Ifo Viewpoint No. 61: How to Combat German Unemployment

Hans-Werner Sinn
Munich, 14 February 2005

This year official unemployment in Germany will amount to more than 4.5 million. Adding those in early retirement and in various training measures, the number rises to 6 million. And including the hidden reserves of people who are willing to work but have given up trying to find a job, we have more than 7, perhaps 8 million.

Unemployment originates when the economy is slack or when labour has become too expensive in relation to full employment productivity. The first factor is insignificant since the unemployment has occurred while the world economy is booming faster than in the last quarter century and German exports are booming too. Exports create more demand than even the most daring government stimulus programmes could ever achieve. Only the second factor provides a suitable explanation for unemployment.

Since the demise of communism, an additional third of the world population is competing for internationally mobile capital and is offering cheap labour and fantastic returns. The combination of wages and productivity, under which the German workers were employed before the fall of the Iron Curtain, no longer applies today. In order to regain their competitiveness, German workers must become more productive or cheaper. Otherwise only the German firms stay competitive. German firms stay competitive regardless of the competitiveness of their workers because they are very well positioned in Eastern Europe and Asia and produce an increasingly larger value-added share of the goods manufactured in Germany in low-wage countries (bazaar effect).

Politicians proclaim that innovations will make labour more productive and will induce more investments at constant wages, thus creating more jobs. But innovations do not come out of the blue. The only measure that is immediately available and has the same effect as a productivity-boosting innovation is the extension of working hours at the same pay. For the laws of economics it makes no difference whether productivity increases because an engineer comes up with a wonderful invention that enhances the productivity of labour and machines or whether the individual worker, and with him the capital in the machines and buildings he uses, works longer every day. Both have fundamentally the same effect and create jobs.

But this will not suffice. Since unemployment is concentrated among low-skilled workers (here Germany is the “champion” among OECD countries), measures must be taken to increase the wage differentials in a socially acceptable manner. The welfare-to-work model developed by the Ifo Institute was designed with this in mind. Basically, it calls for a further modification of the second phase of unemployment compensation, which suffers from an extremely high benefit-withdrawal rate. In other words the current Hartz IV programme must be supplemented by a “Hartz V”. Firstly, this new programme would allow beneficiaries to earn up to €400 without penalties (Hartz IV only allows €50). Secondly, the first €200 of earnings would be supplemented by 20%. Thirdly, the withdrawal of benefits beyond €400 of earnings would be limited such that in combination with taxes no one would lose more that 70 cents for each additional euro earned. (Under Hartz IV 80 to 90 cents is lost.) Fourthly, if the beneficiary does not work, unemployment compensation would be reduced by about a third in order to reduce the financial burden of the state. Fifthly, all beneficiaries capable of working would be offered municipal jobs where they could have an income that would match the current level of social aid (or, equivalently, unemployment compensation II according to the new Hartz IV law). Sixthly, the municipalities would contract out the workers in their charge to the highest bidders.

This is a feasible and affordable way to create jobs for everyone. On the one hand, the wage claims of those affected will fall for jobs in the private sector without their incomes having to fall. At lower wages there will be more jobs because it will be worthwhile for businesses or private households to offer these jobs. On the other hand, for those who cannot be directly placed there will be loan employment, because for everyone there will at least be a fee that is higher than zero for which demand for labour would arise.

The proposal is also a programme that would integrate those now working on the black market into legitimate service-providing firms. Those who use workers in the shadow economy would turn to proper businesses because no workers can be found in the black market (beneficiaries must work eight hours a day). And these businesses can service their customers thanks to the cheap loan-workers they receive from the municipalities.

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

Published under the heading "Mehr Arbeit durch Billigjobs", Neue Ruhr Zeitung / Neue Rhein Zeitung, February 11, 2005, p. NMA2.