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The German problem

The last (and often only) resort of those who argue that regulation is a job killer is the example of Germany, an economy seen by some as weighed down by the sort of regulations and labour market institutions swept away in the UK in the name of structural reform. The conclusion in the BRTF report that 'the combined effects of regulations, collective agreements and works councils has made the German labour market very inflexible, probably contributing to the high levels of unemployment' is fairly typical. Germany it is argued is a terrible example of what would happen to Britain if we go further down this route.

Germany has historically been a low unemployment labour market. Between 1980 and 1995 German unemployment levels averaged between 6 and 6.5 per cent - similar to those in the US but much lower than the average of between 9 and 9.5 per cent in the UK. Throughout this period all of the structural features identified by the BRTF as contributing to 'inflexibility' and high unemployment were in place. We need a more convincing explanation than the BRTF has so far supplied before concluding that works councils, collective bargaining and labour regulation have suddenly made Germany a high unemployment economy.

Many critiques of the German labour market are often completely one sided. The 'inflexible' German labour market structures have created one of the strongest vocational training systems in the industrialised world. This is a key reason why Germany has such a big workplace productivity lead over the UK today. Moreover, it has been a vital factor in keeping youth unemployment in Germany well below that experienced in the UK and the US. Latest figures for 2002 show that unemployment among the under 25s was 9.4 per cent in Germany against 12.1 per cent in the UK and 11.9 per cent in the US.

It is undoubtedly true that the German economy has lost ground against the rest of the EU, including the UK, and also against the US in recent years. However, the evidence suggests that most of the 'growth gap' between Germany and the rest of the Eurozone in the 1990s and the consequent rise in German unemployment is attributable to the economic aftershocks of reunification. High unemployment in Germany today is heavily concentrated in the former Eastern Lander, where rates range between 13 and 17 per cent. In the former Western Lander unemployment rates are comparable with those in the regions of Britain.

A recent research paper by the EU Commission, Germany’s growth performance in the 1990s (ECFIN/292/02, May2002) estimates that two thirds of the growth gap between Germany and the rest of the EU is due to the economic effects of re-unification. As the paper notes, 'Long lasting effects of re-unification seem to play a pivotal role in the twin phenomena of sluggish domestic demand and anaemic job creation. Re-unification brought together one of the most advanced economic areas of the world together with an area of low productivity, state protected companies, artificial exchange rates and an almost obsolete capital stock'. It is more striking how well Germany has done in coping with such a shock than how badly. It is hard to imagine the impact on UK unemployment had the UK been asked to absorb virtually overnight a similarly bankrupt economy and manage the accompanying political and social tensions.

The Commission suggests that labour market factors must be part of the explanation for the remaining third of the German-EU growth gap, but notes that 'it is a difficult task to pinpoint the exact underlying factors which account for the different labour market experience of Germany'. The Commission also makes the important point that 'labour market regulations in Germany are not much higher than in most other continental European economies.' The Commission suggests it is not the overall level but the failure to adapt and modernise regulation to deal with the integration of low productivity East German labour markets into high productivity West German wage bargaining and social welfare systems.

There must be some truth in this, although the Commission notes that criticism of recent labour market reforms introduced by the German government have less to do with their likely impact on actual employment and much more with the political pressure built up both inside and outside Germany for more 'radical' labour market reform. The key point is however that these are very much the specific problems arising from an event unique to Germany. We cannot draw general conclusions from the German experience about regulation in the rest of Europe, much less in the UK. Moreover, it would be more logical to put in place measures to improve productivity in East German labour markets as the key to successful integration rather than dismantle the labour market institutions that helped transform the former West Germany into one of the most advanced industrial economies in the world.

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