Ifo Viewpoint No. 64: Why Minimum Wages Hurt Germany

Hans-Werner Sinn
Munich, 15 April 2005

Low-wage countries from all over the world are vying for German investment capital, and now east European low-wage workers are pushing into the country, directly competing with German workers. The German government wants to protect the country by introducing minimum wages. By expanding the EU directive on the foreign posting of workers from the construction sector to all branches of industry, it wants to force foreigners, who provide services in Germany, to work at German union wages. The government claims it merely wants to prevent wage dumping, but in fact it is hurting the country and driving it further along the wrong road that has been travelled for decades with an excessive wage policy.

The central argument against minimum wages is simple, but little known. If the Poles are willing to work cheaply for the Germans, German customers benefit. Crafts activities, services in restaurants and many other goods and services become cheaper. The real income of Germans rises, and many jobs that would have been left undone, can be done now. The economy grows. Of course, the domestic workers, who directly compete with the Poles, suffer a disadvantage because their wages come under pressure. But this is no disadvantage in the aggregate, as it is offset cent for cent by the identical advantage that accrues to the customers and employers of the domestic workers. Minimum wages would help the craftsmen, but they would block the advantages that Germany as a whole would enjoy from the cheap Polish workers.

Furthermore, the posted worker law is being circumvented anyway, because it is all but impossible to control the hourly wages of the assigned workers. Union wages are paid formally, but people work longer than stated. In the final analysis, minimum wages would reduce the supply of Poles in Germany a little and would allow them to sell their labour better, at the expense of their German employers and customers in Germany, than would otherwise have been possible. The Poles are being helped in a similar way as if they were permitted to form a big wage cartel at the expense of Germany.

If foreigners are forced to work at union wages in Germany, German firms are driven abroad even faster. Germany has the second lowest investment share in GNP among all OECD countries, and its capital exports amounted to almost 4% of GDP in 2004. Domestic investment shrank by 0.9%, although it should have grown by 8% in view of the booming world economy. This alarming development would only be accelerated. The increase in unemployment would continue and would risk running out of control.

If union wages were even declared generally binding by the government, as is being considered, east Germany, in particular, would suffer extremely. Union wages often play no longer a role there, and this is the very reason for the few green shoots. Submitting wages on a broad base to collective bargaining again by declaring union wages as generally binding would mean that entire regions in the east would deindustrialise.

Measures to increase wage rigidity remove an ever bigger share of employable Germans from the labour market and shift them to the welfare state. Germany has travelled this road for over 30 years because the growing welfare benefits have functioned like minimum wages. It cannot continue like this, as its economy is falling back, and the state already has no funds left. Politics cannot undo the laws of economics, as much as it may decry them. The SPD party leader Müntefering’s moral indignation about the laws of economics could just as well be directed at the physical laws of gravitation. Each is equally unrealistic.

There is only one way: Accept the wage competition of the east Europeans, yield to the wage pressure and compensate the low earners by permanent personal wage subsidies. Activating social assistance, as proposed by the Ifo Institute and also recommended by President Köhler, points the way. Starting with Hartz IV, one would have to redesign unemployment pay II, Germany’s new second-tier unemployment benefit system, in such a way that it becomes in fact a wage subsidy. The income-benefit schedule must be designed so that one receives most of the money from the state if one works at least half-time in the private sector and not if one does not work at all. To offset the fiscal burdens, the government would, however, have to lower the benchmark pay rate a bit, which for social reasons can be done only if at least one-euro-jobs with the government are available. For one-eurojobs one should receive the one euro and unemployment pay II at today’s level if one is willing to work in the private sector as a loan worker. Only by paying wage subsidies can the state help the low earners to become competitive with the Poles without asking them to accept Polish incomes. There is no alternative to such a policy.

Politicians call the wage competition of the east Europeans dumping. That is a confusion of terms. Dumping is lowering prices below one’s own costs, not below the competitors’ costs. Only if the Poles were working more cheaply in Germany than in Poland, would this be dumping according to the economist’s definition. Wage competition is the market economy’s elixir of life. Will the Germans ever understand the rules of the market economy? How far does the country want to move downhill until they realise that there will soon be no stopping?


Hans-Werner Sinn
Professor of Economics and Public Finance
President of the Ifo Institute of Economic Research at the University of Munich

Published under the heading "Warum Mindestlöhne Deutschland schaden", Handelsblatt, No. 72, April 14, 2005, p. 9.