Lessons from the German Labor Market Reform

TSURU Kotaro
Program Director and Faculty Fellow, RIETI

The German economy has displayed notable resilience since the European debt crisis. After posting the largest drop in Europe in the first quarter of 2008, a period after the global financial crisis, Germany has generally maintained high growth as the engine of the European economy. With the unemployment rate continuing to rise in many countries, in Germany, after peaking in 2005, it has fallen to the mid-5% level although it slightly increased in 2008 and 2009. The spotlight is currently focused on the German economy, which has shown remarkable resilience, and its labor market.

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Turning back the clock 10 years ago, Germany was called the "sick man of Europe" due to its sluggish economy, and its unemployment level was higher than in other major European countries. In 2002, former German Chancellor Gerhard Schröder appointed Peter Hartz, a Volkswagen AG executive in charge of labor relations, to establish the Hartz Commission. "Agenda 2010" was announced in March 2003 to indicate the direction of reform. The country carried out a series of reforms called the Hartz reforms during the period from 2003 to 2006.

Specifically, pursuant to Hartz I and II (effective in 2003), unemployed persons began to be registered as temporary workers, and personnel service agencies were established to help them find jobs. Other measures included the adoption of a self-help support program through the establishment of individual businesses and a low wage support program, which grants partial exemptions from income taxes and social security payments.

According to Hartz III (effective in 2004) that followed, the Federal Employment Agency and local employment agencies, which are comparable to Japan's public job placement agency (Hello Work), were drastically reorganized to improve their functions. They were now required to set numerical targets and achieve accountability for performance. Furthermore, services were diversified, and competition with the private sector was promoted. Pursuant to the Labor Market Reform Act (effective in 2004), the period of unemployment benefit payments has been considerably reduced. Meanwhile, separately from conventional unemployment benefits, unemployment assistance allowances (to those who do not qualify for unemployment benefits), which had been provided almost permanently, and social assistance allowances (to needy persons) were given. Pursuant to Hartz IV (effective in 2005), the former and part of the latter have been integrated into a new unemployment benefit program to enhance motivation to find employment.

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In the 10 years since the start of these reform measures, analyses focusing on the German "miracle" have been published successively in recent years. They can be broadly classified into those on the impact of the reform and those on the factors that helped the country overcome the Great Recession of 2008-2009.

University of Paderborn Professor René Fahr and University of Munich Professor Uwe Sunde in their 2009 paper estimated the function that indicated the determinants of the number of newly employed workers by using monthly data. The analysis showed that the Hartz reforms mainly had a positive impact on the speed of matching in the manufacturing sector and that Hartz III had a faster and stronger effect than Hartz I and II.

The Deutsche Bundesbank's Michael Krause and the University of Chicago Professor Harald Uhlig pointed out in their 2012 paper that the German unemployment rate dropped 2.8% by discontinuing unemployment assistance allowances, which had been paid almost permanently, in accordance with Hartz IV.

Bocconi University Associate Professors Luka Sala and Antonella Trigari and Sveriges Riksbank's Ulf Söderström in their 2012 paper analyzed changes in the labor markets in Germany, the United States, the United Kingdom, and Sweden by assuming models of the four countries that considered the fact that job finding and matching were time-consuming processes, as well as wages and other rigidities.

According to their analysis, Germany was the lowest among the four countries in terms of benefits received by unemployed persons. They concluded that the reform, which reduced the level and period of unemployment benefits and required unemployed persons to engage actively in job-seeking activities, had a significant impact. Matching efficiency dropped between 1994 and 2005, but it has improved since 2005.

They conducted an analysis of the factors behind the fall in unemployment from 2007 until recently. Major factors contributing to the fall were structural changes in the labor market, including an increase in matching efficiency as a result of the improvement in the job matching program and the weakening of workers' wage bargaining power. This was a point of difference from the other countries, where major factors were technological change and changes in the financial situation.

They also performed a simulation on the assumption that the German labor market had the same structure as that of the United States. The results showed that production would have made a similar move, while unemployment would have increased considerably during the Great Recession. This also suggests a positive effect of the German reform.

Among the analyses focusing on the German labor market during the Great Recession, a paper written by Humboldt University of Berlin Professor Michael C. Burda and Rutgers University Professor Jennifer Hunt in 2011 has drawn attention. As the reasons behind unemployment increasing by only a small margin during the recession, they emphasized a significant reduction in work hours per worker, as well as the limited job cuts during this period due to only a small increase in the level of employment during the preceding economic expansion period based on pessimistic economic assumptions.

They placed special emphasis on the role of working-time accounts. Under this system, employees save up their overtime work hours in their accounts in the same manner as savings in bank accounts, instead of being paid extra wages for overtime work. Saved hours can be used later to take leave, etc. The system was first adopted in Germany, and other European countries, such as the Netherlands, Belgium and France, have followed suit. In Germany, 48% of workers had working-time accounts as of 2005.

If overtime work hours increased during a boom period and if companies need to dismiss workers with balances in their accounts during a slump, they must pay extra wages corresponding to the work hours in the accounts. That is to say, the dismissal cost for workers with balances in their working-time accounts is higher than the cost for those without balances. Therefore, companies try to reduce employees' work hours during recessions and postpone job cuts until their account balances become zero. If business conditions begin to recover when the balances reach zero, then the companies will not need to reduce workforce.

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What are the implications of the German reform for Japan? The Hartz reforms, based on the idea "assist and demand," required workers to make self-help efforts, while attaching importance to facilitating the process of job finding through training and other assistance. In Japan, it is necessary to streamline the current job seeker support programs combining unemployment benefit payments and vocational training for those who are unable to receive unemployment insurance.

The second implication is that the most important factor in the German labor market reform was to improve the efficiency of the job finding and matching processes. A combination of various reform measures generated significant complementary effects. Specifically, employment agencies, which are comparable to Japan's public job placement agency (Hello Work), were reformed and reinforced to allow them to increase the penalties given to those who refuse to accept the jobs offered. Additionally, the deregulation of private placement services was implemented in advance.

The catchphrase of the Abe administration's employment policy is "smooth labor mobility without unemployment." In order to avoid writing it off as an "ear-pleasing slogan," it would be crucial to strengthen cooperative and complementary relations between Hello Work offices and private job placement businesses and to increase matching efficiency by creating an environment where the latter can display their maximum capability.

Finally, Japan should also adopt working-time accounts. There is already a system in place in which extra wages for overtime work exceeding 60 hours a month can be changed to paid leave. But this system should be improved and become a more common and comprehensive one. The working-time accounts will help increase the flexibility of work styles, allowing workers to take paid leave voluntarily and autonomously without hesitation. It is hoped that the system will contribute to an improvement in the work-life balance of workers and act as a trigger to increase the rate of workers taking annual paid leave.

>> Original text in Japanese

* Translated by RIETI.

May 22, 2013 Nihon Keizai Shimbun

June 26, 2013