By voting for a new federal government led by the Christian Democratic Union (CDU), German voters underlined their readiness for economic and social reforms. The election results allow for the interpretation that a vast majority of voters support the continuation of reform policies with increased speed and broader scope. Hence, the new "Grand Coalition" of Christian and Social Democrats can be seen as a "companionship of destiny" condemned to success and confronted with high expectations by the German people.

Germany is now on the right track. The reforms of the Schröder administration have marked a turnaround in German economic and labor policy. The landmarks of this ambitious labor market policy were the preventive nature of labor market programs, their continuous scientific evaluation, and the new focus of the Federal Labor Agency on job placement, closer contact with the business community, improved employment incentives, and the discontinuation of ineffective labor market programs. Another fundamental step was the merging of unemployment benefits and social welfare with a stronger emphasis on requiring people to take up work. This process was accompanied by substantial tax breaks, the new immigration law, longer shop opening hours, a more liberal crafts code, and the rehabilitation of the negative connotation of academic elites.

These developments have triggered an intense debate to redefine the German social market economy without abandoning the concept altogether. The stricter separation between issues of social justice and the efficient use of economic resources makes their particular role and contribution more transparent. The question of how to create more value added now receives priority over matters of redistribution. There has been an obvious shift from fairness of distribution to fairness of opportunity. Social solidarity and individual responsibility are balanced in a more appropriate manner. The idea that social solidarity is a matter of give and take is increasingly viewed as a prerequisite to social fairness rather than the end of the welfare state.

Politics is the art of the possible. The coalition agreement of CDU and SPD, as well as Chancellor Merkel's inaugural address, offer a range of opportunities to get the German economy -- which is basically in a good state of health -- back on a growth track. Among the challenges that need to be met are (1) a reform of German federalism, particularly with regard to limiting the room for partisan obstruction on the federal level, (2) balancing the public budget by cutting subsidies and reducing the size of civil service personnel, (3) a simpler tax system and lower corporate taxes, (4) refinancing the social security systems in order to reduce non-wage labor costs, (5) market deregulation, and (6) improving policy programs in the areas of education, research, and infrastructure.

Representing a broad majority of voters, the "Grand Coalition" has the great chance to communicate the reform steps more easily to the public. Owing to the veto rights of the Bundesrat, both parties have effectively co-ruled over the past years. They are well aware of their room to maneuver in finding solutions to political problems.

By now the new German government has already taken the first important steps towards a consistent continuation of the economic and social reform process. Those efforts include:

- The reform of federalism adopted in February 2006 will help prevent the chambers of parliament (Bundestag and Bundesrat) from blocking each other and thus give more room to the forces of economic reform.

- By cutting several billion Euros worth of obsolete tax subsidies, governments at the federal, state, and community levels have been provided with a new financial scope to improve the infrastructure and attract more investment.

- The efforts at balancing the budget have become powerful enough to enable the government to meet the Maastricht debt criteria again in the near future.

- The planned deregulation and reduction of bureaucracy will continue to improve Germany's attractiveness as an investment location.

- German policymakers finally summoned the strength to reduce non-wage labor costs, which have so far inhibited job creation. The revenues from the VAT increase effective in 2007, which will align Germany's VAT with the EU average, will also be used in part for this purpose.

- The comprehensive evaluation of the labor market reforms implemented since 2003, which had been prompted by the previous administration, provides a better understanding of the effects of labor market programs and the efficiency of job placement. The task now is to draw the right conclusions from the findings that are already available.

- German labor market policy and social policy are taking the first steps towards making the principle of give-and-take an integral part of the social transfer scheme, thus creating more incentives to take up employment.

- Within the framework of the well-proven German system of collective bargaining rights, firm-level agreements will receive a larger weight.

- At the same time, however, there are efforts to establish minimum wages and combination wages, the economic benefits of which are more than questionable.

- The implemented programs for reforming German educational policy are much more important. Shorter schooling durations and more autonomy for universities point in the right direction.

- Policymakers have finally started to address the long-ignored challenges of financing the statutory pension scheme. The government has already decided to increase the retirement age to 67 and will evaluate further inevitable steps to secure future German pensions.

- A comprehensive health reform has finally become a definite part of the political agenda.

- A new family policy aims to improve the underdeveloped day-care system and to deal with the consequences of demographic changes.

Given these important steps towards economic and social reform, there is reason enough to be optimistic that the reform process initiated by the past government will gain momentum under the new "Grand Coalition." This will be of crucial importance for the economic prospects of the European Union in the near future.

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Klaus F. Zimmermann is Director of the Institute for the Study of Labor (IZA) in Bonn, President of the German Institute for Economic Research (DIW Berlin) and Advisor to the President of the European Commission. He is Professor of Economics at the University of Bonn and Honorary Professor of Economics at the Free University of Berlin.
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This essay appeared in the March 17, 2006 AICGS Advisor.