The German economy, once the powerhouse in Europe, is stalling. Unemployment has ratcheted upward since 1970, the social security systems can no longer be financed (even if the population were not ageing) and with an average annual GDP growth rate of 1.2 per cent since 1995, the economy almost stagnates. This paper analyses and suggests solutions to Germany’s three main challenges. To undo the adverse incentives with respect to unemployment, the institutional design for wage formation should be decentralized, the reservation wage adjusted and the tax on labour reduced. To make the social security systems sustainable, the level of social absorption has to be lowered. And, finally, to achieve a more dynamic economy, new stimuli for growth have to be unleashed, including human capital formation and innovation, which are vital for the knowledge society. The role of government has to be rethought and the German social market economy redefined.