Ifo Viewpoint No. 81: Will Eastern EU Expansion Create Jobs in Germany?

Hans-Werner Sinn
Munich, 20 March, 2007

The EU has expanded once again. After the 2004 enlargement, which added 75 million new citizens to the EU, Romania and Bulgaria are now adding 30 million more. What does this mean for the German labour market?

German Foreign Minister Frank-Walter Steinmeier voiced the opinion in a speech in the Munich Residenz that EU eastward enlargement will lead to net job creation in Germany. To be sure, some jobs will be lost as plumbers migrate to Germany or as companies relocate in Eastern Europe, but this will be offset by the expansion of German exports, which will create many more jobs. This argument is familiar. But is it correct?

The enlargement will certainly confront Germany with extremely low wage competition. Whereas a manufacturing worker in western Germany earns €27.90 an hour and a worker in eastern Germany averages €18.60 an hour, in Romania a worker is only paid €2.30 and in Bulgaria a mere €1.60.

If Steinmeier is correct, the Eastern European low-wage earners would complement German workers, and their presence would increase the demand for German workers. Indeed, this is partly the case. German engineers are needed to design sensible products to be manufactured by Eastern European workers, and those with managerial qualities can be sure that their abilities will be needed to integrate the Eastern European workers into the market economy. But for the great majority of those who only have their normal labour to offer, Eastern European workers are substitutes and not complements. They are confronted by low-wage competition from people that have similar skills and ambitions, and they are consequently the losers of enlargement. According to a study by the Berlin economists Geishecker and Görg, the group of losers in Germany extends from low-skilled up to skilled workers.

This has implications for the labour market. For the highly qualified in the German workforce, eastern enlargement will lead to an increase in labour demand but to a decrease for all the others. Since unemployment is low among the more highly qualified, the increased demand for their services will lead to an increase in wages rather than an increase in employment. In the case of the lesser qualified, whose services are now less in demand, a decrease in employment will result because their wages cannot fall. The scope for downward wage adjustements is limited by collective wage agreements and by the minimum-wage levels that the welfare state sets with its wage replacement benefits. The asymmetry in wage inflexibility combined with the substitutional labour performed by the great majority of German workers and their Eastern European counterparts leads to the inevitable conclusion that eastern enlargement will lead to a net loss of jobs in Germany, at least if the German labour market remains as inflexible as it now is.

Steinmeier’s conclusions were certainly not based on complements and substitutes but on the assumptions made by observing exports, direct investments and migration. But in so doing he overlooks the two main reasons why most jobs are disappearing.

The first of these reasons is the structural change of the German economy. To be sure, eastern enlargement is leading to an increase in exports because more markets have been opened in which German firms can sell their products. However, if exports increase, the factors of production, namely capital, qualified workers and unskilled workers, must be diverted from other sectors of the economy, and this leads, on balance, to unemployment. Since the export goods are considerably more capital and knowledge intensive in their production than other goods, the structural change reduces the demand for unskilled labour. The capital and talents that move away from labour intensive to capital intensive sectors, cannot pull all unskilled workers with them whom they formerly employed, and they even prefer it that way since sectoral change is a way to defend themselves against the low-wage competition. The shrinking sectors include the labour-intensive preliminary stages of industrial production, the jobs of which have been unspectacularly outsourced to other countries, a phenomenon that is not apparent to customers nor registered in the statistics on foreign direct investment.

The second reason is capital exports. Steinmeier concedes that jobs can be lost via foreign direct investments. But much more important are the financial investments, that is the loans by which foreign firms are enabled to create jobs on their own. In 2006 Germany had a net capital export of €108 billion, whereas net domestic investment of all sectors together was only €75 billion. Of this net capital export, only €25 billion was for direct investments. Part of this capital export flowed to the new EU members in Eastern Europe, which had, relative to their size, gigantic capital imports.

No, taking all these factors into consideration, the remarks of the foreign minister are no more than empty rhetoric. Since German re-unification we have had more than enough of this rhetoric.

Hans-Werner Sinn
Professor of Economics and Finance, University of Munich
President of the Ifo Institute

Revised version. Published as “Sonntagsreden”, Wirtschaftswoche, no. 4, January 22, 2007, p. 138; additionally printed in a similar form in Les Echos (Mali), The Shanghai Daily (China), The Japan Times (Japan), The Korea Herald (South Korea), Taipei Times (Taiwan), Die Presse (Austria), L’Echo (Belgium), De Tijd (Belgium). Aripaev (Estonia), Molodez Estonii (Estonia), Express (Greece), Diena (Latvia), Logos Press (Moldova), Danas (Serbia), The Scotsman (United Kingdom), Al-Sabah Al-Jadeed (Iraq), Jordan Times (Jordan), Al Ghad (Jordan), Al Raya (Qatar), Al Eqtisadiah (Saudi Arabia).