The German economy’s potential growth – medium-term outlook in the face of demographic challenges

Germany will face perceptible demographic challenges over the next few years. The domestic labour force will shrink and age. The April Monthly Report examines the potential impact this will have on the German economy’s potential growth. The report shows that the dampening effects of demographics can be mitigated if suitable reform steps are taken by the end of this decade, thereby essentially allowing the current growth in potential output of around 1¼% per year until 2020 to be maintained.

This is conditional on the supply of labour being stabilised by further increasing labour force participation and boosting needs-based immigration. In addition, constant productivity gains need to be achieved by up-skilling the labour force and through technical progress.

In terms of domestic labour market reserves, the fact that older employees, who will make up an ever larger percentage of the working population, will work for longer than was previously the case, will have a stabilising effect. Moreover, labour force participation among persons with family commitments could rise – in part thanks to the further expansion of childcare facilities. It is further assumed that Germany will achieve net immigration of around 200,000 a year over the next few years, with the vast majority of immigrants directly available to the labour market.

As structural aspects mean it will be virtually impossible to raise the number of hours worked any further despite the effects offsetting the demographics-related drop in the potential labour force, potential growth will, in future, be fed solely from productivity gains. Strong momentum is conditional on maintaining a high propensity to invest in order to boost capital intensity. Industrial innovativeness as well as the labour force’s skills and training will play an important role in ensuring that technical progress is reflected in the production process. Dampening effects on aggregate hourly productivity in the second half of the last decade, mainly as a result of the (re-)integration of lower-skilled employees into the labour market, will probably be less of a factor in future.

For Germany, as for the euro area as a whole, an increase in the mobility of labour within Europe must be regarded as a positive factor for stability and as facilitating the necessary adjustment processes. It will help to reduce the currently considerable labour market disparities and thus also lower the risk of persistent wage and price differentials. The best growth will be achieved if production factors are allocated not only through cross-border capital flows, but also through migration movements, particularly as this will facilitate the macroeconomic adjustment processes within monetary union.