Five million reasons to worry

Feb 2nd 2005
From The Economist Global Agenda


Over 5m Germans were without a job last month, more than at any time since the Great Depression. The government cannot solve the unemployment problem without first making it worse

SOME economic numbers are as resonant as they are significant. One such figure was announced on Wednesday February 2nd by Germany’s Federal Labour Agency. More than 5m Germans were unemployed last month, the agency revealed, the most since 1932, when the economic devastation of the Great Depression brought the Weimar Republic to an unhappy end.

The numbers are a little less resonant when adjusted for the season; the aftermath of Christmas never flatters the labour market. Taking this seasonal effect into account would reduce the unemployment figure to 4.71m, the statistics office said. More importantly, the new year also brought a new policy. On January 1st, after parliamentary tussles and street protests, the government’s controversial reform of unemployment benefits came into effect. This reform, driven forward by Gerhard Schröder, the chancellor, is supposed to prod the jobless back into work. But its first effect was to prod many who had dropped out of the labour market back on to the unemployment rolls.

Under the “Hartz IV” reform, named after Peter Hartz, the man who proposed it, those who have been unemployed for over a year receive a flat-rate benefit, means-tested and paid only to those who seek work seriously. Previously, not everyone on long-term aid had to sign on at job agencies. Now they do. The labour office reckons that at least 222,000 people not counted as unemployed under the previous system are now registered as such.

Labour markets rarely function perfectly. But Germany’s labour market is not really a market at all. It abjures free competition, which it likens to the law of the jungle. Firing is a last resort. Wages are negotiated collectively. These clubby, consensual arrangements served Germany well for several decades after the war, winning the country an enviable industrial peace. But they have now become, in effect, a conspiracy of insiders against outsiders. The 5m outsiders, who lack a job, might be prepared to work for less than those who have a job. But employee protections and union rules insulate the insiders from any competitive threat the outsiders might offer. As a result, the insiders maintain wages above the level that would make it profitable for employers to hire those out of work.

The longer they remain out of work, the less the unemployed make their presence felt in the labour market. Writing about the Great Depression, Brad DeLong, an economic historian at the University of California, noted that the long-term unemployed become “discouraged and distraught”. After a year without work, “a job must arrive at his or her door, grab him or her by the scruff of the neck, and throw him or her back into the nine-to-five routine if he or she is to be employed again.”

In Germany, jobs are hardly knocking at the door. But thanks to the Hartz reforms, the long-term unemployed are having their collars felt a little. Employment agencies, which used to passively process their benefit cheques, are now supposed to take an active role in placing them in new jobs. They will employ as many as 600,000 of them in jobs that pay €1 per hour plus unemployment benefits. Those who turn down a job offer will have some or all of their benefits withheld.

Opponents of these reforms argue that there is simply not enough work to go round. Such arguments often lapse into what economists call “the lump-of-labour fallacy”, which retains its commonsensical appeal however often economists prove it false. In any economy, the fallacy says, there is only a fixed amount of work (a lump of labour) to do. There is, then, no point throwing the unemployed back into work. Instead, if everyone works a little less, the lump of labour can be sliced more evenly among the population. The French enshrined this fallacy in law in 1998, ruling that no one could work more than 35 hours a week. But such a restriction has proved hard to live with. The law has been weakened several times, and on Tuesday the French National Assembly began debating ways to remove the last of its teeth.

The demand for labour is not a fixed lump. Employers will keep hiring until it ceases to be profitable to do so. The ultimate limits on an economy are on the supply-side: eventually, the labour market will tighten and inflationary pressures will emerge. France’s 35-hour week, which restricts the supply of labour, lowers this limit. Germany’s overhaul of the benefit system, by contrast, raises the supply of labour, relaxing the limits on the country’s economic performance.

Unfortunately, the German economy is still far from testing those limits. Inflation is low, leaving plenty of room for the economy to expand. But the animal spirits of households and firms are falling short. Indeed, some economists worry that efforts to resolve Germany’s supply-side problems may be worsening the economy’s demand-side difficulties. A reform that adds 222,000 people or more to the jobless totals may do little to bolster household confidence and spending. Retail sales fell in December, for the third month in four.

There are some signs, however, that Germany’s spirits, though low, may be improving modestly. The ZEW indicator of economic expectations rebounded in January. Voters also now seem to accept the need for reform. An opinion survey for Stern magazine, conducted in the third week of January, put Mr Schröder’s coalition ahead of the opposition (albeit by less than the margin of error) for the first time since his re-election in September 2002. The Weimar Republic could not survive 5m unemployed. Mr Schröder may yet do so.

5 Millionen Gründe, Deutschland abzuschreiben