Ifo Viewpoint No. 86: The Same Old Mistake: How to Tame the Competitors

Hans-Werner Sinn
Munich, 11 July 2007

In his Agenda 2010 Gerhard Schröder lowered the German minimum wage. By eliminating Germany’s second-tier unemployment assistance (Arbeitslosenhilfe) for a million western Germans and a million eastern Germans, he lowered the wage demands vis-à-vis potential private-sector employers, thereby improving the competitiveness of the affected employees. The wage restraint of recent years, which is responsible for a portion of Germany’s much-cited job miracle of 2006, can also be attributed to Agenda 2010.

The current ruling coalition is turning Schröder’s policies upside down by replacing the implicit minimum wage in the form of unemployment assistance by an explicit minimum wage. The good economic situation has fostered recklessness. When put to the test, the economy seems able to bear more than many thought possible.

Of course, this is an illusion. Germany’s structural weaknesses are currently less apparent because of the booming world economy. If the forecasts are correct, in 2007 the international economy will grow by five percent for the fourth year in succession. This has not happened since the beginning of the records in 1950s. Once the boom is over, the fragility of the German labour market will become obvious again.

Fortunately, the worst has been just barely avoided in the coalition’s recent decisions. A universal minimum wage of €7.50 will not be introduced. Of the 11 percent of private-sector employees in western Germany and 26 percent in eastern Germany that earn less than €7.50, it would have made about one quarter unemployed in both west and east. On the whole, 800,000 private-sector jobs in the west and 300,000 in the east would have disappeared.

But what will now come is bad enough. The generally binding character of collectively bargained wage contracts will be expanded to a non-specified number of industries. If at least half of the employees in an industry work in companies that are subject to collective wage agreements, i.e. companies that are organized in employer associations and thus pay collectively bargained wages, the employer association and the trade union can demand an extension of the negotiated wage rate to the other companies in the industry. Even if in these companies neither management nor workers wish to participate in the wage negotiations, they will be subject to the wage agreements dictated by the majority. A contract can be declared generally binding even in a situation where less than half of the employees work in companies subject to the wage agreements. In this case, a committee with equal representation of unions and employers association will decide on making the agreements generally binding. And what constitutes a majority is not even a true majority: of the employees that work in a company subject to the negotiated contract, hardly more than a fifth are likely to be union members and legally bound to the negotiated wage. In one way or the other, tiny minorities will be able to dictate market wages.

This is an attack on the market economy since it eliminates the mechanism of competition: this is the greatest sin committed by the coalition thus far. In future, organised companies can force their competitors to pay the same wages that they themselves must pay. It’s not surprising that before this decision was made, not only union but also employer representatives were knocking on doors in Berlin.

It is no secret that the German postal service was also in on the act since, after the elimination of the letter-delivery monopoly, it fears being outbidded by United Parcel Service and other private, low-wage providers. It is particularly perverse when politicians sell this as protecting the interests of low-wage earners. This social cover-up only serves to hide the shame of naked political interests. The high postage for letters is only paid by those not yet familiar with e-mail, and they, as a rule, are the poorer groups of society.

This is all very familiar in Germany. As the western employers and the western trade unions moved to the eastern part of the country after German unification to establish their organisations, the motivation was similar. The self-appointed representatives of the eastern Germans negotiated in many districts a full convergence of eastern wages to the western level within five years. Under the mantle of brotherly concern for countrymen oppressed by years of Communism was also then coldly calculated political interests. Without these defensive measures, it would have been very tempting for the Japanese and other investors to establish themselves in eastern Germany, with wages at one third of those in the west, and to conquer the European markets from this base. This was what had to be prevented. The convergence of wages was slowed down, as eastern German enterprises emerged after privatisation, and in many cases not implemented as masses of eastern firms cancelled membership in the employer associations. But eastern Germany was never again able to go beneath the base of high wages created by the first collectively negotiated pay contracts. The investors went to Ireland, and the much-touted “self-sustained recovery” never came to be. The lead of fourteen years that eastern Germany had vis-à-vis its old friends in the ex-Comecon countries at the time of integration into the western markets was foolishly squandered away. The same old mistake is now unfortunately being made by the ruling grand coalition.

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

Revised version. Earlier published as "The Same Old Mistake". Published as "Nichts dazu gelernt", WirtschaftsWoche, no. 28, July 9, 2007, p. 130.