Germany has much to teach about labor law. Though Europe typically points the way to dysfunction on such matters, the German case stands as a remarkable exception. The country has managed a thorough reform of its once-counterproductive labor policies, many of which still prevail elsewhere in Europe and in many states in this country. In their place it has established a much more pro-market and effective system that has clearly contributed to German prosperity and radically reduced joblessness. While no one pretends that policies can cross the ocean whole, these remarkably effective German reforms and especially the principles on which they were built should nonetheless offer welcome guidance to both federal and state policies here. They certainly deserve a close look.
The wake-up call for German reform came from the country’s economic failures in the 1990s. While the global economy boomed, Germany lagged, and by a wide margin. Between 1991 and 2002 the United States, for instance, grew 4.9 percent a year in real terms. Its unemployment rate at the turn of the century had fallen to 4.1 percent of the workforce. Asia, except Japan with its own special problems, took off during those years. Europe grew at a more stately pace, but even there, Germany lagged by comparison. Britain, for instance, grew 3.0 percent a year and France 2.3 percent. Germany averaged annual growth of only 1.5 percent, while German unemployment had climbed toward 8.0 percent of the workforce. The Economist magazine noted the comparisons and labeled Germany “the sick man of Europe.” Even the Germans agreed.
Eager to find a solution, German policy makers took their cue from Dr. Peter Hartz. Against the odds, he had managed to bring labor peace to Volkswagon AG and had spoken openly about Germany’s larger economic problems. He had traced their roots in part to the existing system’s heavy regulation of employment practice and its tendency to discourage hiring, training, and render German business less flexible and dynamic than it could be. He also saw failure in the country’s generous and open-ended unemployment and welfare system. It paid the unemployed a large proportion of their former earnings just about indefinitely and so wasted labor resources at great expense to the public purse. Though the system had existed during Germany’s post-war economic miracle, reunification with the east and in the country’s growing proportions of immigrants rendered the old structure problematic. Goaded by Hartz’s analysis and the clear record of economic failure, Germany’s socialist government asked Hartz to lead a newly formed Commission for Modern Labor Market Services. At some political risk, it quickly adopted the group’s recommended raft of pro-market reforms.
To give firms more flexibility and encourage them to hire more freely, the reforms cut trough the former thicket of labor regulations. They made it considerably easier to fire and lay off workers and in the process made it a lot less risky than previously for firms to hire new. By allowing labor contracts to settle on a firm by firm basis instead of insisting on a national settlement, as the old system had, the reforms have empowered individual firms to adjust more thoroughly and quickly to unfolding economic conditions. By giving managements more freedom to hire temporary workers and write fixed-term contracts with individuals, the recast rules have introduced still more flexibility into management decision making and further reduced the risks of hiring.
The changes also sought to make the government unemployment offices more efficient and motivate them to find work for their beneficiaries quickly. The new structure even sets quantitative goals for placing the unemployed in jobs and when necessary authorizes the unemployment offices to serve as temporary work agencies. Having also established training schemes to better position the unemployed for work, the reforms seek still greater efficiencies by demanding that case workers determine which among the unemployed would benefit most from which training programs. As a further spur to placements, the new system encourages unemployment offices to use private placement services and where appropriate to give the unemployed vouchers to use with such services. Indeed, if unemployment offices fail to place an unemployed worker within six weeks, they must issue such vouchers.
Perhaps most significant, the reforms take steps to encourage the unemployed to get off support. They have ended the old system’s almost perpetual no-questions-asked benefit system. In its place they have substituted a clear set of what the reformers call “rights and duties.” Something approaching the generous benefits of the old system are available to the unemployed initially, but these last only for the first 6 to 12 months of unemployment. Thereafter, benefits decline according to a means-tested form of welfare. Able-bodied unemployed are obliged to enroll in training programs and take any “suitable work” offered. Under certain circumstances, they come under pressure to move to a different city. Failure to comply with any of these provisions could cost them all or some of their benefits. Disabled and older workers face less rigorous terms. To encourage them to work, the reformed system offers them stipends if they have to accept work at much lower pay than they had previously earned, but they must work to get the stipends, and the amounts decline over time. The reforms offer similar stipends for the unemployed who want to start up new businesses, provided their plans can pass a feasibility test with the local chamber of commerce.
In good teutonic fashion, the government has continuously monitored the relative success of these changes. The effort began almost immediately after the full reforms went into effect in 2005 and has grown since. Over 20 research institutions and about 100 researchers have worked on the project, and, remarkably for anything in the political-economic realm, all this independent research, the detailed econometric work and the qualitative institutional assessments alike, have declared the pro-market reforms a success. An independent assessment by the International Monetary Fund (IMF) concurs.
But it does not require massive computers to see the positive effect. A straightforward look at German economic preference before and after the reforms speaks volumes. The German economy since the Hartz measures has closed the relative economic gap that was so obvious previously. Because the global economy has slowed, a growth acceleration in Germany would be asking too much. Nonetheless, it speaks to the effectiveness of the reforms that German growth, unlike every other economy on the globe, has not decelerated. The impact on labor markets, which, of course, was the target of the reforms, is still more impressive. Despite the effects of the severe 2008-09 global recession, German unemployment rates, presently at 4.5 percent of the labor force, are much lower than in 2005, the year the reforms went into effect and near the peak of the global economic cycle. They are also lower than every other major western economy, including the United States.
Americans looking at this experience should know that the Hartz reforms are far from easily transferable, certainly in their specifics. This country never had the generous, open-ended benefits that Germany had, though some states come close even today. Neither has this country, for all its regulatory red tape, imposed the severe controls on hiring and firing that that Germany did before its reforms. Nor does this country’s political structures allow for such thorough, nationwide changes as Germany managed. But beneath such details, the German experience carries a clear message: Better than any specific program, no matter how well thought through and guarded from corruption, the flexibility of pro-market reforms fosters faster, more reliable growth, more hiring, and more prosperity. Washington and the states would do well to take heed.