Ifo Viewpoint No. 49: The German Disease and the Agenda 2010

Hans-Werner Sinn
Munich, 24 October 2003

The German disease is the extremely high unemployment among lower skilled workers, in which Germany tops the ranks of OECD countries. Forty percent of unemployed people in Germany have low-level skills, and among the remaining sixty percent unemployment is also most prevalent among the less qualified. The policies of lump-sum wage increases in connection with an above-average rise in wage replacement payments have compressed the wage scale from below in the past thirty years, although increasing low-wage competition from outside Germany should have required bigger wage differentiation. This is the cause of the German disease.

The most important wage replacement payments that have caused wages to increase among the less qualified are unemployment assistance and social assistance. Both are paid for not working and end when one does. They create a wage level that is above the productivity of many of those concerned and thus make their employment unprofitable for employers. It is good that the Hartz IV legislation will at least abolish second-tier unemployment assistance, which was granted until retirement, but this in itself does not suffice because social assistance is still too high as to permit the wage floor that it sets to create a job surge in the low-wage sector. To create such growth, today’s low wages would have to fall by one third.

For this to happen, the standard rate of social assistance for those fit to work should be lowered, and in return generous earning options should be created with simultaneous supplements to low income, similar to the American Earned Income Tax Credit, as recommended by the Ifo Institute in its Activating Social Welfare programme. This would increase the incomes of the less qualified and create jobs at the same time. To assure that everyone can earn an acceptable income, local communities must be prepared to offer public-service jobs in emergency situations that would be paid at the same rate as today's level of social assistance.

If policy-makers refuse to cut welfare benefits they should at least ensure that the rules for refusing job offers are tightened. A job must be accepted even if the pay is clearly below the social assistance level, since the wage supplement from the government would correct the imbalance. This is at the core of the bill of the federal states, which is based on the Ifo proposal.

Unfortunately, this is prevented by the comparable local wage rule added at the last minute by leftist SPD MPs to the bill that the ruling SPD government successfully launched in parliament. Social assistance is only cut or cancelled if an acceptable job is turned down, but no job need be taken if the wage is below the "comparable local wage". This takes the teeth out of Hartz IV, since obviously not enough jobs exist at comparable local wages. It is precisely these wages that have prevented the creation of sufficient jobs in the low-income sector.

The only positive effect this will have on the labour market is that the more highly qualified unemployed can now be expected to accept jobs in lower segments of the labour market. This will make their labour cheaper, and unemployment in these segments can be expected to fall. However, this effect will mainly be achieved by displacing the less well qualified, who now will encounter more competition in their low-wage segments. Unemployment among the less qualified will grow and the German disease will only get worse.

For this reason the Hartz IV legislation turns out to be the exact opposite of what the labour market needs. The law would lower wages in the segment of the labour market where unemployment is low and prevent wages from falling in the segment where unemployment is high. A more ill-conceived social reform is hard to imagine.

The economist's hope must now be with the second chamber of Parliament, the Bundesrat. Praised be to Germany's federal system that will prevent the misguided wishes of the left-wing SPD from becoming law.

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