From sick man of Europe to economic superstar: Germany’s resurgence and the lessons for Europe

Christian Dustmann, Bernd Fitzenberger, Uta Schönberg, Alexandra Spitz-Oener 03 February 2014

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In the late 1990s and into the early 2000s, Germany was called ‘the sick man of Europe’ (Bertram 1997). Today, Germany is Europe’s economic superstar.

  • German unemployment fell from five million in 2005 to about three million in 2008, with the rate dropping to 7.7% in 2010.
  • Germany’s exports reached an all-time record of $1.7 trillion in 2011, which is roughly equal to half of Germany’s GDP, or 7.7% of world exports.

How did Germany, with the fourth-largest GDP in the world (after the US, China, and Japan) transform itself from ‘the sick man of Europe’ to an ‘economic superstar’ in less than a decade?

Many analysts give much credit to German labour-market changes known as the. Others put it down to a left-over effect of overly cautious hiring during the 2005–07 export boom.

In a recent paper (Dustmann, Fitzenberger, Schönberg and Spitz-Oener 2014), we argue that:

  • The astonishing transformation of the German economy is due to an unprecedented process of decentralisation of wage bargaining that led to a dramatic decline in unit labour costs and ultimately to an increase in competitiveness of the German economy.
  • The process of wage decentralisation was made possible by the specific governance structure and autonomy of the German labour-market institutions, not rooted in legislation, but laid out in contracts and mutual agreements between employer associations, work councils, and trade unions.

In times of challenging economic circumstances, Germany’s labour-market institutions thus proved far more flexible than previously thought.

  • The 2002-05 Hartz reforms played no essential role.

Both the process of decentralisation of wage bargaining and the improvement in competitiveness of German industry started in the mid-1990s, nearly a decade before.

The findings provide a new view on the role of policy in the dramatic resurgence of Germany’s economy. We don’t believe that the political process alone – had the autonomy of wage bargaining not existed – would have been able to achieve a similar degree of wage decentralisation in Germany, which ultimately led to the significant improvement in competitiveness that we have witnessed.

Lessons for southern Europe

Our research has important consequences for what Europe’s ailing southern European countries can learn from the German experience. Other countries, such as Italy and France, have far more centralised and legally anchored labour-market institutions than Germany, and reform will have to rely more on the political process. Whether similarly radical changes can be achieved in these countries remains therefore an open question.

The German experience does therefore not provide support for recommending the Hartz-type of political reforms that Germany implemented. Rather, Germany’s experience focuses attention on reforms that target the system of industrial relations by decentralising bargaining to the firm level while keeping workers representatives involved.

How did Germany improve competitiveness?

Figure 1 plots the ‘relative unit labour costs’ for a country’s overall economy adjusted for the changing composition of the markets in which it competes, for a selection of countries, in dollar terms (see our paper for details on computation). The figure shows that since 1995, Germany’s competitive position has persistently improved, while the competitiveness of some of its main European trading partners has deteriorated (Spain and Italy) or remained close to the 1995 position (France).

We argue that in the early to mid-1990s, the specific governance structure of the German system of industrial relations allowed for an unprecedented increase in the decentralisation (or localisation) of the process that sets wages, hours, and other aspects of working conditions, from the industry- and region-wide level to the level of the single firm or even the single worker. This process of wage decentralisation helped to bring down wages, in particular at the lower end of the wage distribution, and ultimately improved the competiveness of the German economy.

Germany’s system of industrial relations is not rooted in legislation and is not governed by the political process, but instead is laid out in contracts and mutual agreements between the three main labour-market parties: trade unions, employer associations, and works councils (the worker representatives who are typically present in medium-sized and large firms).

This allowed for an unprecedented decentralisation of the wage setting process, driven by two main developments:

  • A sharp decline in the share of workers covered by union agreements; and
  • An increase in opening clauses that strengthened the role of firm-based works councils in wage determination relative to trade unions.

Figure 1.

Source: OECD Economic Indicators, OECD (various).

How much did the ‘Hartz’ reforms contribute to Germany’s economic success?

The Hartz reforms to the labour markets implemented under Chancellor Gerhard Schröder were not central in the process of improving the competitiveness of German industry. The reforms were implemented nearly a decade after the process of decentralisation and the strengthening of competitiveness had begun. Further, while the focus of the reforms was on creating incentives for seeking employment, they did little to support the remarkable wage restraint witnessed since the mid 1990’s which is the key factor in explaining the gain in competitiveness.

Why did the flexibility of the system of industrial relations only become apparent from the mid 1990s onwards?

We argue that the fiscal burden of German re-unification, coupled with an immediately more competitive global environment, made it increasingly costly for German firms to pay high union wages.

  • The new opportunities to move production to eastern Europe changed the power equilibrium between trade unions and employer federations.

This forced unions and/or works councils to accept deviations from industry-wide agreements which often resulted in lower wages for workers. Germany’s unions and works councils realised that they had to make concessions in order not to be further marginalised.

The specific characteristics of the German system of industrial institutions allowed the trade unions to adapt to the new economic realities and to make these concessions. As a result, the German labour market appeared to be far more flexible than many would ever have expected.

Why did other countries not react in the same way as Germany?

The system of industrial relations in other continental European countries does not allow for the same inherent opportunities of flexible adaptation as the German system.

  • In countries like France and Italy, union wages are often bargained at the national level.

They apply to all firms in the economy, regardless of whether the firm explicitly recognises the union contract. Coverage by union wage contracts is remarkably stable at very high levels at about 90% in France and 80% in Italy during the 1990s and the 2000s (OECD 2004, 2012; Visser 2013).

  • In contrast to Germany, union wage contracts are typically extended to all workers in an industry (OECD 2004, Table 3.4, p. 148; Visser 2013, Table 4, pp. 96-98).

More generally, many of the regulations which are determined by labour contracts in Germany are either legally enforced in other countries (such as the minimum wage in France) or nationally implemented (for example, union agreements extend to all firms in the economy). They thus require consent on a much higher level (nationally, or even on the political level) to be modified and changed. There is much less scope in these countries for a decentralisation of wage setting (and other aspects of working conditions) within their system of industrial relations.

What are the lessons for Europe?

Although one sometimes hears the argument that other continental European countries should muster the political will to adopt their own version of the Hartz reforms, we believe that such a recommendation may be misleading.

In our view, it was the specific governance structure of the German system of industrial relations that – activated under extreme duress - has paved the way for the remarkable decentralisation of wage determination, from the industry level to the level of the single firm or single worker, which together with a significant increase in productivity ultimately improved Germany’s competitiveness. Whether the political process would have been able to achieve a similar degree of wage decentralisation, had the autonomy of wage bargaining not existed in Germany, is doubtful.

Therefore, the policy recommendation from Germany for the rest of continental Europe should not be the Hartz reforms (an advice often given by German economists, e.g. by Rinne and Zimmermann (2013), or policymakers, e.g. by Chancellor Angela Merkel, but reforms that would target the system of industrial relations by decentralising bargaining to the firm level while keeping workers’ representatives involved to secure that employees benefit again when economic conditions improve.

References

Bertram, C (1997), "Germany: The sick man of Europe?", Project Syndicate, 18 September.

Dustmann C, B Fitzenberger, U Schönberg and A Spitz-Oener (2014), "From Sick Man of Europe to Economic Superstar: Germany’s Resurgent Economy", Journal of Economic Perspectives 28(1), pp. 167-188; also available as CReAM Discussion Paper No. 06/14.

OECD (2004, 2007, 2012), Employment Outlook, OECD Publishing, Various Issues, Paris.

Rinne, U and K F Zimmermann (2013), "Is Germany the North Star of Labor Market Policy?" IMF Economic Review, 61(4), 702-729.

Visser, J (2013). Wage Bargaining Institutions - from crisis to crisis. Economic Papers 488

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Topics:  Labour markets

Tags:  unemployment, Hartz reforms

Professor of Economics, University College London and Director of the Centre for Research and Analysis of Migration

Professor of Statistics and Econometrics, University of Freiburg

Associate Professor in the Department of Economics, University College London

Professor of Economics at the Department of Business and Economics, Humboldt University Berlin; Research Fellow, Institute for Employment Research