Germany needs a service sector to match its makers

The chance for a more liberal reform agenda should not be wasted.

Only 10 years ago, Germany was considered the sick man of Europe, but the German economy is now admired for its strength. However, important domestic sectors are still held back by regulation.

Lawyers and solicitors enjoy privileges granted by law. Pharmacies and the health sector in general remain largely unreformed. Tradesmen must be members of trade organisations, which can act as a barrier to entry. For business in general, the licensing and permit system is burdensome. It acts as an obstacle to entrepreneurship, including in the services sector. According to OECD data from 2008, Germany ranks only 18th – behind France and Spain – in terms of ease of entrepreneurship. Few reforms to change this picture were pushed through by the last government.

The consequence is an economic model in which the services sector has hardly increased in importance. The sector’s share of the total economy has remained at 68 per cent since 1995, according to the European Commission, in contrast to its rising importance in other European countries, Japan, the US and the UK.

This failure has held back German economic performance. Empirical evidence suggests that reforms to remove entry barriers and foster competition would not only improve productivity but also raise investment. A reduction in the regulation-driven entitlements in the German services sector could therefore increase output substantially.

New business opportunities would trigger investment in the sector and also offer new employment opportunities. This would make the German domestic sector more attractive and probably lead to higher wages underpinned by higher productivity. These reforms could also improve the quality of German exports. The manufacturing sector depends on the provision of cost-efficient and innovative solutions from the service sector. Higher overall German growth would be the likely result of such a liberalisation push.

Such reforms could also help Europe, including the ailing southern countries. First, opening the services sector would increase labour demand in this part of Germany’s economy. Less qualified workers would shift from the manufacturing sector to the services sector. The German export sector would be forced up the value-added chain and tasks that required lower levels of qualifications would be outsourced. This would open up opportunities for manufacturing in other European countries, where manufacturers tend to be in lower valued-added segments than in Germany.

Second, liberalisation would increase demand for immigrants to work in the sector, which would support German growth and ease unemployment elsewhere.

Third, the improved growth prospects would be triggered by an increase in investment, which would also constitute an increase in demand. A reduction in savings and greater German consumption would probably follow because of the improved growth prospects. This would further contribute to the adjustment of current accounts in the euro area. Finally, the efficiency gains in Germany could foster structural change elsewhere.

In the coalition negotiations for the new German government, the opportunity to agree on a more liberal reform agenda should not be wasted. An advisory body should be established and tasked with reviewing regulation and other impediments to market-driven growth and adjustment that hold back German business – although the group should not be blind to legitimate concerns about the quality of products and consumer protection. This supply-side reform agenda should be complemented by increased public investment that would increase demand and help to counteract the recession in the eurozone.

The “liberal” party in the previous German government – the Free Democrats – prevented far-reaching reforms, for example of the German compulsory chamber system and in the health sector. Their absence from the new government should be turned into an opportunity for more supply-side reform in Germany. This will be good for Germany and for Europe.

This article was first published by the Financial Times.