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The German government's decision to reduce the size of the state is attracting considerable controversy. Most importantly, this policy seems to go against the commitment by the Social Democrats not to take money away from pensioners to fund cuts in company taxation, and it also breaks the implicit commitment that the state will reliably fund social services through the 21st century. Developments in Germany can be seen as a test case for the whole of continental Europe.

European monetary union (Emu) is likely to increase competition within Europe and this means that non-wage costs of employment have come under greater scrutiny. Countries where such costs are high are at a disadvantage. Germany is one such country, with higher costs than elsewhere in the European Union (EU). Harmonization of non-wage costs in the EU is unlikely to be successful. Germany is likely to have to carry out reform in order to reduce these costs.

Germany faces a number of economic problems arising from its tax system, bureaucracy, social security system and inflexible labor market. The government has sought to change these systems but has been opposed by vested interests and the Social Democrat party. Social security costs add to the cost of labor compared to US and Japanese labor costs. Germany has been classed as a newly declining economy. The UK has been declining since 1885, yet change only began in 1979.

There is a need to change the German system of pension provision since the proportion of people of working age is decreasing and the proportion of pensioners is increasing. This makes a pay-as-you-go system unviable and means that the private sector will become increasingly involved. Fund management companies from Germany and abroad are assessing the opportunities. Increased private sector provision will mean that there is more available to invest on the stock exchange which will help new issues.

The German pension system is coming under increasing pressure as the population ages. Pension contributions will rise from 19.2% of gross salaries in 1996 to 20.3% in 1997. This increases total social security contributions from 40.8% in 1996 to 41.9% in 1997. The number of Germans aged over 60-years-old in 2030 will be 80% of those aged between 20-years-old and 59 years old, compared to 36% in 1996. Critics argue that there is a need to switch to a funded system, and that younger people are likely to want to take more responsibility for their pensions.

Germany faces unemployment at more than 10% of the active population, and has to adapt to globalization of the economy. The government announced an economic program in April 1996, geared to reducing the weight of the public sector in the economy. This includes reductions in welfare spending, tax reform, privatization and deregulation. Labor unions won in a dispute with Daimler-Benz which sought to cut sick pay. This illustrates obstacles to change, but labor unions are losing power world wide, as are employers' groups.

Germany faces fiscal problems with revenues for 1996 and 1997 88 billion German marks less than the forecast sum, despitewelfare reform and tax changes. There are doubts as to whether Germany will qualify for the single European currency. Gerhard Schroder and Kurt Biedenkopf argue that Germany will be unable to fund welfare provisions from employment, and the high cost of welfare makes German labor expensive, so discourages employers from taking on workers.

The German government has put forward plans for public spending cuts totalling 30.43 billion pounds sterling. These will include the relaxation of job protection and tax relief for providers of household employment, measures which could create 1.2 million jobs. Supporters of these reforms believe that businesses could see an easing of their fiscal burden in 1997 and that the tax regime for middle income earners will improve. However, opponents believe that the package will not go far enough towards meeting the government's target of halving unemployment by the end of the 1990s.

Helmut Kohl, German chancellor, has introduced welfare and other reforms in order to reduce costs. The chancellor's performance was seen as clumsy, but the awkwardness of his presentation has endeared him to some commentators, and criticisms of cuts in spending have been muted. The measures have already been discussed with labor unions and employers. Some critics argue that they undermine labor unions. German shopping hours are also to be liberalized.