Kiel Institute Focus 7

Towards an Explanation of the German 
"Labor Market Miracle"*

by Klaus-Jürgen Gern and Dominik Groll

The German labor market has been remarkably resilient during the finan­cial crisis. The unemployment rate increased only slightly between autumn 2008 and summer 2009, by not more than 0.5 percentage points on the standardized measure (ILO), compared to roughly 3 percentage points in the euro area as a whole. This is especially surprising given that the loss in German output was even higher than in the euro area average (-6.3 percent and -5.1 percent from peak to trough, respectively). What's more, the labor market seems already to have turned. Unemployment is on a downward trend on a seasonally adjusted basis since July last year, and April saw a particularly strong drop. The unemployment rate is now at the level of the trough seen before the crisis. To be sure, unemployment sta­tistics have been favorably influenced by statistical changes which re­moved an estimated 230 000 unemployed (approximately 0.5 percent of the labor force) from the statistics (Figure 1). But compared with expectations held by most observers one year ago, actual developments remain a big positive surprise. In a similar vein, employment numbers have been extremely robust given the dramatic decline in production experienced last year. The number of employees fell only very slightly – by just 0.4 percent from peak to trough – and seems to have started to rise again already.

Source: EUROSTAT, own estimation.

The burden of the crisis has been shared almost evenly by employees, who reduced average hours worked sharply, and by employers who accepted a steep decline in productivity (Figure 2). Both of these factors have initially led analysts to expect that the labor market would be weak during any incipient recovery of production for a prolonged period of time as firms would be pressing for recuperation in productivity and average hours. Accordingly, a strong rise in subsidized part-time unemployment (short-time work) observed during the crisis would have to be reduced before the labor market could recover. However, in contrast to popular understanding, although an important mechanism in keeping workers on the payrolls during the crisis, short-time work is not at the heart of the story.

Source: Federal Statistical Office of Germany (Destatis),
own calculations.

A closer look at the way how the reduction in working time was achieved reveals that short-time work is only responsible for less than one third of the total, according to estimates of the Deutsche Bundesbank (Figure 3). Short-time work has already been reduced substantially, and this has not impeded the improvement in the labor market visibly. Moreover, short-time work, as an instrument designed for short-term adjustment in cyclical down­turns, has been available in Germany for a long time. Its use during the recent crisis has not been exceptional by historical standards given the depth of reces­sion. Around 20 percent of reduction in hours worked has been due to short-term adjustment mechanisms such as reduction of overtime and reductions of the balance on working time accounts. The latter have become a common and important instrument in German companies increasing flexibility in production, particularly in industry. While drawing on working time accounts can be regarded a one-off adjustment which could also be reversed quickly, around one half of the reduction in average working hours is due to more structural factors such as the reduction of regular working hours and increased part-time work. Especially the latter factor, responsible for almost 30 percent of the total reduction in average working time, should be permanent as it reflects the structural composition of the recession in Germany which has been very much concentrated in industry. Accordingly, losses in employment have been almost entirely confined to industry and construction (where working full-time is dominant), while employment in services (with a much higher incidence of part-time work) continued to increase even during the recession.

Source: Bundesbank; IAB.

Forecasts for employment have to be based on assumptions about the extent to which the pronounced reduction in average hours worked will be reversed. Ultimately, this boils down to making an assessment of the trend in average hours worked to which actual numbers should eventually converge. The German economy has been characterized by a declining long-term trend in hours worked per employee (Figure 4). While reductions of regular weekly hours and increases in the number of holidays had been important in the period until the mid-1990s, the dominant factor afterwards has been an increasing share of part-time work, not least due to the in­creasing participation of women in the labor market. The number of hours worked per employee stopped declining, however, around the year 2004 and even increased during 2006–2008. This has been interpreted by many observers (including the Kiel Institute) as a structural break in the trend which led to an upward revision of potential output estimates. More recent analysis, however, suggests that the structural factors behind the decline in average hours worked – especially increasing part-time work – are still largely unchanged. The robust development of hours worked in the years preceding the crisis should be rather attributed to increasingly flexible working time arrangements (working time accounts in particular which allow workers to accumulate hours beyond regular working time over an extended period of time in times of high demand and to reduce these accounts in times of low demand) which had been used extensively during the years of boom in German manufacturing. On our current esti­mate of the underlying trend in average hours worked, a return to the trend ("back to normal") by 2011 would imply only a small increase in hours worked per employee over the coming quarters.

Source: GD (German joint economic forecast), spring 2010.

This revision of the trend estimate in hours worked is an important element for us being optimistic about German unemployment over the forecast horizon (standardized unemployment is projected to decline to 7.2 percent in 2010 and to 6.6 percent in 2011). Another significant aspect is that firms are apparently willing to hoard labor in order to retain human capital in a labor market which is expected to become increasingly tight in the segment of qualified labor in the coming years. This attitude has been facilitated by sufficient flexibility in working time arrangements (see above) and a very low level of unit labor costs at the height of the boom which was the result of prolonged wage moderation. As a result, the wage share in the economy had dropped substantially between 2002 and 2008 and, despite the drastic reduction of productivity during the crisis, it has only returned to the levels that had been normal before. Given the prospect of increases in hourly wages continuing to be modest and productivity continuing to gra­dually recover, we do not expect that pressure on firms to abandon their policy of labor hoarding will accelerate markedly.

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*The Kiel Institute Focus Series presents papers on current economic policy topics. Their authors are solely responsible for their content and their views or any policy recommendations they may make do not necessarily represent the views or recommendations of the Institute.