(in cooperation with Ulrich Fritsche)
With politicians from right and left in Germany discussing a possible new extension of the duration of unemployment benefits for the elderly, a new debate in Germany has started concerning the reasons of the recent upswing. The central question of the argument is: What role did the labour market reforms of the Schröder government play for the “Teutonic turnaround” as Michael Burda calls the recent development in his first post for this blog?
While the German mainstream is now mainly crediting the “Agenda 2010” reforms for the recent upswing along the lines of Michael Burda’s analysis (although, in contrast to Michael, at the time of the reform package being discussed in the Bundestag most of them criticised the bills as being not far-reaching enough to have a feelable impact on economic growth or unemployment), there are dissonant voices from abroad: FT columnist Wolfgang Munchau calls the idea that the reforms contributed to the recent upswing as “nonsense”. David Soskice from Oxford and Wendy Carlin from London also question this assumption in a very careful comparison between the German and the British experience (published as CEPR discussion paper).
The discussion on the sources and driving forces of the turnaround in Germany is of great interest. First, the German case will surely be referred to as a benchmark for further reform programs as it is one of the few natural experiments we have for labour market reforms in large economies. Second, the analysis of the origins of the German turnaround is of great interest to investors. If the turnaround was mainly due to the reforms, a partial scaling back of the Agenda 2010 as it seems to be in the cards now would mean a danger of Germany falling back into stagnation with corresponding risks for German assets.
In a mini-series of three posts, Ulrich Fritsche (another contributor to RGE Monitor’s European EconoMonitor) and me will confront the story of the Agenda 2010 being the jump starter for the German recovery with some recent empirical data on economic developments in Germany.
We will start today with a look at the German labour market. In a second part over the coming days we will disect the impressive gain in German stock valuations since 2003 and will ask how plausible it is that this gain comes from a reform dividend. Finally, in a third post, we will propose an alternative explanation for the German turnaround.
While the Agenda 2010 was a potpourri of unrelated small reforms in many areas (dropping the regulation of a number of small crafts; speeding up some income tax cuts already decided by one year; closing some tax loopholes), the main thrust was the labour market: The duration for the receipt of unemployment benefits for the elderly was cut and the unemployment assistance for those being unemployed for more than one year was completely scrapped, pushing long-term unemployed into the welfare system. For the long-term unemployed this meant not only significant cuts in benefits, but also that they had to run down their savings as the new benefit was means-tested (which the old unemploment assistance was not). In addition, rules for temporary work were relaxed. Another key element was the reform of the Federal Unemployment Agency (“Bundesanstalt für Arbeit”) supposedly to enable the agency to bring unemployed into work more easily.
For most economists, the reform of unemployment assistance was the most important (and among the population the most unpopular) element of the reform. According to supply-side analysis, the cut has increased the incentives for the long-term unemployed to seek a new employment. As most German economists believe than unemployment in Germany was mainly (if not exclusively) structural as opposed to cyclical, this is seen as being at the root of the turn-around in the labour market.
Empirically, however, there is a problem with this analysis: If the increased incentive for the long-term unemployed to seek employment were behind the turn-around of the labour market, unemployment among this group should have fallen most.
However, this is not the case – not by far. The number of unemployed in Germany has fallen by an impressive 1.1 million to 3.7 million over the past 24 months. Over the past year alone, the number of unemployed dropped by 700,000. Since the fall of 2005 (two years ago), unemployment among the short-term insured unemployed (those who did not experience any cuts in benefits) has fallen by almost half from 1.33 million to only little more than 700,000. In contrast, the number of long-term unemployed in the welfare system has fallen by a little more than 10 percent from a little more than 2.8 million to 2.5 million now. Moreover, the drop in the number of long-term unemployed reacted later to the upswing than that of the short-term unemployed. Figure 1 below taken from the labour agency’s recent monthly bulletin illustrates the point: The number of those receiving benefits for short-term unemployment (“SGB III”) has fallen much faster than those on welfare (“SGB II”).
Of course, the strong drop of short-term unemployment is what you would expect in a cyclical upswing. However, it is not what you would expect in an upswing induced by increased incentives of the long-term unemployed to seek employment, but rather what you expect in any cyclical expansion of aggregate demand.
However, theoretically there might be another channel which can help to explain how the labor market reforms might have stimulated the turnaround: The scrapping of unemployment assistance might have made unemployment more painful thus diminishing the wage bargaining (monopoly) power of trade unions in labor markets. This might correct some insider-outsider bias at work in labor markets, which for a long time might have led to excessive wage demands and destroyed jobs. The resulting wage restraint not only redistributes the earnings of the boom differently by increasing the profit share but helps to invest in labor-intensive technology. In fact, this is the argument the Kiel institute makes in its analysis of the upswing.
Undoubtedly, there has been impressive “wage restraint” in Germany. However, the claim that it was induced by the reforms is rather weak as it has started much earlier – and long before the announcement of any reform package. The following figures illustrate this point. First in figure 2, we plotted nominal wage increases per employee of the total economy (sorry for not using hours but these data are not consistently available for our reference groups) for Germany vs. EU 15 (Source: AMECO). To smooth the fluctuating data and extract a trend, we used a regular Hodrick-Prescott filter (to avoid end-point problems, the data were extended using the forecast of the DG ECFIN). There is clear evidence that wage increases have been falling behind the EU 15 average for a decade.
The same conclusion can be drawn if you look at the nominal wage per employee of the total economy calculated as an index relative to reference groups (figure 3) — the source again being the AMECO data base.
What matters of course for competitiveness, however, is the nominal wage increase relative to productivity as measured by unit labor costs. Figure 4 shows the relative nominal unit labor cost index of several countries relative to the Euro area average (1998 = 100), the calculations are explained in a paper by Dullien and Fritsche (2006). Again, it is impressive to see how Germany steadily improved its competiveness over 10 years in a row — whereas other countries in the Southern cone of the Euro area show a steady decline over the same time span. But there is no evidence whatsoever that this trend accelerated after March 2003 when the Agenda 2010 was introduced (or after 2005 when it came into effect).
Thus, in our opinion, the empirical case is rather weak that the Agenda 2010 reforms of the Schröder government actually have triggered the recent turnaround in the German economy.
Read next: Why the development in German stock prices does not tell much about a German reform dividend
This post was co-posted at Eurozone Watch.