Scott Sumner  

German success is surprisingly recent

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Many people assume that Germany has long been an economic success story. It was certainly successful back in the 1950s and 1960s. But as recently as 2004 it was widely viewed as the "sick man of Europe" despite all those sleek BMWs and Mercedes they churn out each year.

The normally reliable Matt Yglesias falls into the trap of (implicitly) assuming long term German success in a piece on youth unemployment. Yglesias tries to explain the low rate of youth unemployment by pointing to their system of technical training for students that are not college bound. That certainly seems like a fine system, but it's been around for decades, and thus can hardly explain the amazing post-2004 German jobs miracle. Why do I use the term 'miracle'? Consider:

1. Germany was hit roughly as hard by the 2008-09 recession as the US.
2. Unlike the US, the German working age population is not growing.

Put those two together and you'd expect very little German job creation in recent years. And yet German employment has risen by 6% over the past 6 years, whereas American employment has declined, despite a RGDP recovery that is far more brisk than the eurozone, indeed faster than in Germany. That's pretty amazing.

I sometimes wonder how progressive readers would filter Yglesias's message. The type that thinks that if a program works in Sweden it would certainly work over here. The ones that Paul Krugman insists are "reality based" in their thinking. German job training seems good, and Obama has recommended some programs for America. The highly inegalitarian German high school system might make American progressives squirm, but Yglesias reassures them that this approach would be hard to implement in a country that lacks the tight cooperation between companies, unions and local governments.

Of course none of this has anything to do with explaining how Germany went from being the sick man of Europe to its shining star, all in a period of 10 years. Here's the German unemployment rate since 1960. Notice that Germany had 8% unemployment as far back as the mid-1980s, during the Reagan boom in America. Things had been getting worse for decades, and the 1980s figures suggest that the problem wasn't just German reunification.

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So what's the real explanation for the German success? That's pretty obvious; the Hartz reforms of 2003 sharply reduced the incentive to not work, and sharply increased the incentive to take low wage jobs. As a result, today Germany has lots of very low wage jobs of the type that would be illegal in France or California. (Germany has no minimum wage.) Here is the Guardian:

Exactly 10 years ago today, Germany's labour market was subjected to the first of the so-called Hartz IV reforms. Brought about by the smooth centre-left chancellor Gerhard Schröder, it was a watershed moment that changed the way the German government deals with poverty.

The changes were riddled with the kind of Anglicisms that German officialdom likes to deploy for any modernisation. In the past decade, unemployed Germans have been bewildered with a kaleidoscope of new "Denglish" terms, from "Jobcenter" to "Personal Service Agentur" to "Mini-Job" to "BridgeSystem". But the measures recommended by the Hartz commission - named after its chairman, former Volkswagen executive Peter Hartz - boiled to down to this: the bundling of unemployment benefits and social welfare benefits into one neat package.

The immediate effect was to leave those living on benefits worse off (as of 2013, the standard rate for a single person is €382 a month, plus the cost of "adequate housing" and healthcare). But the new element that brought the most profound change was the contract, drawn up between the "jobseeker" and the "Jobcenter", which defined what each party promised to do to get the jobseeker back on somebody's payroll. This was coupled with "sanctions" - in other words, benefit cuts - if the jobseeker failed to keep up his or her side of the bargain. With those two measures, Germany came to accept the modern interpretation of the word "incentive" in the job market: the doctrine that poor people will only work if they are they are not given money.

There are myriad debates about the net results or benefits of the Hartz reforms. Unemployment, both long-term and short-term, has certainly dropped considerably in Germany since 1 January 2003, but critics say that's only because most jobless people are forced to accept the next job they can find - and often they end up in one so low-paid and part-time that they were still dependent on some sort of state welfare anyway. Then again, the flexibility that allows employers - especially major industrial companies - to take on and lay off part-time shift workers depending on the state of the export market has certainly helped Germany to ride out the global economic crisis in the past three years.

But what is hard to overlook is that the Hartz reforms have had two social effects. First, they have helped to accelerate inequality in Germany. According to an April 2012 OECD report, "Germany is the only [EU] country that has seen an increase in labour earnings inequality from the mid 1990s to the end 2000s driven by increasing inequality in the bottom half of the distribution." The report goes on to point to "a set of reforms in 2003 meant to increase the flexibility of the labour market" which help to explain the "wage moderation".

So the one major success story among developed countries has achieved its success by doing essentially the exact opposite of what progressives want. Germany has no minimum wage, reduced its incentives to live off welfare, and has a level of wage inequality that is increasing even faster than in the US. It's no wonder that progressives prefer to focus on things like "vocational training programs," which were just as common during the 30-year period of steadily rising German unemployment.

And yet Paul Krugman can say the following without blushing:

Just to be clear: Yes, you can find examples where *some* liberals got off on a hobbyhorse of one kind or another, or where the liberal conventional wisdom turned out wrong. But you don't see the kind of lockstep rejection of evidence that we see over and over again on the right. Where is the liberal equivalent of the near-uniform conservative rejection of climate science, or the refusal to admit that Obamacare is in fact reaching a lot of previously uninsured Americans?
Here's an example for Krugman. Much of the progressive movement seems entranced by a pied piper from France who thinks inequality can be reduced almost costlessly, and that even France needs to be much more socialist. Meanwhile they almost totally ignore a highly successful social market economy. The biggest economy in Europe. What would Al Gore call German labor market policy success? An inconvenient truth?

PS. I have a follow-up post on Germany here.

Comments and Sharing

COMMENTS (15 to date)
Sven_ writes:

One additional information: While wage inequality grew in germany since the introduction of the Hartz reforms, income inequality actually decreased slightly!

I think it is not all too difficult to explain why.

Ricardo writes:

Why do you suppose the seasonal pattern became so muted eight years ago? It's as if the seasonality disappeared almost completely!

Scott Sumner writes:

Thanks Sven, Very interesting data.

Ricardo, I'm really not sure. Perhaps they switched to seasonally adjusted figures?

Norman Pfyster writes:

I assume wage inequality grew because no one counts people not earning a wage in the calculations. If they counted at $0, maybe wage inequality would not have increased.

MikeP writes:

If they counted at $0, maybe wage inequality would not have increased.

Indeed. It is exactly correct to average in at zero wage someone who is unemployed considering that someone who is underemployed gets averaged in at whatever nonzero but low wage they are making.

Anand writes:

I looked at the OECD 2012 study cited in the Guardian piece you mentioned. Here are some more points made there:

"Disposable income growth has been very low al
most throughout the distribution in both Germany and the Netherlands, in particular in the lower deciles. This is especially evident from the mid-1990s to 2008 when 30% of the poorest Germans actually had negative real income growth."

They further comment: "Recent years wage moderation can to some extent be explained by weakening power of unions since the mid-1990s, as well as a set of reforms in 2003 meant to increase the flexibility of the labour market (Burda and Hunt, 2011)."

Here are the growth rates of disposable incomes per decile for Germany for the period 1995-2008 (Table 3):

"-0.14 -0.20 -0.03 0.02 0.16 0.18 0.21 0.25 0.35 1.32"

Should one be holding up negative growth in disposable incomes in the bottom deciles as a model to emulate?

Caveat: The study does not have the figures disaggregated post-2003, so perhaps the picture looks different there.

As to Germany weathering the recession well and even increasing employment, you have good points. I mentioned one part of the picture in an earlier post, which referred to work-sharing policies implemented in Germany. It certainly does not explain all or even the majority of the picture, but it is an important point not mentioned in your post.

Scott Sumner writes:

Norman and Mike, Good points.

Steve Sailer writes:

In 1990, West Germany acquired a vast underclass of East Germans who had lived under the debilitating effects of Communism for up to 45 years. West German leaders said that reunification would cost Germany trillions and the economy might lag for many years under the burden, but that was the right thing to do for the German people as a whole.

We now know that they were right.

Steve Sailer writes:

Also, you need to read between the lines to note that German reforms were targeted in part at Turkish layabouts. Immigrants from Turkey and their children and grandchildren had developed an entitlement culture of extracting as much from the German taxpayers as possible while doing the minimum amount of work. Germans aren't allowed to be explicit about what they are doing about other ethnicities' bad habits, but the Germans seem to have pretty successful at quietly cracking down on the Turkish immigration and welfare fraud complex.

MingoV writes:

Germany had economic problems until the late 2000s because it still felt the costs of unification. East Germany was an economic basket case when it was merged into the economically stable West. Most of the East German workers did not have skills needed by the West. East German unemployment was nearly 20%. Its infrastructure was a disaster. Many former East German factories were closed because they were inefficient or heavy polluters. The attitude of the former East Germans was that government would solve their problems, which made integration into the slightly socialist West Germany difficult. I was in Germany during the 20th anniversary of unification. I was in Dortmund, a small city in the coal mining region. (Ironically, "green" Germany still produced a third of its energy from coal.) I was impressed with the state of the economy in this small city. It was too socialist for my tastes, but the infrastructure was good, mass transit was well-run (but didn't break even), unemployment was low, and the people seemed content. I was astonished at how well the country was doing. I spoke to college students about this, and they were surprised that I was surprised. To them, it just happened, and they paid no attention to the anniversary. This also impressed me: the government did not spew propaganda about the successful merging.

Steve Sailer writes:

Right, contemporary Germany is a monument to enlightened patriotism but very few Americans or Brits pay much attention to Germany because, hey, we won The Big One.

Scott Sumner writes:

Anand, You asked:

Should one be holding up negative growth in disposable incomes in the bottom deciles as a model to emulate?"

Absolutely, if the alternative is mass unemployment. I can't even imagine any sensible person disagreeing. Wage subsidies assure that the low wage workers have adequate living standards.

Steve, I agree that reunification was the right call.

I am opposed to welfare, and would prefer to replace it with low wage subsidies, so there's much to admire in the German labor market model.

Mingo, That's a common misconception. The German unemployment problem got dramatically worse between the 1960s and the 1980s, even before reunification. Yes, in 2004 eastern Germany had substantially higher unemployment than the west, but that's also true today. The East/West problem has not been solved, and tells us very little about why overall unemployment fell sharply in the post-2004 period.

Yancey Ward writes:


It is almost certain that the UE numbers were non-seasonally adjusted until 8 years ago.

Anand writes:

I hadn't thought of posing the question so starkly: "Do you prefer mass unemployment or lower disposable income for the bottom deciles?"

My thinking was more whether the bottom deciles are better or worse off after the reforms. Employment is a means to that end. If one forces non-working people to work to get benefits, it is possible that unemployment may reduce but they might still not be better off.

Here is one measure: poverty remained flat in the post-2004 period (barring 2009 where it was much higher) and in fact was higher than the earlier period. This holds for both before (25% in 1990, rising gradually to 32% post-2004) and after (5.6% in 1985, 7.3% in 1995 and 8.3% post-2004) tax and transfer measures.

The data run to 2010 in OECD stat and 2012 in Eurostat.

Sven_ writes:

For further information about income inequality see this as an example:

On page 7 you can see two graphs showing the decline in inequality.

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