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Germany's Labor Reforms May Not Deserve Their Fame

Europe’s growth engine may owe more to luck than specific market refinements
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Germany’s start-of-the-century labor reforms are getting a lot of attention these days, both as the cure-all for the country’s previous economic woes and as the culprit behind inequality.

Yet the importance being awarded to the famous “Agenda 2010” reforms might be a little exaggerated, according Christian Odendahl, an economist at the Centre for European Reform. Germany’s metamorphosis from the “sick man of Europe” into the continent’s growth engine may owe more to luck than specific labor market reforms, he says, and a little myth-busting may be in order before other countries — such as France — try to emulate them.

For one, Odendahl says, the mid-2000 reforms came just at the right time. As the government of then-Chancellor Gerhard Schroeder made it easier for companies to fire workers and drastically reduced benefits, emerging markets enjoyed an economic boom, jump starting demand for German products. 

Companies also did a lot of the heavy-lifting — they restructured, cut costs and shifted operations to countries like the Czech Republic, Hungary and Poland, all of which (in another stroke of luck) had just joined the European Union. The risk of having jobs moved east also put pressure on German unions to keep their wage demands in check.

The bottom line is that positive effects from the reforms were amplified by the environment in which they took place.

That observation holds an important lesson for another eager reformer — French President Emmanuel Macron, whose desire to loosen labor laws has already put him on a collision course with his country’s powerful trade unions. And France may not be as lucky as Germany. The Chinese economy is slowing and cranking up government spending in France to cushion the blow from the reforms could be tricky as the nation's budget deficit is already running afoul of EU rules.

Odendahl believes the first order of action should be to “lower payroll taxes, invest in training and job centers, and make it easier for people to move to where the jobs are. Only when the economy has recovered, should the labor market be made more flexible.”

The myth-busting exercise is also relevant for Germany’s own political discourse. Social Democrat Martin Schulz — Merkel’s main challenger in this fall’s election — has proposed rolling back some of the reforms, blaming them for generating inequality and expanding Germany’s low-wage sector. As for the latter, historical data shows that isn’t quite the case.

What is true is that German reforms raised job instability and probably contributed to weak consumer spending and a rise in precautionary savings, says Odendahl.

“The rest of Europe, rather than copying these reforms, should learn more nuanced lessons from the German experience,” Odendahl concludes.

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