Why Is Reducing Unemployment Unpopular?

by Adam S. Posen, Peterson Institute for International Economics

Op-ed in Welt am Sonntag
March 16, 2008

English version © Peterson Institute


Another anniversary has rolled around for the previous Red-Green government's package of labor reforms and with it another long-unseen low in Germany's number of unemployed. Precisely one year ago, I explained in this space why "Hartz IV Worked—As Far As It Went," and recent developments in the German economy have continued to demonstrate the validity of that assessment. Changed labor supply incentives have meant that more unemployed people took real jobs when the current upswing provided them with the opportunity than did during previous German recoveries.

Nevertheless, the Hartz IV and prior labor reforms are being partly blamed for the recent rise of Die Linke's (the Left's) electoral fortunes in Hamburg and Hesse and the more general backlash against further liberalization in Germany today. Why is such a successful set of economic policies so lacking in support among the public? Why are many leading Social Democrats repudiating a reform they should be taking credit for? The additional year allows us a closer look at the reforms' impact and thus a clearer understanding of why the politicians have run away from, and in some cases even run against, a successful policy.

The largest effect of the labor reforms was to reduce the enormous incentives older male skilled workers had under the previous system to glide into retirement starting in their fifties. This targeted impact was by design, for the gap between Arbeitslosengeld and Arbeitshilfsgeld was widely recognized by economists as the most distortionary labor disincentive in the German economy. The temporary freezing and relative decline of retirement benefits also played a role in changing the relative attractiveness of working versus staying unemployed for those same workers who already had high retirement benefits as a function of their previous wages.

And thus changing the incentives had the desired and forecasted effect: These privileged workers were less willing to accept layoffs or stay unemployed when the German economy expanded strongly in 2006–07 than their counterparts had been during previous recoveries. One can see this in the fact that while overall German unemployment has declined by more than 25 percent since its peak in mid-2005, unemployment for those older males has declined by 35 percent in the same period. For women of the same age and for younger workers, the decline in unemployment during this cycle has been significantly less. This makes sense because women and younger people in Germany were likely to receive little more than the basic unemployment benefit upon losing a job and had to wait longer to get lower retirement benefits, so they were not going to be as affected by the change in incentives than the older males were.

For those groups, their lower contribution to labor supply (seen in higher unemployment rates than those for older males) has less to do with being too comfortable when unemployed than with their being ill-matched with and little rewarded by the work available to them. Their problems thus run deeper and are partly due to social exclusion. That is why the Ich AGs, mini-jobs, and related initiatives, while constructive, have not had much impact to date. Progress on this problem would require not only more active labor market policies, perhaps on the Danish model, but also a reduction in the marginal tax rates on female labor and a true expansion of the service economy—two areas where Germany still lags far behind most of Europe.

The persistence of this insider-outsider division in German labor markets, including among the unemployed, is ultimately the source of the political backlash against the successful labor reforms of the Schröder government. Criticism is not due to sympathy for the poorer and lower-skilled people in Germany being treated more cruelly after the reforms than they were before, as some have claimed, for they are not—their situation has been largely unchanged, or in a few instances been improved by the creation of the mini-jobs sector. In contrast, after the US welfare reform of the mid-1990s, to which the German labor reforms are sometimes compared, the decline in unemployment during the following recovery was largest among young women, particularly those of color and single-mothers. It may be that the burden of adjustment and forced work was put upon those unskilled women in the United States rather harshly, but it also was they who got the jobs that resulted from the reforms.

In Germany today, most of the adjustment and associated pains caused by labor reform, as well as most of the jobs that resulted, went disproportionately to those middle-aged and older males who were already relatively privileged. Of course, many of them feel that they were made worse off by the reforms, since before they could receive much of their previous salary for years without working. Of course, this is also the demographic group most strongly over-represented in the German union movement and in the SPD membership. And, of course, these older males are the workers least likely to be satisfied by taking a new job in a sector in which they did not work before, say in health care instead of manufacturing, as opposed to those whose options were more limited to begin with.

So the success of Hartz IV and other labor reforms was predictable and has been borne out in the recent recovery. But the political opposition to the reforms' very mechanisms of success also is predictable and is borne out by recent state elections and the SPD's apparent pandering to the left. This is an important reminder for us all that economic reform is not just a matter of trading off pain today for benefit tomorrow, that is, not just persuading voters of the right thing for the country as a whole. Economic reform also often requires reducing the privileges and protections of incumbent interest groups and thus fighting for the right thing over opposition.

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