The German President, Horst Köhler, encouraged politicians to introduce a welfare-to-work plan in Germany in his speech of 15 March. Welfare-to-work is a subsidy system for low wage-earners that the Ifo Institute for Economic Research proposed in May 2002 in the form of an extensive expertise.

Parts of the model were incorporated into the Hartz reform proposals that were published in the late summer of that year. The model was also adopted by the Scientific Advisory Council of the Federal Ministry of Economics and in the autumn by the German Council of Economic Experts.

The heart of the system is to make the welfare state a partner instead of a competitor of the private sector. The motto is that everyone should work at wages for which they find jobs and that the state should provide a personal subsidy for those who do not earn enough, so that the total of earnings and subsidy assure an adequate total income.

In the place of a wage substitute, as granted by welfare or unemployment benefits, there would be wage subsidies. With the change to wage subsidies the wage claims of the lesser qualified would fall, and at lower wages there would be higher employment. At the same time the subsidies would prevent negative effects for low-wage earners, or at least cushion these effects, since they would supplement wages. The system would only apply to those who are fit to work. The status of social welfare recipients who are unable to work would not change.

The Hartz IV reforms have already taken some aspects of the Ifo welfare-to-work proposal into consideration with the one euro jobs and the merging together of unemployment assistance and social welfare. Nevertheless, the new unemployment assistance is still designed as a wage substitute that creates a high entry barrier to the labour market. Depending on the amount of income, between 80% and 90% of income from additional work is taken away again. The wage claims that result are too high for new jobs to be created.

The following measures would convert the Hartz-IV reforms into a welfare-to-work system.

1. The additional earnings options should be improved. Up to €400 monthly without penalties can be earned in addition for people on unemployment assistance. Both unemployment pay and wages are available to the full extent.

2. The first €200 of earnings are subsidized in addition at a rate of 20%.

3. Beyond €400 in earnings, taxes and transfer withdrawals are limited such that the withdrawal effect never exceeds 70%.

4. To limit the financial burden on the state, unemployment compensation are cut by a third for those who do not work.

5. To prevent people’s incomes from falling below the level of unemployment compensation (previously social welfare) wide-scale municipal jobs will be made available for which in cases of a full-time job a wage will be paid that is the equivalent of unemployment assistance. (Where the state fails to make such jobs available, people who do not work will not suffer cuts in their unemployment compensation.) It will no longer be possible to refuse a job offered on the grounds that the work is not “reasonable”.

6. Municipal jobs should primarily be in the form of loan employment in which the employees express willingness to be employed in the private sector. The conditions of lending depend on the current legal situation. The municipalities can use the services of existing temporary employment agencies. The fees paid by private customers of the labour lending firm can be freely negotiated.

In contrast to the Hartz-IV legislation, the cost of the welfare-to-work system will involve savings to the state, according to calculations of the Ifo Institute. This also takes into account that the lowered wages will also be transferred to existing jobs for low-income workers. People affected here must also be subsidized. In contrast to subsidies for employers, this is the advantage of the welfare-to-work system. It cushions income losses among the low-wage earners on a broad scale. Wage subsidies only for workers with new jobs would lower the wages of the less skilled who are already employed without the availability of compensation. In addition, the welfare-to-work system has the advantage that it can be adjusted to personal circumstances and therefore there would be no subsidies for employees with higher wages, which would make it difficult to control the fiscal burdens for the state.

It can be expected that unemployment in the low wage sector would be reduced to a large extent. In the long term it would also result in a larger wage differential, which would help mobilise the labour market as a whole.