German Reforms Pay Off:
Labor Market Largely Unaffected by Crisis

While many western industrial nations are battling with the consequences of the global and financial crisis, the German labor market has shown a remarkable resistance. The expected rise in unemployment did not appear. In fact, there are already signs that the labor market will emerge unscarred from the crisis as the economy picks up again. This observation is in stark contrast to assessments made only a few years ago when Germany’s labor market structure was rightly criticized as too rigid and inefficient. The current stability must certainly not be attributed to the policy measures implemented during the crisis to support the economy and save jobs. It is much rather the positive result of the fundamental labor market and social policy reforms known as “Agenda 2010”, which were initiated in 2003.

Against this backdrop, IZA is urging policymakers to continue down the road of reform in order to achieve full employment by the end of the decade. This goal is ambitious but not unrealistic. However, it can only be reached if the success of the Agenda 2010 is built upon rather than calling it into question.In a recent contribution to the IZA Policy Paper Series, IZA Directors Klaus F. Zimmermann and Hilmar Schneider provide a first assessment of the Agenda 2010 and outline the core principals of a new “Agenda 2020” that would further stimulate the dynamic development of the German labor market.

Agenda 2010: Successful formula for security and flexibility
The labor market reforms of 2003 have changed the way of thinking in German social policy by introducing the principle of “supporting and demanding”.

Generally speaking, this approach to the problem has been proven right. Despite its mechanical of laws and a hesitant pace of reform, this new orientation of labor market policy has been shown to be successful, even in a relatively short period of time. The abandonment of the policy of rewarding non-work, the liberalization of temporary work and the efficiency-enhancing organizational reform of employment administration have led to a reduction of structural employment for the first time in three decades.

The labor market reforms have been accompanied with consistent corporate restructuring efforts. Unions have also set the right priorities in wage bargaining by giving precedence to job security. This in turn has been rewarded in the petering out of the economic crisis.

These measures have kept unit labor costs in Germany virtually constant since the mid-1990s while they have risen considerably in the most important comparable countries. All of which has resulted in a substantial rise in the international competitiveness of German companies in recent years.

The most striking progress can be seen in the reduction in unemployment by more than 1.4 million since 2005. Even at the end of the crisis year of 2009, unemployment was at its second-lowest since 1994; in the former East Germany unemployment even sank to its lowest level since reunification. Employment hardly decreased in comparison with 2008 and is still at a record level of over 40 million employed individuals. This is all the more remarkable because working hours have been drastically reduced. The fact that this has not resulted in a comparable decrease of employment shows how highly businesses value retaining their qualified workers.

This was undoubtedly helped by the rapid expansion of short-time work with few bureaucratic hurdles, which created an enormous buffer. Many companies, however, have since then returned to regular employment. The number of short-time workers had nearly halved by the end of 2009, following the peak in May of that year, without having resulted in a noticeable increase in the number of unemployed.

The policy instrument of short-time work has thus fulfilled its purpose as a crisis buffer. It is now time for a gradual return to its “normal level” in order to discourage companies from delaying structural adjustments, which are independent of the crisis (see also the next article in this issue of IZA Compact).

Evidence of any positive effects of personnel placement consultancies (Transfergesellschaften) has yet to be shown. Funded mainly by the Federal Employment Agency, these organizations are meant to provide laid-off workers with effective job search assistance. For this, however, the employment contract with the current employer is ended in exchange for a new, fixedterm contract with the placement consultancy in question. The workers are de facto giving up any job protection. They can officially remain with the placement consultancy for up to a year. The model is based on the idea that job seekers avoid being stigmatized when they are employed under the auspices of the consultancy; and hence they are in a better position to find new employment.

The only existing evaluation of placement consultancies found them to be no more effective than the Federal Employment Agency. Hence claims for an expansion of the placement model cannot be justified. In particular, there is an underlying danger that the period of unemployment benefit entitlement can be abused. The supposedly improved protection can easily bring about the incentive to do exactly the opposite: namely the active triggering of the risk which was meant to be avoided.

How closely the labor market is connected to government regulations is shown particularly by the rise in the labor market participation rate of older people by 15 percentage points to 54% in only five years. For decades it had seemed as if an apparent declining productivity of older workers had been responsible for the decrease in their employment opportunities. We now know that financial incentives often defined the position of older workers in the employment process. As long as the welfare state actively promoted early retirement options, companies and employees made ample use of it.

Since early retirement options have been drastically restricted, either employees or companies have themselves been forced to bear the costs which arise from an early exit from the labor market, which they are evidently not prepared to do. This is where the still very strong employment protection legislation suddenly comes into effect, a right which in the past many employees themselves had willingly sold. As a result companies have suddenly “discovered” that their older employees are indeed still of use.

In the same breath, the myth that older workers prevent younger ones from entering the labor market has been shattered. The labor market participation of 15 to 24-year-olds has also been increasing since 2003. The number of jobs in an economy evidently is not a fundamental constant which can be met with a redistribution of work. The recent reforms have contributed substantially to the rising rate of employment.

The introduction of Hartz IV abolished many benefits, including unemployment assistance. As a result the amount of benefit can drop to the income support level in as little as 12 months after becoming Furtherunemployed. The pressure on those unemployed to find a job as quickly as possible has increased because of this. This explains not only a large part of the labor market success but also the political resistance against the Hartz reforms. The unemployed are prepared to make greater concessions to avert the threat of income loss. The result is that the unemployment duration has noticeably decreased and the proportion of unemployed who go from receiving unemployment benefit type I to unemployment benefit type II is clearly lower than before when the process was from unemployment benefit to income support. In this way unemployment was actually halved, albeit only among those who receive unemployment benefit I. They are prepared nowadays to accept jobs which they would not have done under past conditions. This may be regrettable, but it cannot be denied that it is still better to accept a job which pays less than the last one than to become longterm unemployed.

The situation of the long-term unemployed in Germany clearly demonstrates how important it is to promote a greater willingness to make concessions when searching for a new job. Although the 2005 reforms have improved the labor market prospects of long-term unemployed, they have not wholly succeeded in providing the exact help this group needs. Short-term unemployment has fallen considerably more quickly than long-term unemployment, which now accounts for over 50% of total unemployment. Offers of further training are insufficient in helping their plight.

Social justice requires reciprocity
The central problem of the German welfare state is that low-wage work is not sufficiently attractive. It is particularly true of low-skilled workers that it is often not worthwhile to be engaged in regular work because the wages are often little more than welfare benefits when unemployed. The wages employers would have to pay for menial labor to pay off bear no relation to the market value of the service provided. Empirical studies for Germany have shown that the implicitly generated minimum wage calculated in this manner is in the range of 10 to 12 euros an hour gross.

A consequence of this is that Germany is a world leader in do-it-yourself, and cash-rein- hand work is on the rise. The extent of the shadow economy can only be guessed. According to recent estimates, it generates one sixth of German GDP, which is equivalent to six to seven million illegal jobs when calculated proportionally to the number of employed. The cause of the high unemployment rate among the low-skilled can definitely not be that there is too little work in Germany.

There is currently sufficient employment in the low-wage sector for those who do not have any other employment prospects because of a lack of qualifications. However, it is a matter of making these jobs worthwhile.

Benefit claims should generally be coupled with an obligation for something in return in the form of work in the broadest sense, to which measures of further professional and social training belong. This means that benefits have to be “earned” one way or another. This principle, also known as workfare, creates strong incentives to work in the low-wage sector for those people whose qualifications are not enough to attain a sufficiently high hourly wage in the market. Workfare works without lowering the basic minimum income level and results in higher income. Whoever has the opportunity to earn more with menial work than the minimum income level has an incentive to do so. Workfare turns benefit recipients into taxpayers, and thus helps to lower public spending and create more leeway for future investments. Furthermore, workfare prevents companies from paying low wages at the burden of the welfare state.

An alternative that is still being discussed in political circles is a more generous arrangement to earn additional income when claiming benefits. However, this is just another form of in-work benefit that would generate substantial windfall and an undesirable subsidization of part-time work. Instead, policymakers should focus on a gradual implementation of the quid pro quo approach embodied in the workfare principle. Also, in order to create more equal opportunities, the court-mandated revision of child benefits should lead to a higher share of benefits being paid in the form of vouchers.

Job centers:
More individual support needed
The top priority for job centers should be that each customer is guaranteed one-stop support with effective and custom-tailored advice from one particular caseworker. Strictly speaking, this would require the creation of a wide-reaching federal organizational structure. Early intervention and support makes sense at the onset of unemployment, especially for those in danger of becoming long-term unemployed, such as older, low-skilled or immigrant workers. An independent organization should support the whole process for these groups right from the beginning, i.e., at the time of job loss. Later, it should also take responsibility for all other long-term unemployed. Only in this way can structural unemployment be reduced once and for all. In addition, job centers could be created which are independent from local government and unemployment insurance and whose task is to find work in the most efficient manner, as is the model in the Netherlands (where it applies to all those unemployed). In this model the task of finding work for these problem groups would be taken away from the Federal Employment Agency and the local administration. In practice this would mean that the current structure in place for advising Hartz IV recipients would be dismantled, become independent and be replaced with one with expanded responsibilities and instruments. Only in this way can we ultimately avoid the collapse of effective support of job seekers in a federal structure which works against itself. The Federal Employment Agency could confine its work to processing unemployment insurance benefits and supporting the short-term unemployed.

On the road to these changes, the existing job centers can be improved by strengthening the position of the caseworker. The caseworker is the central figure at the job center for a successful integration process and new employment. Performance pay is necessary for good caseworkers and counselors, as is usual in other areas of industry; even in the public sector the idea of a stronger link between pay and performance is gaining ground. In addition, benchmarking could increase competition for performance and competency among job centers.

This help often comes too late for young drop-outs, low-skilled workers, immigrants, single-parent families and older recipients of Hartz IV. Hence these groups often remain dependent on state benefits for too long, sometimes permanently. It is not only about help in finding a job for these groups with specific needs, but also about solving diverse social conflicts, family problems, a lack of motivation and qualifications, all of which prove to be barriers to finding work. Effective support tailored to individual needs must be improved. Particularly single mothers need more help not only to escape from benefit dependency, but also to avoid their children becoming the next generation of Hartz IV recipients. Single parents with children under age 18 make up about half of all benefit recipients with children.

Moreover, it would make sense to grant more non-cash benefits such as vouchers for training and employment programs. This would stimulate the market for certified training providers, prevent the misuse of benefit payments and improve the effectiveness of qualification measures.

Educational reform, migration and integration
The IZA strategy paper for labor market modernization also contains recommendations for the education sector. Knowledge and skills are becoming increasingly important as key resources for growth and prosperity, all the more in the face of the imminent demographic change. The parameters of the labor market will drastically change in the coming years compared to the situation at the turn of the millennium. On the one hand, there is an easing of the labor market due to demographic changes and the opportunities resulting from new areas of employment; on the other hand, there is growing financial strain on labor through the burden of increasing social security contributions. New employment opportunities can come from this if politicians, unions and employers react sensibly to this process of change. Society and politicians must be aware that education and migration policies face especially difficult challenges in light of a shrinking and aging working population and the simultaneously growing demand for human capital.

Even before the PISA study it was recognized that the German education system had to be put to the test. In the face of an internationalization of labor markets, German education institutes have fallen behind. Compared internationally, childcare facilities with qualified programs are too few, educational outcomes have too great a regional variance, the average time required for school, training and university is too long, and the proportion of workers with no qualifications is still too high. All of these show that the education factor is not being sufficiently utilized as a key to the labor market. To a certain extent it is also a failure of the market, as the importance of education and further training is not being recognized early enough and, by international comparison, human capital is not being sufficiently rewarded. In a phase when using the available knowledge most effectively should be all that matters, allowing highly qualified workers to emigrate to countries which offer much more attractive working conditions is a luxury Germany cannot afford.

The crucial foundation for cognitive and non-cognitive development is laid in early childhood. Family background should not determine children’s opportunities later in life. More autonomy and competition between the schools will enhance performance; student selection for the different levels of secondary education should occur at a higher age. The dual system of vocational training, which combines classroom learning with apprenticeships, can be shortened. To avoid a financial entry barrier to university education, tuition fees could be financed by a graduate tax on employed workers with a university degree.

Notwithstanding all the efforts at educating Germany’s youth, the country is dependent on the immigration of high-skilled workers to combat the consequences of demographic change and the growing shortage of skilled labor. A selection system based on economic criteria would significantly increase the economic benefits of immigration. Sustainable migration and integration policies are a prerequisite of successful labor market modernization and a major step on the road to full employment.

IZA Policy Paper No. 15
Agenda 2020: Strategies to Achieve Full Employment in Germany
Hilmar Schneider
Klaus F. Zimmermann