The roots of the German miracle

Hermann Gartner, Christian Merkl, 9 March 2011

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While the US labour market has seen a dramatic loss in jobs in the Great Recession, the German labour market has seemed to be unaffected – the number of employed workers has remained stable. This is all the more surprising as German GDP dropped more than in the US in 2009 (-4.7% vs. -2.7%). Some economists (e.g. Möller 2010) have correctly pointed out that German firms were hoarding labour and thereby absorbing part of the output shock.

We believe that German short-time work (“Kurzarbeit”) and the lack of qualified workers are not sufficient to explain labour hoarding by German firms. To make this point, it is instructive to compare the development of the labour market during the two strongest post-World War II recessions:

  • The Great Recession in 2008, and;
  • The first oil-price shock in 1974.

There are remarkable similarities, but one key difference. The 1974 recession hit Germany at a time of rising unit labour costs (i.e. real wages divided by productivity), while the Great Recession arrived at a time of wage moderation. We argue that the wage moderation in Germany is at the root of the German Miracle, potentially interacting with other measures such as the public short-time work scheme.

Figure 1. Output and working hours

Note: Quarterly data, output is real GDP, the peak in GDP (t = 0) is in 1st quarter 1974 and in 1st quarter 2008, series are standardized to one at t=0. Cyclical components are log-deviations from HP-trend with smoothing parameter lambda=1600. Source: Federal Statistical Office and IAB

At first glance (Figure 1), the 1974 and the 2008 recessions look very similar. In both slumps:

  • Output dropped (the log-deviation from trend is very similar in both recessions) and
  • Firms reduced the working hours per person by a similar amount.

Interestingly, the number of employed workers shows very different dynamic patterns (Figure 2).

  • While employment dropped in the 1974 recession, it remained more-or-less stable in 2008.

Identities from national accounting tell us that productivity per working hour rose in 1974, while it was falling in 2008, in fact by 4%.

Figure 2. Employment and productivity

Note: see above, Productivity is the output per working hour

We believe that German short-time work (Kurzarbeit) helped to stabilise employment in both recessions (see Faia et al. 2010 which simulate the quantitative effects of short-time work). But the marked differences between these two recessions can certainly not be explained by short-time work alone. The measure was used to a similar degree (the maximum share of short-time workers on total employment was 3.6 in 1974 and 3.8 in 2008). Similarly, the lack of qualified workers can probably not explain why firms hoarded workers in 2008 but not in 1974. Workers were also very scarce at the beginning of the 1970s when the unemployment rate was around 1%.

Figure 3. Real wages per unit of output



Note: see above

The most pronounced difference between the 1974 and 2008 recession can be seen in Figure 3.

  • Unit labour costs were rising substantially before the 1973 oil crisis, but
  • Germany experienced strong wage moderation for at least four years before the Great Recession.

Why do we expect this to matter?

Aggregate shocks (the wage moderation can be interpreted as a positive permanent supply shock) take a long time until they show their full effect on the real economy (due to adjustment mechanisms). To put it differently, what we see in the data is Germany’s move to a higher permanent employment level which was interrupted by the Great Recession. Since firms saw a fall in their wage costs before the crisis, they could accept a temporary rise in wage costs during the crisis (anticipating that the crisis would be temporary) and afford to keep their workers (see Boysen-Hogrefe et al. 2010, Boysen-Hogrefe and Groll 2010 for theoretical and empirical analyses on this issue).

Conclusion

Without the wage moderation before the Great Recession, the German miracle would have been impossible. This is a point that is often ignored in the German public debate. The German Hartz reforms, which made the unemployment benefit system less generous, were certainly one of the reasons for the wage moderation. The reform was initiated in 2002 by a governing coalition, led by chancellor Schröder and the ruling Social Democrats. For some reason the Social Democrats are currently ashamed of this reform. If only they were to look at the facts from the Great Recession, they would surely be proud.

References

Boysen-Hogrefe, J, D Groll, W Lechthaler, C Merkl (2010), “The Role of Labour Market Institutions in the Great Recession”, Applied Economics Quarterly, 61:65-88.

Boysen-Hogrefe, J and D Groll (2010), “The German Labour Market Miracle”. National Institute Economic Review, 214:R38-R50.

Faia E, W Lechthaler and C Merkl (2010), “Fiscal Multipliers and the Labour Market in the Open Economy”, Kiel Working Papers 1592, Kiel Institute for the World Economy.

Möller, J (2010), “Germany's Job Miracle in the World Recession – Shock-Absorbing Institutions in the Manufacturing Sector”, Applied Economics Quarterly, 61:9-28

Topics: Europe's nations and regions, Labour markets
Tags: Germany, Labour-market reform, unemployment

Hermann Gartner
Senior Researcher, Institute for Employment Research, and Lecturer, Institute for Economics, University of Erlangen-Nuremberg
Christian Merkl
Professor of Macroeconomics, University of Erlangen-Nuremberg