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The German Geist

At some point in every generation, British policymakers look in envy and awe at the German economy.

It last happened in the early 1990s, when the UK was recovering from the post-Lawson bust and the ignominy of forced exit from the exchange rate mechanism. Will Hutton’s The State We’re In captured the zeitgeist of this era brilliantly: a time when the Rhineland social market economy appeared to offer a stronger and fairer variety of capitalism than its rapacious, unequal and structurally weak Anglo-Saxon competitor.

The tables turned as the 1990s wore on. Anglo-Saxon economies boomed and created jobs while the German economy got stuck in low growth and high unemployment. Gerhard Schroeder talked about the ‘Neue Mitte’, in conscious emulation of the Clinton–Blair ‘third way’. Germany embarked on difficult structural reform of its labour market and held down real wages as it entered the euro.

The pendulum has swung back and the German model is now in vogue again. The TUC has produced a detailed report on the lessons of Germany’s manufacturing strength, attributing its export prowess to deep institutional foundations in its social partnerships, apprenticeships and industrial strategies. Maurice Glasman regularly sings hymns of praise to Germany’s regional banks, vocational traditions (implanted, he argues, by Ernie Bevin after the second world war), and the fact that workers share fully in company decision-making. Meanwhile, shadow business secretary Chuka Ummuna has recently been on a study tour of Germany to mug up on how it achieves a more patient, responsible and resilient capitalism.

More surprisingly perhaps, British free market conservatives have recently joined in these paeans to German economic might, not because they admire the Hayekian logic of its central bankers, but because they believe it has deregulated its labour market and made it easier for small businesses to hire and fire. An economy once considered over-regulated, highly taxed and utterly sclerotic now apparently offers the way forward for free enterprise.

Germany’s appeal is not difficult to understand. Its famous Mittelstand of medium-sized family companies that export all over the world has long been admired. It has a superb apprenticeship system and huge investments in both physical and human capital. Its industrial social partnerships have proved a source of durability and strength in the era of globalised markets, not a weakness. Recently it has coupled an expanding service sector to its historic industrial pre-eminence.

What has attracted most attention recently, however, is its astonishing employment performance. As the graph below shows, Germany’s unemployment rate is now lower than it was before the financial crisis struck, while in most of the rest of the OECD it remains high or rising. This is a huge turnaround from the position Germany was in barely half a dozen years ago.

Unemployment rate

What explains this impressive labour market recovery? Deregulation of service sector employment and the creation of ‘mini jobs’ through employment agencies certainly account for part of the story. The Hartz reforms introduced greater flexibility in the German labour market outside the core export and public administration sectors, particularly in hotels and catering. The generosity and duration of unemployment benefits were reduced, in order to lower the reservation wage (although these remain set at far higher levels than in the UK or US), and labour market activation strategies were implemented. Small businesses were exempted from unfair dismissal laws, although workers could opt for severance pay instead of legal action.

Marginal employment (minijobs) relative to employment covered by social insurance by sector, March 2008 (100% = parity)

Note: Broad sectors in capital letters; other lines are selected subsectors.
Source: Federal Employment Agency

These reforms created a large sector of low-wage employment in the Germany: one in five jobs is now low-paid. Importantly, however, these jobs are topped up by in-work benefits, rather like a tax credit system, so that work still pays. Sectoral minimum wages have also been extended.

At the same time, the German model has retained the core building blocks of its social partnership model in its higher-skilled sectors. In these sectors, flexibility has been introduced not to make it easier to dismiss highly valued workers but to ensure that they can be retained when demand for labour is weak. Work sharing arrangements and short-time working, with social insurance benefits to top up workers’ incomes, have played a key role in preventing job losses. Half of all German employees also have so-called working time accounts, in which wages for overtime and extra hours built up during periods of expansion are banked to cover hours lost during periods of recession, thus smoothing income from employment over the business cycle.

Hours worked adjustment in the crisis and hourly labour productivity in the crisis

Hence only the most partial account of recent German experience could attribute its labour market success merely to deregulation in the service sector. A fuller picture would record its ‘dual path to flexibility’ by which the high-skill equilibrium of its core political economy has been strengthened and reformed, alongside measures to facilitate the creation of flexible service sector employment. Indeed, some re-regulation of the margin is now being considered, with calls for a national minimum wage. The following table from Werner Eichhorst and Paul Marx’s important study, Reforming German Labor Market Institutions: A Dual Path to Flexibility, sets out the logic and sequence of these reforms in summary fashion.

Sequences of reforms since the early ’90s

One area where Germany still needs reform to improve its employment rate in the context of its rapidly ageing society is childcare and family-friendly employment. In recent years, it has taken a Nordic turn towards expanding the supply of preschool places and in 2013 a new childcare entitlement will come into force for children over the age of one. Social conservatives have secured an equivalent financial entitlement for stay-at-home parents – but if the Nordic experience is anything to go by this will impede increases in female employment rates and lead to lower take-up rates of early learning by new migrant families, thus increasing segregation and inequalities in schooling. Nonetheless, the expansion of childcare is another important step forward for Germany on the road towards a modern, family-friendly and fiscally sustainable welfare state.

So what lessons should we learn from Germany? To avoid the swings of intellectual fashion or ideological cherry-picking, we would do well to heed Matthew Taylor’s advice in his recent and nuanced blog on the subject and ‘aim to find our own mix of the strengths of the UK Anglo-Saxon model and the German social market model’. For its part, Germany needs to heed the call from the rest of Europe and rebalance its economy towards higher domestic consumption. A large part of its success rests on a consolidation of competitive advantages it secured within the eurozone during the boom years. The imbalances this produced will not be overcome by imposing austerity and unemployment on the rest of the continent.









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