Reforming the Labor Market: What Can Be Learned from Germany?

After decades of mainly negative perception both from within Germany and abroad, the German employment “model” is attracting quite some attention again. This is mainly due to its success in weathering the recent global economic crisis: While other countries experienced major job losses, Germany witnessed decreasing unemployment rates and record levels of newly created jobs. In fact, after a long period of stagnation, Germany has now one of the highest employment rates in Continental European countries, closing up to such countries as Denmark, Sweden or the Netherlands and similar to the UK (see figure on the right). Quite unexpectedly, as Germany was often seen as a laggard with a persistent weakness in job creation, the country is now on par with former role model or benchmark countries. Furthermore, accelerated job creation in Germany cannot only be attributed to the emergence of an additional layer of “bad jobs” at the margin of the labor market due to deregulation, but it is also partly driven by structural changes encouraging the creation of many “good jobs” in skilled service sector occupations. However, the recent change in labor market conditions did not evolve over night. It is not sufficient to focus only on the impressive performance during the crisis. The overall improvement in labor market outcomes is the effect of a longer sequence of cumulative structural and institutional adjustment revitalizing some of Germany’s traditional strengths and adding some new elements. Particularly remarkable is the fact that most of these adjustments were not part of a long-term strategy, but rather short-term oriented. Instead of relying on systematic economy-wide coordination, small steps of adjustment were taken in employers’ staffing policies and collective bargaining, as well as in public labor market policies and regulation.

Key components of the German success

After a protracted period of change, the German employment system is fundamentally different from its previous situation which was characterized by a “welfare without work” dilemma. With the recalibration of the German labor market and production model – not in an ideal but in a second-best manner – Germany was able to essentially overcome mass unemployment, the persistent Achilles’ heel of the 1980s and 1990s, and has generated continuous employment growth over the last five years, even during the crisis. Germany seems to have found an arrangement that makes the most out of given and adapted institutional settings. The current arrangement seems to fit with the economic environment so that a better performance can be achieved in comparison to the situation some 10 to 15 years ago. Clearly, compared to that period, market mechanisms have become stronger, and the “buffering” role of law or collective agreements is more limited.

Regarding the core of export-oriented manufacturing, companies have redrawn their boundaries and reorganized the division between their core staff and the marginal labor force, and between workers on standard contracts and those with non-standard contracts. At the same time, there is now a stronger role of subcontracting as well as national and international supply chains. The “purified” core of those firms is characterized – and stabilized – by an elaborate arrangement of working time flexibility and more flexible remuneration policies within collective agreements. Co-management by works councils is crucial here as is managed decentralization of collective bargaining and more flexible collective agreements (regarding working time and wages). Hence, quite surprisingly against the background of earlier debates, many features that were seen as rigid or outdated a decade ago are currently reappraised: dual vocational training is still an effective instrument to ensure smooth transitions from school to work and to provide skilled labor; collective bargaining has been modernized and stabilized successfully via strong internal flexibility, which has made German manufacturing competitive again; co-determination and co-management help stabilize the productive core, which also benefited from the use of publicly subsidized short-time work scheme. So with hindsight this must be seen as a superior response to the crisis as compared to relying mostly on external flexibility. Together with many “good jobs” in services, open-ended full-time employment – which continues to make up about 60 percent of all jobs – is remarkably stable. Thanks to wage moderation and internal flexibility, crowding out by flexible contracts was essentially stopped in major parts of the economy.

Opportunities vs. risks

There are obvious benefits and trade-offs for different categories of workers. For the skilled core labor force in manufacturing and parts of the service sector, neither employment stability nor the pay level has deteriorated. Working time flexibility, organizational reshuffling and more flexible and moderated wage setting have contributed to the robust existence of these jobs that are crucial for the performance of high-productivity firms. Yet, work intensification and performance pressure have increased. The marginal work force faces a different situation: entry into the labor market, in particular into some specific categories of flexible employment, has become easier over time. This was due to deregulation of this type of employment on the one hand, and increased availability of such jobs as a result of structural change and employers’ adjustment on the other. Of course, pay and employment stability are less favorable in this case, and the marginal work force puts indirect pressure on those core members of the labor force that could rather easily be replaced. It should be noted, however, that most employees live in couple households. Stagnating wages in the main job (full-time, often male) could be offset by expanding labor supply (often part-time, mostly female) so that, despite some subjective discontent, the aggregate income figures for the medium stratum of society (“Mittelschicht”) are remarkably stable. Still, a more substantial labor market integration of women is impeded by lack of external care services and high marginal taxation.

Overall, the risks of labor market flexibility are distributed unequally. Some groups bear more external flexibility (unstable jobs) and wage risks. At the same time, those on permanent contracts benefit from fine-tuned models of internal flexibility resulting in strong job stability in exchange. But in addition to concessions regarding wage developments and work intensification, there continues to be some competitive pressure on the core stemming from flexible jobs. Policies to deregulate the margin of the labor market – and activation policies, at least to some extent – have opened up a segment of cheaper and more flexible types of work, in particular agency work, fixed-term employment, freelance and part-time, most notably marginal part-time work. Job growth in the service sector can to some extent be attributed to the increased external flexibility of this partial labor market. But not all developments can be explained by institutional change. There is also a strong occupational logic of sectoral and labor market change as well as specific forms of labor supply in these areas. Put differently, many of these highly flexible jobs constitute a quasi-liberal part of the labor market – with few restrictions on employment stability and pay, particularly in segments with strong employer power and an absence of high skill requirements which would encourage longer tenure.

What does the German case really tell us?

The German labor market underwent a fundamental transformation over the last two decades. However, while much attention is paid to labor market reforms, in particular liberalization of non-standard employment and activation policies, the role of micro-level adaptation of actors on the labor market is a necessary element in explaining change in employment outcomes. While changes both at the level of general public policies and at the level of individual companies or sectors need time to generate substantial effects, at some point a pattern of quite effective solutions may emerge that fits the current economic environment. This seems to be case with the German labor market and political economy now. In this sense, the adjustment capacities of government, the social partners and companies seem to be stronger and more powerful than expected in the late 1990s or the early 2000s. Vocational training and collective bargaining have been modernized and are important elements of the “new” German model. Ever stronger managed flexibility regarding working time and wages in areas with strong bargaining capacities at the sectoral and plant level was complemented and supported by a dynamic service sector relying partly on different patterns of flexibility, some of them set by legislative provisions.

For other countries, which are currently searching for solutions to bring down (youth) unemployment and overcome labor market dualization, the German case shows the beneficial role of vocational training, sectoral and plant-level social partnership and labor market regulation which is less dualizing than in many Mediterranean countries. However, these features took time to develop and cannot be transferred instantly. In particular, they require the active involvement of employers and trade unions in a pragmatic relationship regarding training, working conditions and employment adjustment. The longer-term perspective shows that public policies only had a limited influence on actual restructuring and employment creation. Cumulative change observed in Germany also shows that significant remodeling can be achieved without systematic coordination or a long-term political strategy – or a big societal and political deal as observed in corporatist countries. While the current pattern of labor market flexibility seems viable for the time being, institutional stability as such cannot be expected. In the face of various challenges arising from the ongoing process of globalization, the German labor market and the economy will undergo further remodeling along recent reform paths.