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For over six months, the Iraq conflict and the imminent war weighed on the world economy through a strong increase in crude oil prices and an extended and intensified slump in stock prices. Uncertainty about the outcome of the conflict prompted companies and consumers to adopt a wait-and-see attitude and postpone their investment projects. As a result, the much-feared economic weakening did materialise. In any case, global economic growth slowed down noticeably in the past winter months.

The swift conclusion of the war in Iraq has eliminated some of this uncertainty. The oil price has risen from just under US$ 35 per barrel immediately before the start of the war to US$ 25 per barrel, while the equity markets have clearly recovered from their mid-March lows.

The drop in the oil price means reduced costs for companies and an increase in consumers’ purchasing power. In the oil-consuming countries, the lower oil price has the effect of an economic stimulation package financed by third parties and acts as a "lubricant" for monetary policy, which is more or less expansionary throughout the world and is becoming increasingly effective. This means that the environment for a recovery of the world economy has improved noticeably in the course of the summer months. In the opinion of WestLB, a cyclical recovery that is worthy of the name "upswing" and will last into next year is quite likely.

Global GNP growth rates of 3% in 2003 and 3¾% in 2004 mean, however, that momentum is lower than in previous upswing phases. In particular, the after-effects of the longest and deepest post-war slump in share prices are putting a damper on the upswing. In addition, there is the latent risk of strong shifts in currency relations due to growing imbalances in global trade relations.

The German economy will participate in the – expected - recovery of the world economy only to a below-average extent. The steep rise in the euro exchange rate, which has already had a noticeable impact on German manufacturers’ price competitiveness, will dampen international demand for German products in the coming months. Domestic demand has been flat for several years and is not likely to provide any significant stimulation. Private consumption will remain weak due to the higher level of taxes and contributions and the desolate state of the labour market. As for the ailing construction industry, there is no end in sight for the structural crisis which began in 1995.

Contrary to expectations, GDP did not rise between the fourth quarter of 2002 and the first quarter of 2003 but rather declined, and there are no indications of a substantial recovery in the second quarter. This suggests that aggregate economic output in 2003 will at most be slightly higher than in the previous year. The likelihood of a noticeable recovery setting in before year-end is diminishing with every increase in the euro exchange rate.

This means that GDP growth will remain below the 1% mark for the third year in succession. There has never been a phase of such persistent weakness in the history of the Federal Republic of Germany. So what we are seeing is not a cyclical but rather a structural growth problem.

The lack of dynamic growth, coupled with what is a low employment intensity of growth by international standards, is the main reason for Germany’s numerous economic problems such as high and persistent unemployment, the tight federal, state and local government budgets and the financing bottlenecks in the social insurance systems, which will intensify in the coming years as a result of the demographic development.

The number of unemployed will continue to rise, with its seasonal high early next year probably exceeding the 5 million mark for the first time ever in the history of the Federal Republic. The annual average number of unemployed will probably be a good 4.5 million, while the aggregate government deficit is likely to expand to 4% of GDP.

In view of such deep-rooted problems, curing the symptoms - as has been attempted in recent years - is not the way forward. Fundamental reforms are required instead. For many years to come, strengthening the forces of growth and creating competitive jobs must take precedence over redistribution policies. This requires action and concessions from economic, fiscal and social policy-makers and from employers and trade unions alike.

The Federal Government’s "Agenda 2010" is a first step in this direction - others will have to follow. Flogging the plans and projects to death in the current debate would be fatal. The important thing now is to implement the measures swiftly and consistently - even against resistance from individual groups representing other interests.