The conceptual framework of this paper assumes that macroeconomic performance depends on the interplay between the economic environment and policies. Declining labor shares, wage moderation, and employment performance in Germany and the Netherlands have been presented. A number of policy changes are under way, but additional reforms may be needed to fully reap the benefits of the new economy. The tax reform package marks a radical and constructive shift in German tax policy, and the pension system requires a sea of change in public policy reforms.

Abstract

The conceptual framework of this paper assumes that macroeconomic performance depends on the interplay between the economic environment and policies. Declining labor shares, wage moderation, and employment performance in Germany and the Netherlands have been presented. A number of policy changes are under way, but additional reforms may be needed to fully reap the benefits of the new economy. The tax reform package marks a radical and constructive shift in German tax policy, and the pension system requires a sea of change in public policy reforms.

Germany: Basic Data

article image

Staff projections.

Change as a percent of previous year’s GDP.

According to place of residence.

On national accounts basis (ESA95); Unemployment as defined by the international labor organization (ILO).

Deflated by the national accounts deflator for private consumption.

Germany: Basic Data

article image

Staff projections.

Data for federal government are on an administrative basis. Data for the general government are on a national accounts basis. Debt data are end-of-year data for the general government in accord with Maastricht definitions.

Government revenues in 2000 include the proceeds from the sales of mobile phone licenses of DM 99.4 billion (2.5 percent of GDP). The proceeds also affect the financial balances and the government debt.

Including supplementary trade items.

From 1999 onward data reflect Germany’s position in the euro area.

From 1999 onward data reflect Germany’s contribution to M3 of the euro area.

Data for 2000 refer to September 12, 2000.

Data for 2000 refer to September 8, 2000.

Data for 2000 refer to August, 2000.

I. Strategies for Turning Germany’s Labor Market Around1

A. Preliminaries

1. Since the early 1970s, Germany’s performance in utilizing its labor resources has been lackluster. In particular, real output growth during the last three decades has fallen short of what was needed to prevent the unemployment rate from drifting upward—in marked contrast to the growth and labor market experience of the Wirtschaftswunder era in the 1950s and 1960s (Figure I-1). Each of Germany’s growth cycles since the early 1970s left behind a legacy of higher structural unemployment, as can be gleaned from a scatterplot of western Germany’s unemployment against capacity utilization rates during 1970–99 (Figure I-2). Thus, a large and growing number of Germany’s productive workers remained inactive, preventing the economy from living up to its full potential.

Figure I-1.
Figure I-1.

Germany: Unemployment Rate and Real Output Growth, 1950–2000

(In percent)

Citation: IMF Staff Country Reports 2000, 142; 10.5089/9781451810424.002.A001

Source: IMF, World Economic Outlook.
Figure I-2.
Figure I-2.

Germany: Unemployment Rate and Capacity Utilization, 1970–99 1/

Citation: IMF Staff Country Reports 2000, 142; 10.5089/9781451810424.002.A001

Sources: Deutsche Bundesbank; and OECD Economic Indicators.1/ Data refer to western Germany.

2. At the same time, Germany’s performance in terms of labor productivity growth—the key determinant of increases in living standards—has remained clearly above par. Labor productivity continued to expand at a robust pace (of 2¼ percent) during 1973–99, significantly above the OECD’s average rate of growth (1¾ percent) in the same period. Moreover, based on data for western Germany, the “productivity gap” vis-à-vis the leader country—the United States—was almost closed by the end of the century (Figure I-3).2 Thus, Germany’s economy continued to provide what has been dubbed the “2 percent answer” to each generation’s economic dream: labor productivity growth of 2 percent a year implies a doubling of living standards every 35 years, enabling parents to provide their children with a standard of living double the level they enjoyed themselves when they were children.

Figure I-3.
Figure I-3.

Germany: Real Output per Employee, 1950–99 1/

Citation: IMF Staff Country Reports 2000, 142; 10.5089/9781451810424.002.A001

Source: Perm World Tables.1/ Thousands of U.S. dollars at 1995 prices; logarithmic scale.2/ Data for 1991–99 refer to western Germany.

3. Not surprisingly, against this background, improving the labor market’s ability to more fully use available labor resources is Germany’s number one economic policy priority. “The reduction of unemployment is the most important objective of the new government. Herein lies the key to resolving the economic, financial, and social problems of Germany.”3 The purpose of this chapter is to review the debate on policy strategies that could allow Germany to make a clean break with the labor market disappointments of the last three decades.

4. What are the causes behind Germany’s anemic labor utilization performance over the last three decades? The chapter’s discussion is premised on the following potted account of this portion of Germany’s growth cycle history: adverse shifts in the economic environment (shocks) were propagated through inflexible labor market arrangements (institutions) and reinforced by largely endogenous fiscal and monetary policy responses (financial policies).4

  • Role of shocks: Germany’s postwar Wirtschaftswunder economy was envied by much of the world during the 1950s and 1960s for combining rapid productivity growth and full employment without compromising on social consensus and equity objectives. Germany appeared to have found an unusually favorable mix between a market-oriented Ordnungspolitik (the sum of policies charged with providing a sturdy and trust-promoting legal and financial framework within which markets could operate efficiently) and an active social policy (policies charged with setting bounds within which market forces would need to operate, foremost in the labor market). However, beginning in the early 1970s, the economic environment worsened drastically, with Germany’s economy battered by an array of adverse shocks including skill-biased shifts in labor demand, a quickening pace of deindustrialization, and, above all, during the 1990s, the massive economic fallout from German unification. In this much less favorable economic environment, maintaining high levels of resource utilization in the labor market would have required flexible labor market institutions.5

  • Role of institutions: However, Germany’s labor market institutions were not in sync with the more adverse economic environment. Two basic labor market coordination (or mismatch) problems obstructed the adjustment to shocks. First, the structure of labor costs was not responsive to shocks to relative labor productivities of workers (across skills, sectors, and regions).6 Relative labor cost adjustments were blocked by the principle of “wage growth solidarity,” enshrined in the trade unions’ objective to benchmark negotiated (real) wage increases on the economy’s overall rate of labor productivity growth. And second, social security arrangements underpinned high and inflexible reservation wages relative to take-home pay offered by the markets, where rigid reservation wages reflected unlimited durations of unemployment benefits, generous early retirement incentives, and weak re-activation requirements for the unemployed.7 The social insurance system added a vicious circle element to the two basic mismatch problems. Rising social contribution rates—in large part an endogenous consequence of Germany’s lackluster employment growth record—drove an increasing wedge between labor costs and take-home pay, crimping take-home pay and increasing labor costs, particularly of the lower-skilled, initiating a further round of employment losses.

  • Role of financial policies: Largely endogenous fiscal and monetary policy responses added demand side strains to the supply-side consequences of an ill-functioning labor market. To begin with, the design of Germany’s fiscal institutions—especially the presence of a large-scale social insurance system based on pay-as-you-go (PAYG) principles and a highly decentralized fiscal structure—lends itself to “endogenous procyclicality” in the fiscal stance. More importantly, the massive labor market shakeouts that became a defining feature of Germany’s cyclical downturns implied sharp deteriorations in the underlying fiscal position, reflecting the upward ratcheting of structural unemployment. Moreover, with the anchor of a reasonably stable structural rate of unemployment missing, fiscal policy making was all at sea—orienting the fiscal stance on cyclically adjusted deficits became an exceedingly difficult exercise at best. In this situation, “putting the fiscal house back in order,” even at the cost of a procyclical bent in fiscal consolidation efforts, was widely seen as a prerequisite of sound government. Finally, two historical events—the obligation to finance the fiscal cost of unification and the drive to meet the Maastricht deficit limit in 1997—also led to a strong procyclical thrust in fiscal policy during most of the 1990s. Monetary policy (until 1998, the sole prerogative of the Bundesbank) was bound by a strictly interpreted constitutional mandate to “safeguard the currency.” Faced with a wage bargaining regime that tended to alternate between persistent phases of wage moderation (following cyclical downturns and labor shakeouts) and wage push (during cyclical upswings), as well as a fiscal policy stance that was prone to procyclicality, the Bundesbank tended to meet perceived inflationary pressures promptly, decisively, and steadfastly, while taking a more cautious and wary attitude toward relaxation of its monetary stance during periods of persistent economic slack.

5. With the relative patterns of labor costs, take-home pay, and reservation wages largely impervious to adverse shocks, active labor market policies took on the role of “labor policies of last resort.” It was hoped that active labor market policies would help to raise labor productivities and re-motivate the unemployed by training or direct job creation. However, the success of active labor market policies appears to have been limited, although direct evidence on this is scarce owing to a distinct lack of evaluations of the effectiveness of Germany’s vast array of active labor market programs.8

6. The labor market fallout from the interplay of shocks, institutions, and financial policies was heavily concentrated among the lower skilled (Figures I-4 and I-5). On the labor demand side, with the shocks biased against lower-skilled workers and the wage bargaining institutions effectively blocking relative wage adjustments that could have preserved jobs, the incidence of labor shakeouts fell heavily on the lower-skilled. On the labor supply side, a social safety net characterized by high and sticky reservation wages was unlikely to also serve as a social springboard for reabsorbing the lower-skilled during cyclical upturns.

Figure I-4.
Figure I-4.

Germany: Employment by Skills, 1976–97 (1976=100) 1/

Citation: IMF Staff Country Reports 2000, 142; 10.5089/9781451810424.002.A001

Sources: Reinberg and Rauch (1998); and staff estimates.1/ Data refer to western Germany.
Figure I-5.
Figure I-5.

Germany: Unemployment Rates by Skills, 1976–97

(In percent) 1/

Citation: IMF Staff Country Reports 2000, 142; 10.5089/9781451810424.002.A001

Sources: Reinberg and Rauch (1998); and staff estimates.1/ Data refer to western Germany.

7. What could be done to improve the workings of Germany’s labor market while preserving an enviable record of sustained labor productivity growth and paying heed to Germany’s deeply embedded social equity objectives? The debate on this has produced two distinct lines of argument, implying strikingly different policy strategies:

  • The first line of argument is based on the premise that marked improvements in the utilization of labor resources can be achieved without abandoning the broad features of Germany’s present labor market institutions. This line of argument tends to highlight the role of an unusually unfavorable economic environment (shocks) during the last three decades, not least the adverse economic effects of German unification. Moreover, it is claimed that endogenous adjustments in the functioning of labor market institutions, particularly collective bargaining on wages and work conditions, have already increased flexibility, although further piecemeal reforms may be needed. A “corporatist policy strategy” based on this line of argument would prescribe across-the-board wage moderation (a policy consistent with the “wage growth solidarity” principle) as the centerpiece of an effort to increase use of available labor resources through two channels: (i) by improving Germany’s labor cost competitiveness; and (ii) by boosting labor intensity (relative to capital) of production. At the macroeconomic policy level, a key supporting role would be provided by a fiscal policy that blunts the impact of wage moderation on take-home pay, mainly by cuts in the income tax and contribution burden. Thus, a corporatist policy strategy would seek to exploit a virtuous circle running from wage moderation in the labor market (leading to stronger employment growth) to fiscal policy (lower social spending makes it possible to lower the contribution and tax burden) and back to the labor market (more employment growth), essentially trying to reverse the vicious labor market circle of the last three decades. In continental Europe, this type of corporatist strategy has been widely associated with the economic turnaround of the Netherlands since the early 1980s—Germany’s Alliance for Jobs has been explicitly modeled on the Dutch experience.9 Indeed, during the second half of the 1980s, Germany and the Netherlands appeared to follow similar labor market strategies—and labor market improvements in the Netherlands and Germany during the second half of the 1980s were also noticeably similar—but, in the event, Germany’s wage moderation policy was derailed by the shock of German unification.10

  • The second line of argument is premised on the assumption that a comprehensive overhaul of Germany’s labor market institutions is needed to bolster the shock-resistance of Germany’s labor market and unwind the unemployment legacy of the last three decades. An “institutional reform strategy” based on this view would focus on changing the ground rules that govern collective bargaining, social insurance, and the social safety net, while taking measures to boost take-home pay at the lower end of the labor market to uphold Germany’s equity objectives. By unblocking adjustment channels in the labor market, institutional reforms would also buy insurance against future shocks and the repetition of past cyclical disappointments. Within continental Europe, Switzerland’s specific set of labor market institutions provides a possible benchmark in line with the aims of an institutional reform strategy.

8. To set the stage for the remainder of the chapter, the next section lays out illustrative scenarios for Germany’s medium-term cyclical growth prospects. The final section describes in more detail and evaluates the two competing lines of argument on how to improve the functioning of Germany’s labor market.

B. Germany’s Growth Cycle Prospects: Alternative Scenarios

9. Germany’s growth cycles since the early 1970s can be well described by a three-stage pattern: first, a cyclical downturn or labor shakeout stage (Stage 1); then, a slow stretched-out cyclical recovery stage with essentially no employment growth (Stage 2); and finally a strong cyclical upswing stage, ending invariably in another labor shakeout (Stage 3) (Figures I-6 and I-7). The contrast between the last Wirtschaftswunder era cycle in the 1960s and the later cycles is noteworthy. All of Germany’s growth cycle recessions since the mid-1960s have coincided with massive labor shakeouts. However, while the labor shakeout during the 1967–68 recession was followed by a quick and sustained rebound to above-average output growth, the three growth cycles since the early 1970s have been characterized by increasingly anemic growth rates during the early phase of the cyclical recovery. Output growth has tended to exceed average growth only in the final upswing phase of the growth cycle.

Figure I-6.
Figure I-6.

Germany: Cyclical Expansions of Real GDP

(Index) 1/ 2/

Citation: IMF Staff Country Reports 2000, 142; 10.5089/9781451810424.002.A001

Source: Deutsche Bundesbank; and staff estimates.1/ The troughs, calibrated at time zero, are as follows: 1967Q2 for the 1967–68 recovery; 1975Q2 for the 1975–76 recovery; 1982Q4 for the 1983–84 recovery; 1993Q1 for the 1993–94 recovery. The cyclical trough dates fulfill two criteria: (i) the annual GDP growth rate was negative; and (ii), within the year, the cyclical trough was located in the quarter with the sharpest quarterly decline in GDP.2/ Data prior to 1991 refer to western Germany only.
Figure I-7.
Figure I-7.

Germany: Cyclical Expansions of Employment

(Index) 1/ 2/

Citation: IMF Staff Country Reports 2000, 142; 10.5089/9781451810424.002.A001

Source: Deutsche Bundesbank; and staff estimates.

10. The dynamics of these growth cycles reflected the following stylized pattern. The cyclical downswing and labor shakeout of Stage 1 was typically followed by a phase of moderate, across-the-board wage growth to restore enterprise profitability and competitiveness; fiscal consolidation efforts including marked increases in social contribution rates to restore the soundness of public finances; and a slow and cautious relaxation of monetary policy. This setting of wage, fiscal, and monetary policies translated into slow (Stage 2) output growth and virtually flat employment (see Figure I-7). At some point, with external competitiveness restored, exports typically provided the impulse for a more pronounced cyclical pickup that was then transmitted, with some delay, to domestic demand, mainly via investment in machinery and equipment. As the cyclical upswing took hold and profits began to soar (Stage 3), across-the-board wage moderation gave way to more aggressive wage demands by higher-skilled workers—during this stage, trade unions would refer to the need to put an end to “excessive wage modesty.” While these higher wage demands were largely compatible with the rising productivity levels of the higher-skilled, labor costs for the lower-skilled were pushed out of line with their productivity. In the meantime, on the policy side, fiscal policy typically shifted to a procyclical stance—the PAYG finance principle made it possible to cut social contribution rates; lower government levels could use rising revenue to finance additional spending; and tax reforms were timed to coincide with a favorable budgetary situation. With the cyclical upswing gathering steam, increasingly supported by buoyant private consumption, monetary policy became more and more preoccupied by medium-term domestic cost pressures and turned restrictive at an early stage. At this point, adverse shocks, including a sharply appreciating real exchange rate or specific other shocks (oil prices, Germany unification), further aggravated cyclical strains on the economy, especially in the manufacturing sector, finally tipping the economy into the cyclical downswing stage.

11. Turning to Germany’s present cyclical position, in mid-1999, the German economy regained the cyclical momentum lost during the Asian and Russian crises. By mid-2000, several key indicators of the cyclical state of the economy—including the rate of capacity utilization in manufacturing and the Ifo business climate index—were at or close to previous cyclical peak levels (Figure I-8). However, at the same time, activity in some sectors, particularly the construction and retail trade sectors, remained below normal levels. Staff estimates suggest that the economy’s output gap in 2000—a rough, uncertain, and controversial measure of overall economic slack—was close to the euro area’s average of some ½ percent of potential GDP (Figure I-9) and was likely to close in 2001.

Figure I-8.
Figure I-8.

Germany: Capacity Utilization in the Manufacturing Sector and Ifo Business Climate Index, 1970–99 1/

Citation: IMF Staff Country Reports 2000, 142; 10.5089/9781451810424.002.A001

Source: WEFA database.1/ Data prior to 1991 refer to western Germany only.
Figure I-9.
Figure I-9.

Germany: Output Gaps in the Euro Area, 2000 1/

Citation: IMF Staff Country Reports 2000, 142; 10.5089/9781451810424.002.A001

Source: IMF, World Economic Outlook.1/ Defined as the difference between actual and potential GDP, as a percent of potential GDP.

12. In the short term, macroeconomic policies are likely to be expansionary or at least neutral. Following an extended stretch of consolidation, fiscal policy is set to turn expansionary in 2001, owing to the income-boosting effects of the tax reform package adopted in July 2000. Monetary conditions—as measured by short-term real interest rates—are close to neutral, at least by Germany’s standard over the last 20 years (Figure I-10). Taking account of the weak euro—Germany’s real effective exchange rate against all trading partners is significantly below its longer-term average (Figure I-11)—a more broadly defined monetary conditions index (MCI) would suggest that monetary conditions are presently quite relaxed.

Figure I-10.
Figure I-10.

Germany: Monetary Conditions Index (MCI), 1992–2000

Citation: IMF Staff Country Reports 2000, 142; 10.5089/9781451810424.002.A001

Sources: Deutsche Bundesbank; and staff calculations.1/ Average 1981–2000=0. Calculated using as weights 2.5 for the short-term interest rate and 1 for the effective exchange rate. Upward movements denote tighter monetary conditions.
Figure I-11.
Figure I-11.

Germany: Real Effective Exchange Rates, 1987–2000 (1987=100)

Citation: IMF Staff Country Reports 2000, 142; 10.5089/9781451810424.002.A001

Sources: Deutsche Bundesbank; and staff calculations.1/ Based on unit labor costs in total economy.2/ Based on unit labor costs in the business sector.

13. Recent wage settlements locked in wage moderation for 2000–01. Wage settlements in early 2000 agreed on nominal wage cost increases of about 2¼ percent in both 2000 and 2001, equivalent to prospects of flat unit labor cost for the next two years. At the same time, income tax cuts are projected to boost take-home pay in 2001.

14. In this setting, most forecasters expect the economy’s cyclical expansion to continue into the short term (2000–01). Nevertheless, significant downside risks to the short-term growth outlook include a possibly sharp appreciation of the euro, a persistently higher oil price, and a hard landing in the United States associated with a major stock market correction.

15. Looking further ahead, medium-term prospects for growth and labor market performance are much more uncertain, with the range of uncertainty perhaps circumscribed by three illustrative scenarios for the time range 2000–05:

  • Stable structural unemployment rate scenario (“central staff scenario”). This scenario relies on the assumptions that the economy’s medium-term expansion path is anchored by a stable structural rate of unemployment, which is estimated by staff at 7½ percent relative to an actual rate of about 8 percent in mid-2000 (standardized national accounts definition), and by stable medium-term labor productivity growth of about 2 percent per annum. Moreover, with the actual unemployment rate converging to its stable structural rate over the medium term, in this scenario real output growth is assumed to be sufficient to close the output gap by 2005 (Figure I-12).

  • Increasing structural unemployment rate scenario (“cyclical-history-repeats-itself scenario”). This pessimistic scenario reflects the assumption that over the next three years cyclical tensions build up to a point where a sharp cyclical downswing takes place in 2003 (Figure I-12). Broadly in line with Germany’s previous growth cycle experiences, the scenario assumes that the labor shakeout would boost the structural unemployment rate by a cumulative amount of some 3 percentage points during 2003–2005, increasing the structural rate of unemployment to about 10 percent by 2005. The marked rise in unemployment is reflected in slower real GDP and employment growth, where a 1 percentage point change in the unemployment rate is assumed to change real GDP growth by 2 percentage points in the opposite direction, roughly in line with Okun’s law estimates for Germany.

  • Declining structural unemployment rate scenario (“new-growth-cycle-era scenario”). This optimistic scenario illustrates how the present cyclical upswing could reverse a significant portion of the accumulated unemployment legacy. The driving assumption underlying this scenario is a decline in the structural rate of unemployment totaling 3 percentage points over the period 2002–05—other continental European economies, especially Denmark and the Netherlands, saw declines of similar magnitudes from high structural rates of unemployment over four- to five-year periods during the 1980s and 1990s. As a result of the declines in the structural rate of unemployment, in this scenario real GDP growth could be kept well above previous “speed limits” for an extended period.

Figure I-12.
Figure I-12.

Germany: Growth Cycle Scenarios, 2000–2005

(In percent)

Citation: IMF Staff Country Reports 2000, 142; 10.5089/9781451810424.002.A001

Sources: IMF, World Economic Outlook; and staff calculations.1/ Assuming an increase in the unemployment rate by a total of 3 percentage points over the period 2003–2005, broadly in line with past cyclical recession experiences.2/ Assuming a cumulative reduction in the structural rate of unemployment by 3 percentage points during 2002–2005.3/ A 1 percentage point change in unemployment is assumed to change real GDP growth by 2 percentage points in the opposite direction, in line with Okun’s Law estimates for Germany.

C. Policy Strategies for Underpinning a New Growth Cycle Era

16. The conceptual framework of this chapter assumes that macroeconomic performance depends on the interplay between the economic environment (shocks) and institutions (policies). Within this framework, a given macroeconomic performance can in principle result from different combinations of shocks and policies. Thus, it is conceivable that a more auspicious economic environment (relative to the economic environment underlying the staffs central scenario) could combine with the unchanged policies and yield a favorable growth and labor market performance close to the new-growth-cycle-era scenario. But, conditional on a given economic environment, it is policies that matter.

17. As regards the future economic environment, most of the adverse shocks that have shaped Germany’s cyclical history since the early 1970s may have lost much of their momentum. In particular, the number of lower-skilled workers has declined sharply since the mid-1970s (by more than 50 percent). The pace of de-industrialization in Germany is likely to slow. At the beginning of the 1970s, the share of manufacturing employment in Germany accounted for some 40 percent of employment (compared with some 30 percent in the EU); by the mid-1990s, the share of manufacturing employment in Germany had fallen to some 22 percent, close to the level in the EU (about 20 percent). Finally, most of the adverse economic effects of unification, a major and largely Germany-specific adverse shock, may have finally rippled through the system, although it left behind a difficult legacy including a hefty fiscal burden (largely reflected in higher social contribution rates) and a massive regional labor market problem in the new Länder.

18. However, there are a number of possible new challenges (shocks) that could test the flexibility of Germany’s labor market:

  • The “new economy:” Prima facie, the “new economy” is akin to a positive supply shock that could spur faster output growth at a stable inflation rate (see Chapter III for details). At the same time, the “new economy” phenomenon could also lead to a wider dispersion of labor productivity across skills and sectors, exacerbating the tensions associated with inadequate wage differentiation (see Chapter III for details).11

  • Regional specialization in the EU: Integrated economic areas and monetary unions tend to produce regional clusters of specialized activities (Krugman (1992)). Regional specialization and the associated increase in the instability of regional growth rates could require a widening of wage differentials to allow locational clustering to be underpinned by labor mobility.

  • EU’s eastern expansion: This may require a higher degree of labor market flexibility to the extent that it may lead to changing patterns of migration and division of labor within the EU.

  • Population aging: The lack of flexibility in labor market adjustments has in the past undermined the employment opportunities of older German worker cohorts—reflected in one of the lower labor force participation rates among industrial countries. The projected rapid aging of the population will considerably swell the size of older worker cohorts, cohorts with presently significantly higher unemployment rates than those for younger cohorts.

19. Could recent policy changes or endogenous adjustments in labor market institutions have already transformed the functioning of Germany’s labor market? There have been changes of a largely endogenous nature—in particular collective wage bargaining has become somewhat more flexible under pressure, notably in eastern Germany, as reflected in the declining share of workers and companies covered by collective bargaining agreements and the increased use of “opening and hardship clauses” (clauses that allow firm-level agreements that deviate from collective bargaining settlements). At the same time, the rules governing social insurance and the social safety net have remained broadly unchanged over the last few decades.

20. Two stylized strategies have emerged as the main competing policy paradigms for reviving Germany’s growth cycle performance: a corporatist strategy, mainly modeled on the Dutch experience of the 1980s and 1990s; and an institution a list strategy, which would aim at more fundamental changes of labor market institutions. The corporatist strategy would seek to exploit a virtuous circle in the labor market, essentially reversing the vicious circle that has plagued Germany’s labor market during the last three decades. This virtuous circle would run from stronger employment growth (stimulated by wage moderation) to lower social spending (due to faster employment growth) to lowering the tax and contribution burden to more employment growth. Thus, fiscal policy would seek to soften the impact of wage moderation by cutting the burden of income taxes and social contributions. Income tax cuts, in particular, would most likely benefit higher-skilled/higher-income workers overproportionally, reducing the potential pressure from this side to abandon across-the-board wage moderation. Within continental Europe, a version of the corporatist policy agenda has been widely associated with the economic success of the Netherlands since the 1982 Wassenaar Agreement.12 Indeed, the broad features of the Dutch approach have been echoed in the setup of Germany’s Alliance for Jobs, which in turn has been widely credited for engineering the moderate wage settlements at the beginning of 2000.

21. By contrast, an institutionalist reform strategy would focus on fundamental changes in the rules governing collective bargaining, social insurance, and the social safety net. The aim of these changes would be to unblock the adjustment channels in the labor market and to buy insurance against future adverse shocks. As its main planks, the institutionalist agenda would address:

  • Collective bargaining: by modifying the rules that insulate the present collective bargaining system against outsider competition. In this context, the Council of Economic Advisors in its 1999/2000 Report urged the authorities to modify three key legal rules that underpin collective bargaining: (i) the rule in the Works Constitution Act stipulating that in case of a collective agreement, wages and nonwage bargaining cannot be subject to firm-level bargaining unless the collective agreement expressly allows for this; (ii) the rule in the Wage Contract Law stipulating that firms bound by collective bargaining agreements can only conclude agreements that deviate from collective bargaining agreements in favor of workers (“favorability principle”); and (iii) the rule in the Wage Contract Law that allows the parties to a collective bargaining agreement to extend it to employers that were not covered by the collective agreements (“declaration of general validity”).

  • Social insurance system: by moving to a multipillar social insurance system. A downsized public social insurance pillar would mitigate the vicious circle mechanism described before and allow lower mandatory social contributions, particularly at the lower end of the wage distribution. The government’s recent proposal for pension reform are (conceptually) in line with this objective (see Chapter V for details).

  • Social safety net: by putting limits on the duration of unemployment benefits and tightening of rules on the acceptability of jobs to bring reservation wages more closely in line with available market opportunities. At the same time, complementary reforms would likely be needed to boost take-home pay at the lower end of the market to respect Germany’s embedded equity objectives.

22. As a possible benchmark for an institutional reform agenda, the example of Switzerland’s labor market institutions is of specific interest. Apart from an obvious difference in size, the Swiss and German economies share a number of important characteristics: an export-oriented, high-wage manufacturing sector; high saving rates; similar education and training systems; similar exposure to demand and technology shocks; and highly decentralized political systems that require broad social consensus on far-reaching reforms. Moreover, Switzerland’s policies and institutions are held to standards of social equity that are broadly similar to Germany’s own. At the same time, Switzerland’s relatively favorable labor market record is underpinned by labor market institutions that allow flexible responses to adverse shocks: (i) a largely decentralized wage bargaining system that relies more on firm-level bargaining; (ii) a multipillar social insurance system with significantly lower social contribution rates; (iii) time limits on the duration of unemployment benefits, coupled with requirements to participate in active labor market programs; and (iv) lower employment protection and less generous nonwage benefits.

23. In terms of timing and political feasibility, a corporatist policy strategy would have some advantages, but its longer-term sustain ability is questionable. A corporatist strategy is consistent with Germany’s existing labor market institutions and can therefore be implemented more quickly than institutional reforms that call for changes of embedded formal and informal rules of a society. Moreover, once implemented, a corporatist agenda might yield quicker results in terms of employment growth. However, at the same time, a corporatist strategy is largely based on time-limited agreements among the social partners that can be revoked—raising a time inconsistency issue. But more importantly, the longer-term sustainability of a corporatist agenda is open to question, especially as regards the sustainability of wage moderation. Moreover, this policy strategy would not address the need to improve the economy’s resistance to future shocks that could test the labor market.13

24. Implementing an institutional reform strategy holds considerable longer-term promises but may also have some short-term cost. Institutional reforms would add built-in error correction mechanisms that could help reducing the existing stock of unemployment as well as provide insurance against future shocks. At the same time, a rapidly growing literature on institutional change in labor markets suggests that changing inefficient institutions is costly in the short term, in part because of the loss of knowledge and political power that relates to organizations and individuals operating in the context of the existing institutions.14 Institutional reforms tend to be time-consuming as they involve difficult political trade-offs.

25. These considerations suggest that a two-track approach in terms of sequencing labor market reforms could be promising. Elements of a corporatist policy strategy, especially wage moderation, could help the economy to prolong the present cyclical upswing and—with some luck regarding adverse future shocks—could deliver the first installment of a “new-growth-cycle-era” scenario. In the medium to longer term, however, elements of the institutional reform strategy would need to be put in place to lock in gains and increase the labor market’s shockresistance. A key difficulty with this two-track approach, though, would be to ensure the incentives that the institutionalist reform steps are indeed undertaken. This would be an issue if the initial benefits of a corporatist agenda created the misleading impression that meaningful but difficult institutional reforms were not essential for durable improvements in the functioning of Germany’s labor market.

References

  • Advisory Council to the Ministry of Economics and Technology, 2000, Aktuelle Formen des Korporatismus, June 2000.

  • Calmfors, Lars and Per Skedinger, 1995, “Does Active Labor Market Policy Increase Employment? Theoretical Considerations and Some Empirical Evidence from Sweden,” Oxford Review of Economic Policy, Vol. 11, No. 1, pp. 91109.

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  • Council of Economic Advisors, 1999, Wirtschaftspolitik unter Reformdruck, Stuttgart.

  • Deutsche Bundesbank 2000, “The Economic Scene in Germany in Summer 2000,” Monthly Report August 2000, pp. 566.

  • Flanagan, Robert, Joop Hartog, and Jules Theeuwes, 1993, “Institutions and the Labor Market,” in: Labor Market Contracts and Institutions: A Cross-National Comparison, eds. Hartog and Theeuwes, pp. 41546, North-Holland.

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  • Jaeger, A., L. Kodres, C. Kollau, S. Hubrich and E. Prasad, 1999, Germany—Selected Issues and Statistical Appendix, Chapter I: Institutional Change and Economic Performance: A Fifty-Year Perspective, IMF Staff Country Report No. 99/130 (Washington: International Monetary Fund) pp. 833.

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1

Prepared by Albert Jaeger.

2

Moreover, Germany’s labor productivity levels are likely to be underestimated (relative to the United States) owing to differences in the statistical treatment of investments in new information technologies. See Deutsche Bundesbank (2000, p. 8).

3

Preamble of the government’s coalition agreement (dated October 1998; own translation).

4

This interpretation of the interaction between shocks, labor market institutions, and financial policies in Germany draws on Chapter I (Institutional Change and Economic Performance: A Fifty-Year Perspective) in last year’s Selected Issues Paper on Germany, which also provides a number of references to articles and books that adopt similar interpretations of Germany’s postwar growth cycle history, specifically Paqué (2000) and vander Willigen (1995).

5

Labor market institutions are defined as the formal (legal) and informal rules that underpin bargaining on wages and other work conditions, the social insurance system, the social safety net, and active labor market policies. See Williamson (2000) for a survey of the “new institutional economics.”

6

Prasad (1999) documents the stability of Germany’s wage distribution over time.

7

Prasad (2000) presents evidence on the spreads between reservation wages (based on survey data compiled within the German Socio-Economic Panel (GSOEP)) and take-home pay offered by the market.

8

Calmfors and Skedinger (1995) discuss theoretical considerations and empirical evidence (for Sweden) that suggest that the effectiveness of active labor market policies may be quite limited.

9

The Alliance for Jobs is a social partner forum initiated by the government in 1998 to coordinate a comprehensive approach to improving labor market conditions; the Alliance comprises the government, employers’ associations, and the trade unions.

10

Chapter II provides a detailed analysis of the economic effects of wage moderation and the Dutch experience.

11

U.S. data suggest, however, that since 1995—the period most clearly associated with the “new economy” boom in the United States—wage inequality has ceased to worsen.

12

This agreement between labor unions and employers formalized an understanding to aim at wage moderation to stimulate employment. For more details on the overall Dutch experience, see Watson and others (1999).

13

In this context, however, a recent report by the Advisory Council to the Ministry of Economics and Technology (2000) argued that corporatist policy strategies entail significant costs in terms of conserving statusquo structures.

Germany: Selected Issues
Author: International Monetary Fund