Draft Budgetary Plan for 2017 (European Commission, 2017d) noted that there is still no procedure to have an independent body produce or endorse the macroeconomic forecast, as stipulated in Regulation (EU) No 473/2013. The German legislator adopted a law that defines the process for the preparation of macroeconomic forecasts by the government and the process for their endorsement by an independent body. The law came into effect on 4 July 2017. In September 2017, the ordinance governing the appointment of an independent body ("Vorausschätzungsverordnung") was published. In accordance with Regulation (EU) No 473/2013, the "Gemeinschaftsdiagnose", an association of several economic research institutes, is appointed as an independent body tasked with assessing and confirming the forecast released by the Federal Government. The ordinance will come into effect on 1 July 2018. As regards the compliance with the upper limit on the general government structural deficit of 0.5 % of nominal GDP, the Advisory Board of the Stability Council provides a favourable assessment in its report of December 2017 (Stability Council, 2017). Since 2015-2016, the Federal Ministry of Finance conducted spending reviews designed to make federal budget spending more effective. The first cycles of spending reviews focused on the following policy programmes: ‘support of combined traffic ( )’, ‘support for the professional mobility of young people seeking vocational training in Germany’, ‘housing’, and ‘energy and climate’. The ongoing review cycle for 2017/2018 covers the topics ‘procurement of standardised bulk articles’ and ‘humanitarian aid and transition aid including crisis prevention, crisis response, peace-keeping and development cooperation’. 4.2. Financial sector* Banking sector The main challenges facing the industry are squeezed revenues from the low-interest-rate environment and costs incurred owing to digitalisation and regulatory requirements. Heavy dependence on interest income (more than 73 % of aggregate revenue) and the large number of small institutions make German banks particularly vulnerable to these challenges. At a time when they have very high operating costs — in 2016 the cost-to-income ratio exceeded 69 % — banks may need a strategic vision to address these challenges. This could involve adapting their business model, considering mergers, and cutting costs. Maintaining positive profitability through realising hidden reserves, increasing the maturity transformation, and more risk-taking does not appear to be sustainable. The survey on low interest rates (German Central Bank, 2017) indicated that structural adjustments are necessary to maintain profitability. If interest rates stay at current levels, small and medium-sized banks expect their profits to fall further between 2016 and 2021. This would imply a drop of 16 % in their return on total capital. Moreover, keeping up with regulatory developments has a large fixed cost component.

Table 4.2.1:Financial soundness indicators, all banks in Germany Source: ECB Profitability remains very low. ECB data shows that Return on Equity (RoE) stood at 0.6 % in March 2017, amongst the lowest in the EU. Lacklustre performances by several medium-sized banks, low intermediation margins, and a weaker capacity to generate non-interest income all weigh on profits. While overall employment expanded strongly in Germany, in the banking and insurance sectors it fell by 10 000 in the first half of 2017, according to the federal employment service. Significant headcount reduction usually has up-front costs and lead to cost savings only in the medium term. The number of branches decreased by only 14.4 % between 2007- and 2016, keeping Germany in the top third of EU countries with the highest branch density. At the same time, the equity and leverage situation remains acceptable. Banks’ June 2017 Tier 1 ratio stands at an acceptable level (16.0 %), slightly above the EU average (15.4 %). Yet, the leverage ratio is the lowest in the EU in percentage. Compared to most member states, German capitalisation ratios increased less, as most banks in Germany are not listed on the stock exchange and therefore rely more on organic capital generation instead of issuing shares. Asset quality is very strong. End June 2017, non-performing loans (NPL) amount to 1.6 % of total gross loans, compared to 1.9 % twelve months earlier and significantly below the euro area’s average of 4.5 %. Loan-loss provisions went from 42.4 % to 43.6 % between June 2016 and June 2017. Housing market developments do not yet give rise to neither macro- nor financial stability risks. House price increases are particularly pronounced in some cities, yet overall the process can still be considered (the end of) a normalisation process across time and countries (see Chapter 4.5, IMF 2017a). Housing loans’ growth keeps on accelerating, 4.2 % year-on-year in September 2017 compared to 3.8 % in September 2016. The overall outstanding stock of mortgages now stands 20 % above its January 2011 value (Table 4.2.1). Nonetheless as nominal GDP grew at a similar pace, aggregate mortgages hover around 36 % of GDP over the past 6 years, which lends further evidence to the assessment that current real estate price increases are not primarily driven by mortgage lending. Graph 4.2.1:Mortgages and corporate loans in billion EUR and in % of GDP Source: ECB Corporate loans continue to accelerate in line with economic developments and slightly lower credit standards. Outstanding corporate loans have increased by 4.1 % over the 12 months preceding September 2017. This represents an acceleration from 3.2 % one year earlier. The main drivers were the services sector (including real estate) and to a lesser extent manufacturing (e.g. machinery, chemicals). Particularly strong credit growth for longer maturities may indicate a more positive outlook for companies. Still, in relative terms, corporate loans barely amount to 30 % of GDP (Graph 4.2.1). This stands below European Commission fundamentals-based benchmarks for Germany, and reflects more than a decade of deleveraging ( ). New leasing contracts are on track for another record-year. The leasing market Europe-wide amounted to EUR 164 billion in the first half of 2017 — out of which EUR 59 billion stemmed from Germany. Leasing in Europe grew by 10.5 %, while the German market grew 5.7 %, pulled by vehicle leasing which grew 6.3 %. Despite offering one of the lowest yields in the euro area, German private sector deposits grew 3.6 % annually. ECB statistics show that corporates’ new overnight deposits bear negative interest rates on average, i.e. -0.01 % since March 2017. Household deposits with maturities up to 2 years yield 0.28 % — the euro area’s lowest returns. Private sector deposits grew 3.6 % yoy in November 2017 totalling EUR 3 531 billion (109 % of GDP – 67% coming from households, 18% from corporates and 24% from the non-bank financial sector), which exceeds the rather low level of private sector loans (EUR 2 777 billion) by 23 pps. of GDP. Overall, deposits have increased slightly above nominal GDP growth, at times when the German private sector debt grows at moderate pace. As both household and corporate indebtedness decline slightly as percentage of GDP, passive deleveraging continues despite Germany's private sector debt being amongst the lowest in the euro area. Graph 4.2.2:Annual change of different household loan categories Source: ECB The economy is strongly financed through own funds, while both debt and equity finance is below EU average. Unlike companies in other big member states that rely more on capital markets, the classic German Mittelstand (medium-sized enterprises) relies more on internally generated funds as evidenced by the slightly above EU-average gross operating surplus (25.0 % and 22.7 % respectively, cf. Graph 4.2.3). Graph 4.2.3:Funding sources of non-financial corporations Source: ECB, European Commission, Invest Europe Listed shares represent the largest funding source to corporations. They amount to 46.7 % of GDP, 7.3 percentage points below EU average. Since the turn of the century German companies have embarked on a long-lasting deleveraging trend. While German corporates traditionally relied strongly on bank financing, now the importance of bank loans is considerably below EU average (29.8 % versus 35.8 %). After a decade of net negative debt issuance, German companies’ net bond stock has stabilised in early 2016. Debt securities amount to barely 5.0 % of German GDP versus an EU average of 12.3 %. In addition to debt securities, many public entities and small and medium sized enterprises in Germany rather use a promissory note (Schuldschein), which is a mixture between a bond and a loan. Their set-up cost is a fraction of normal debentures as for instance no prospectus has to be drawn up. Between January and August already EUR 21 billion were emitted with an average interest rate of 1.23 % compared to EUR 25.4 billion in new emissions for 2016 adding up to a total outstanding of EUR 86 billion (2.7 % of German GDP). 40 % of emitters are foreign (mainly Austrian) companies. As some notes qualify for deposit guarantee scheme protection they are not accounted under debt securities. The role of venture capital remains relatively limited (see Chapter 4.6 for more in-depth discussion). Overall, banks display healthy stability ratios and ample liquidity. Cost cutting still has a long way to go in times where challenges of digitisation have to be addressed. Banks will have to re-orient their business strategy to reduce dependence on interest margins. Yet, smaller margins are somewhat counterbalanced through growing loan volumes as liquidity is amply available. The real economy is thus benefiting from the high liquidity position and competition in the sector. Only 11 % of companies surveyed in Germany in spring 2017 cite financing difficulties as a restraining factor, 4 pp less than in 2014. Most companies do not claim any financing constraints and agree that it's’ the least important factor hampering investment (59 %) (Cologne Institute for Economic Research, 2017; German Savings Banks Association, DSGV, 2018). 4.3. Labour market, education and social policies Labour market* Despite record low unemployment and high job vacancy rates, wage growth remains moderate. On the back of sustained economic growth, employment continues to grow and unemployment has dropped to record lows (see Section 1). Graph 4.3.1 displays the link between wage growth and unemployment rate (the so-called Phillips curve) for different periods starting from 2001. The relationship appeared stable before the crisis, moving leftward after, pointing to further structural improvements in the German labour market. In 2011-2015, this relationship became also flatter.( ) In 2016, wages expanded at above 2% and accelerated somewhat to 2.7% in the first three quarters of 2017 as the labour market tightened, showing some responsiveness. Graph 4.3.1:Phillips curve in Germany: compensation growth and unemployment rate Source: European Commission, Eurostat Weak inflation expectations, falling structural unemployment and the level of productivity growth partly explain the moderate nature of recent wage growth. The level of productivity growth impacted wages, while inflation expectations have remained weak. Recent wage increase have not yet compensated for the accumulated divergences between wage and productivity. Over 2000-2016, real labour productivity per person increased by about 10.8 %, while real compensation per employee only increased by about 6.2 %. The recent increase in immigration did not seem to have prevented strong wage dynamics in lower wage segments particularly affected by immigration.

The modest increases of low wages and the higher number of hours worked in lower wage deciles contributed to keep wage growth subdued before the minimum wage introduction. Based on the recently released Eurostat survey on the Structure of Earnings Statistics, while the proportion of full-time employees (40 hours per week/160 hours per month) remained high, the proportion of employees who worked less than 10 hours per week rose between 2010 and 2014 from 6.7 % to 8.8 %.( ) Because of these changes in the distribution towards mini- and midi-jobs employees, which in general receive a lower wage than full-time employees, it is estimated that aggregate wage growth was 16 % lower than without a shift in the distribution.( ) This effect can persist if transition to regular employment is not ensured (Galassi, 2016). Weaker coverage of collective bargaining may have also contained wage growth. Over the past 30 years, coverage has declined more rapidly in Germany than in other western European countries, from about 85 % in 1985 to 56 % in 2014 (See European Commission, 2016b for causes). In Germany, the sector-led bargaining system resulted in subdued wage developments in sectors with weaker unions – most of them dealing with non-tradables, such as services. Box 4.3.1: Monitoring performance in light of the European Pillar of Social Rights The European Pillar of Social Rights, proclaimed on 17 November 2017 by the European Parliament, the Council and the European Commission, sets out 20 principles and rights to benefit citizens in the EU. In light of the legacy of the crisis and changes in our societies driven by population ageing, digitalisation and new ways of working, the Pillar serves as a compass for a renewed process of convergence towards better working and living conditions. Germany performs relatively well on the Social Scoreboard ( VI ) supporting the European Pillar of Social Rights. Germany has high employment rates and very low unemployment. Regarding equal opportunities in the labour market and fair working conditions, the issue of labour market segmentation deserves continuing attention. A number of challenges remain, such as making it more attractive for women to work more hours and reducing the high gender pay gap. Specific tax arrangements create disincentives for second earners (Ehegattensplitting) and low wage earners (marginal tax rate) to work longer. Changing the default tax combination from 2018 only slightly adjusts the situation. Germany took measures to address the gender pay gap by adopting in 2017 the Act on greater wage equality between women and men. Companies are expected to analyse wage developments on a regular basis, prepare a report and undertake measures ensuring equal pay for equal work. Germany has with 6.8 % (November 2017) one of the lowest youth unemployment rates in Europe. The German dual system of vocational education and training provides an excellent approach to skill development; in particular initial vocational education and training. Thanks to this system the country enjoys low youth unemployment and provides young people with high skill levels. About 50 percent of all school-leavers attend vocational training provided by companies, reach high skills level allowing companies to acquire skilled staff. Overall, vocational integration benefits and services for young people are provided both by the Federal Government and by the Länder and local authorities. Job centres, employment agencies and youth welfare offices, providing social services, cooperate in order to provide young people with one-stop support. Germany also has various initiatives that all share the goal of helping young people to transit successfully from school to vocational training or academic study and subsequently into employment. Box 4.3.2: Policy highlights: The introduction of the general minimum wage Germany introduced on 1 January 2015 a statutory general minimum wage of 8.50 EUR per hour. This was seen also as a response by German legislators to the continued erosion of the collective bargaining system and declining bargaining coverage, which resulted in a high share of low paid workers. Now a commission (Mindestlohnkommission), which represents employers and employees, and includes labour market researchers as observers, is responsible for recommending adjustments of the minimum wage, based on comprehensive analysis of the labour market. The government either accepts the recommendation or leaves the minimum wage unchanged. The minimum wage was first increased as of 1 January 2017 to 8.84 euros, where the Commission took into account in particular recent developments of collectively agreed wages. In general the minimum wage is applicable in all branches of activity and all regions, with exceptions for apprentices, certain interns, people aged below 18 years and long-term unemployed people during their first six months of employment. Temporarily further exemptions were allowed for collectively agreed sectoral minimum wage floors, which incentivised collective bargaining and may have allowed mitigating negative employment consequences. In addition to the statutory general minimum wage, branch-specific minimum wages may be applied. Fears that the introduction of the minimum wage would lead to significant employment losses have not materialised. Helped by the expansion phase of the business cycle, employment creation remained strongly positive, even in East Germany where wage increases were particularly pronounced due to the low initial wage level. Only so-called mini-jobs (marginal part-time employment) declined noticeably at the start of 2015. Many of these lost mini-jobs were upgraded to regular, socially insured employment. An evaluation of the effects of the minimum wage is planned for 2020. Beyond workers's wages, work satisfaction also improved. The introduction helped to increase lower wages at the bottom of the distribution, as expected. Moreover, it also incentivised employers to invest in human capital, improve working conditions, and thus increased employees' satisfaction at the workplace (Pusch and Rehm, 2017) Some aspects of the minimum wage setting may merit fine-tuning. Continuous assessment of the impact of the minimum wage remains an important task for the Commission, and the system may be tested when the economic cycle will worsen. In addition, it is not clear whether the resources available for enforcing the minimum wage are adequate to tackle non-enforcement. Out of the 27,323 investigations conducted in the first half of 2017, about 10 % (2,433) found non-compliance, primarily in construction and the hospitality industry. Early 2016, still a significant number of workers were earning below the minimum wage, with estimations ranging from 750 000 workers based on a survey of firms (Destatis, 2017) to nearly 2 million workers based on the SOEP survey of individuals (Burauel et al, 2017). As a result, service sector wages are the lowest in the EU relative to manufacturing wages (80 % in Germany, 91 % in the euro area, 103 % in the EU-28). Moreover, while collective agreements could have been extended, thereby partly remedying the reduction in the coverage of original agreements, this was done only a very few cases. Although the law introducing the general minimum wage provided for an easing of the conditions for general extensions( ), the number of general extensions remained similar to that in previous years, with 447 extensions in July 2017. (Federal Ministry for Labour and Social Affairs, 2017b) The introduction of the statutory general minimum wage helped to increase lower wages. The introduction of the statutory general minimum wage in 2015 increased wages at the bottom of the distribution, as expected (see Box 4.3.2). The current round of wage negotiations has a strong focus on working time flexibility, on top of wage increases. The 2017-2018 wage negotiation round covers 9.7 million employees in the metal and electronics industries, the civil service, and the construction industry. IG Metall, the trade union of workers in the metal and electronics industries called at the start of the negotiations for the possibility of opting for a 28-hour working week rather than a 35-hour one. This was also the outcome of the ‘choice’ model agreed between Deutsche Bahn and trade unions, which allowed employees to choose between a wage rise of 2.6 %, six more days of annual leave, or a one-hour reduction in weekly working hours ( ). External price competitiveness remains strong. As a result of wage growth and moderate productivity gains, the nominal unit labour cost increased 1.7 % in the first three quarters of 2017, above that in the euro area, indicating a slight loss in the external competitive position. As inflation rose, real earnings growth decelerated, from 1.8 % in 2016 as a whole to 0.7 % in Q3 2017. (Graph 4.3.2) Graph 4.3.2:Trends in labour costs and its components Source: European Commission A tight labour market and ageing population call for fully utilising the labour force. Vacancies registered by the public employment service have been rising steadily, reaching 770 000 by November 2017. Demographic ageing means that cohorts entering the labour market are smaller and immigration can only partially offset this trend (see also Section 4.4). At the same time, there was still substantial long-term unemployment 862 000 in November 2017, (for further discussion see also European Commission, 2017c). The high female part-time employment rate is accompanied by the second highest gender gap in part-time employment (37.5 % as compared with an EU average of 23.1 %). As a result, Germany has a very wide gender pay gap( ). To reduce the gender pay gap, the Parliament adopted a law to promote transparency in wage structures between women and men in March 2017. Under this law, companies with over 500 employees are expected to assess wage developments regularly, report on them, and take action to make sure that women and men earn equal pay for equal work. Disincentives to working longer hours, coupled with the lack of sufficient childcare and allday school facilities are key reasons for women’s lower attachment to the labour market. Germany has one of the highest tax wedges ( ) for low earners, which creates disincentives to working or to working longer hours. About 60 % of low earners in 2015 were women (Kalina and Weinkopf, 2017). The impact of parenthood on employment is also higher in Germany: the employment rate of women with children under 6 is 16.1 pp. lower than that of women without children, versus an EU average of 8.8 pp. (See also Box 4.3.1) With increased demand for childcare and more places in all-day schools, it remains key to improve quality in early childhood education and care. In 2015, 97.4 % of 4 to 6-year-olds' were enrolled in early childhood education and care establishments. The rate is markedly lower for the under-threes. The participation rate in daycare of school children up to 11 rose from 10.6% to 16.1% between 2006 and 2015, while the participation rate in all-day schools rose from 9.8% to 39 % (Conference of Ministers of Culture, 2016). However, in early childhood education and care alone, unsatisfied demand and demographic changes necessitate more than 600 000 additional places until 2025 for children up to school age (German Youth Institute, 2017). Issues persist around service quality and flexibility. In 2017, additional financing of EUR 1.1 billion was approved for additional places. The Government also announced that a ‘quality development law’ was to be drawn up. Mini-jobs provide flexible arrangements for people who want to work a limited number of hours, but also create lock-in effects. The total number of mini-jobs remained around 7.5 million. The number of people whose only job was a mini job fell from 5.1 million in 2014 to 4.8 million in 2017, while the number of those with a mini-job as their second job rose from 2.0 million in 2010 to 2.7 million in 2017. Nearly half of people with mini-jobs are either of pensionable age or students, and the majority are women. This seems to suggest that mini-jobs have not led to an ever increasing erosion of standard employment. However, there appear to be strong lock-in effects. High marginal tax rates just above the earnings threshold of EUR 450 yield strong threshold effects and in 2016 more than 23 % of mini-jobbers earned exactly EUR 450. Interaction with the tax system (exemptions for secondary jobs, tax treatment of second earners) further increases lock-in effects. People with a migrant background are generally less well integrated into the labour market, notably to limited language skills and lower qualifications. The employment rate of nationals of other EU countries rose by 1.5 pp. between 2015 and 2016, reaching 78.2 %, as they move to Germany to take up employment. However, the same does not hold for non-EU migrants. The employment rate of non-EU nationals fell by almost 3 pp between 2015 and 2016. It is below the EU average (54.2 % v 56.5 %) and significantly below the employment rate of German nationals (26.5 pp. lower; see Graph 4.3.3). The main reason for this is the large inflow of non-labour migrants who face considerable difficulties in finding jobs. Women are particularly affected with an employment rate of 44.7 %: Lack of language skills together with lower qualifications seem to be among the main reasons for this. Getting non-EU nationals into jobs will thus continue to pose a lasting challenge (Bähr et al., 2017, Gürtzgen et al., 2017). While overall youth unemployment in Germany is one of the lowest in the EU, young people with a migrant background face challenges. This is also reflected in the significantly higher NEET (young people neither in education, employment or training, aged 15-24) rate of third country nationals as compared to that of nationals (21.1% vs 5%). Moreover, the employment situation of native-born with foreign born parents (i.e. second-generation) is also unfavourable. ( )The proportion of early leavers from education and training among foreign-born students (23.2 %) was almost three times that of students born in Germany (8.2 %) in 2016. Graph 4.3.3:Employment rate by citizenship Source: Eurostat While the number of newly-arrived asylum seekers has fallen, integrating the large number of young refugees into education and work represents a long-term challenge. The total number of newly-arrived asylum seekers (according to registrations in the EASY-system) fell strongly in 2017 to an estimated 198 000 (Federal Office for Migration and Refugees, 2018), from about 890 000 in 2015. Various stakeholders ranging from the Federal Government, the Länder and local governments to the Federal Office for Migration and Refugees (BAMF), public employment services, social partners, companies and foundations took important measures in 2017 aimed to help the new arrivals to find work, with an expanded range of integration courses focusing on career guidance and vocational training. (Federal Ministry of Education and Research, 2017) Considering difficulties in labour market integration, demand for training and active labour market policies is expected to remain strong in 2018. Social policy* The steady rise in the at-risk of poverty rate and inequality seen since the crisis slightly reversed. In 2016, the percentage of the population at risk of poverty or social exclusion continued to fall, owing to improvements in all of its three components. The at-risk of poverty rate has fallen slightly, from 16.7 % to 16.5 %, the first decline since the crisis. Following a steady increase since the crisis, in-work poverty also fell slightly in 2016. However, this improvement remains modest (and only benefits men, as in-work poverty among women increased further). Further improvements are held back by disincentives to work longer (second earners, mini-jobs lock-in effect, see above) and the moderate wage dynamic.

Positive economic and labour market developments are only recently accompanied by reduced income inequality. In 2016, the richest 20 % of households had 4.6 times as much income as the poorest 20 %, a decline of 0.2 from the previous year. Germany currently lies somewhere in the middle of the EU countries, according to the Gini index of equivalised disposable income ( ). However, income inequality worsened in the early 2000s, and the Gini coefficient subsequently hovered around this higher level (see Graph 4.3.4). The recent declines in inequality and poverty risk may be explained by the positive labour market developments, plus the new national minimum wage. Improvements in the income position of low income households have helped reduce rising disposable income inequality. Germany ranks well above or close to EU average for indicators related to coverage and adequacy of unemployment benefits.( ) Still, duration for a one year work record is comparatively low and unemployed overall have a high at-risk of poverty rate. Germany also performs well for the indicators related to adequacy of minimum income benefits, which play a major role as the last safety net. Graph 4.3.4:Gini coefficient and poverty risk Source: Federal Ministry for Labour and Social Affairs, 2017 The declining replacement rate in the statutory first pillar has a negative effect on pension adequacy and