Ifo Viewpoint No. 39: Getting Down to Work after the Election

Hans-Werner Sinn
Munich, 11 October 2002

The German coalition government has been given a second chance, but the slim majority will probably not suffice to implement the long-overdue economic reforms that economists have insisted on. To shoulder the tremendous tasks a grand coalition would have been better, but the power interests of the parties have prevailed. Now we can only hope that the present coalition has learnt from the past four years and will finally tackle Germany’s long-term economic problems. Merely waiting for the economic upswing will not suffice to stimulate the labour markets and the growth forces of the country. Germany is enmeshed in a fundamental economic crisis that has less to do with the business cycle than with the structural incrustations of the social system and the labour markets as well as neglect of the educational system.

Social reform that replaces wage compensation payments with wage supplements is urgent because wage compensation payments create reservation wages that are too high for many employees and prevent the creation of jobs. Unemployment assistance and social welfare benefits should be combined and reduced drastically. The money saved should be used to pay wage subsidies in the low-wage sector. State-guaranteed loan employment in the low-wage sector – and only here – must be made available to prevent poverty from arising. The motto of the new welfare state should be “help people help themselves”. Very little can be achieved with programmes such as €500 jobs or the Mainz Model, or even with better job placement by the Federal Labour Office as foreseen by the recent Hartz proposal. Better concepts have already been presented by the Ifo Institute and by the Scientific Advisory Council of the Federal Ministry of Economics.

In addition, labour law and collective bargaining must be reformed. Industry-wide wage agreements should not have a cartel status. If the majority of a company’s employees accepts wage cuts to save jobs, no union should be allowed to intervene. Universally binding declarations, rules to honour wage agreements, and the favourability principle are now cartel-like political instruments. They are not compatible with a functioning labour market. Dismissal protection must be loosened for newly hired employees so that they can be employed in the first place. At least the option of labour contracts with limited dismissal protection should be admitted.

The state must no longer be the implicit accomplice of the job-holders’ cartel by concealing unemployment and easing labour market pressure with early or semi retirement schemes and Job-Aqtiv laws. Government subsidies that encourage able workers to retire at sixty or even before – a policy initiated under Helmut Kohl – betrays a naive understanding of the effectiveness of labour markets, a unscrupulousness attempt to falsify unemployment statistics, and a kow-towing to the union cartels. Such policies are extremely costly and are poison for the labour market. In a country with an ageing population, the retirement age must be raised instead of lowered.

The educational system must be fundamentally reformed, leaving the true asset of German education, the vocational dual training system, intact. All-day schools should be introduced and the thirteenth year of obligatory education eliminated, the sciences should be emphasised, and the teaching profession should be made more attractive. Teachers should have the social status they had a hundred years ago when Germany was an educational model. The best talents in the country should become teachers and not those who wouldn’t stand a chance in private enterprise. Salaries for new teachers should be raised to encourage the most talented to apply. Germany spends 30% of GDP on social programmes but only 4% on education. More competition should be introduced in the universities so they can become centres of top research. The lukewarm solutions proposed by the German Conference of Educational Ministers have prevented this from happening.

Educational reform will cost money, and simultaneously the burden on labour must be lowered. In Germany, the marginal tax burden on the value added generated by an average employee is the highest in the world at 66% and is one of the main reasons for unemployment and the growth of the shadow economy. The lowering of the tax burden on labour and the promotion of education will create tremendous budgetary problems. Government borrowing is not an option because of the Maastricht criteria, and privatisation revenues are also limited under the current capital market situation. There is no alternative to broad cuts in government spending.

Implementing these cuts will be the real task of the new government. A swathe must be cut through the jungle of subsidies. Reducing subsidies by half would bring budget relief of between €50-75 billion and would lower the government share in GDP by 2.5 percentage points. In addition the government must stop the spiralling increase of health insurance and pension costs. Health insurance can certainly be privatised, and a new pension formula that slows down the rate of pension increases would bring considerable budget relief. Without cutting back the social budget, which accounts for 30% of GDP, Germany is ill-prepared for the future. But does reform have a chance with the coalition’s slim majority?

Hans-Werner Sinn
Professor of Economics and Public Finance
President of the Ifo Institute