Lessons from German Labor Market Policy

Klaus F. ZimmermannIZA, DIW Berlin and Bonn University

September 25, 2009

Chinese University of Hong Kong

2

Outline

1. The German Labor Market: An Overview

2. Structural Deficits before 2003

3. Major Labor Market Reforms (2003-2005, “Hartz Reforms”)

4. ALMP: The German Experience

5. Conclusions: The Design of Labor Market Policy

3

The German Labor Market: An Overview

• High unemployment as a central problem in post-unification Germany

• This has often been linked to:– The high level of employment protection– The high labor costs– The strictly regulated labor market

• Protection of employment risks characterized by:– High level of statutory employment protection for regular contracts– Predominance of compulsory social insurance providing

earnings-related benefits in case of unemployment after a sufficient contribution period

– Until 2005 also earnings-related long-term unemployment assistance– Replaced by a means-tested flat rate benefit in 2005:

Major break with Germany‘s long tradition of status maintenance in case of unemployment

► Part of a broader policy shift towards activation (“Hartz reforms”)

4

Unemployment in Germany (1960-2009)

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

5,500

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010

in t

ho

usa

nd

s

Reunited Germany*

West Germany

East Germany

1,094,229

2,368,217

3,462,446

Source: Federal Employment Agency

► In October 2008 the unemployment dropped under the level of 3 million for the first time since 1992► This might be an indication that the fundamental structural problems of the German labor market

could have been decisively loosen by the Hartz reforms

Oil crises

Germanreunification

Post-war economic boom

Dotcom bubble

Hartz reforms

5

Policy Responses to the German Reunification

• After the German reunification, the integration of the East German economy led to an increase in unemployment

• The political decision to finance a large share of the transition costs through social insurance contributions (and not by general taxation) increased the burden on labor costs

• Policymakers reacted in a selective way:– Higher non-wage labor costs put pressure on standard forms of

employment and dampened new employment opportunities

– Growth of flexible jobs, i.e., non-standard forms of employment, facilitated by several legislative steps that required less employment regulation, involved lower or no non-wage labor costs, or offered even subsidies for such employment forms

• Additionally, active labor market policy (ALMP) measures were extensively used in East Germany– In particular, public training programs and job creation schemes

6

3.5

4.0

4.5

5.0

5.5

6.0

6.5

7.0

7.5

in m

illi

on

s

25.0

25.5

26.0

26.5

27.0

27.5

28.0

28.5

29.0

in m

illi

on

s

mini-jobs (exclusive) mini-jobs (incl. side jobs) regular employment

Post-Unification Germany: Development of Standard vs. Non-Standard Forms of Employment

Source: Federal Employment Agency

► Non-standard forms of employment gained importance in recent years► Increase particularly strong in 2003 and 2004

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Post-Unification Germany: Extensive Use of Job Creation Schemes and Public Training Programs

Annual Number of Entrants into ALMP (2000-2006)

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

2000 2001 2002 2003 2004 2005 2006

0

100,000

200,000

300,000

400,000

500,000

West Germany: total (left scale)East Germany: total (left scale)West Germany: job creation schemes (right scale)East Germany: job creation schemes (right scale)West Germany: training programs (right scale)East Germany: training programs (right scale)

Source: Federal Employment Agency.

... but both „traditional“ ALMP measures in Germany lost importance in recent years

8

Labor Market Institutions: Historical Perspective

• Compulsory unemployment insurance introduced in 1927(complementing existing insurances for health, accident and old age)

• A generous benefit system emerged after World War II, especially during the economic boom in the 1960s

• ALMP introduced when unemployment started to rise in the 1970s– When unemployment was still low, measures were designed

to prevent rather than to combat unemployment

– After German reunification, ALMP played a central role in alleviating the social consequences of the breakdown of the economy in East Germany

– For instance, in 1992 the number of individuals participating in job creation schemes or training programs exceeded the number of unemployed (in East Germany)

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Labor Market Institutions: Set-Up during the 1990s

• Unemployment benefits (UB) meant to maintain the worker‘s social status during unemployment rather than providing a safety net as a last resort– Duration: 6 to 32 months

(depending on previous employment duration and age)– Amount: 67 percent of last net income; maximum: 4,250 € per month

(60 percent without children)– Financing: unemployment insurance contributions (employers/employees)

• Unemployment assistance (UA) paid after UB entitlement period had expired– Duration: without time limit (!)– Amount: 57 percent of last net income

(53 percent without children)– Financing: taxes

• Social assistance (SA) as a possibility to supplement UB/UA– Every household with an income below a certain threshold qualified for SA

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Labor Market Institutions: The Need for Reforms (1/2)

Passive Labor Market Policy:

• Unlimited UB/UA payment duration extraordinary feature of the German system

• Replacement rates for long-term unemployed were higher than in any other OECD country (OECD, 2004)

• Replacement rates for short-time unemployed comparable to many other OECD countries

• Incentives to take up a job were very low, especially for low-skilled:– Generous benefit levels

– High benefit reduction rates

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Labor Market Institutions: The Need for Reforms (2/2)

Active Labor Market Policy:

• High expenditure levels and long durations of programs• Most important programs:

– Job creation schemes

– Training programs

• Job search assistance and monitoring was given low priority• Sanctions were rarely implemented• Assignment to programs based on the caseworkers‘ discretion

(no systematic individual profiling)• No systematic evaluation

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Major Labor Market Reforms (2003-2005)“Hartz Reforms”

Implementation in four waves („Hartz I-IV“) between 2003 and 2005:

• Hartz I-III – Stronger role of activation (e.g. sanctions)– Significant reduction of long-term benefits – Massive deregulation of fixed-term contracts,

agency work and marginal part-time• Hartz IV

– Restructuring of the unemployment benefit and social assistance schemes

– Means-tested flat-rate benefit replaced earning-related long-term unemployment assistance

► Implementation of the reforms was tied to an evaluation mandate

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Underlying Principles of the Reforms

► improving employment services and policy measures

► activating the unemployed according to the principles of „right and duties“

► stimulating employment demand by deregulating the labor market

Shift towards activation, effectiveness and efficiency

core element: principle of „rights and duties“

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Threefold Reform Approach (1/3)

Improving employment services and policy measures

Re-designing of old measures and introduction of new measures of ALMP

Modernization of employment services along the lines of New Public Management• Results-based accountability of local employment offices• Outsourcing of many offices• Open competition between private service providers

Customer-orientated one-stop-centers, offering individual profiling, job search assistance, social services and administration of benefit payments

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Threefold Reform Approach (2/3)

Activating the unemployed according to the principle of „right and duties“

Implementation of an activation strategy in various policy changes • Priority to measures that support unemployed workers who are pro-

actively seeking integration into regular employment

Introduction of jobs exempt from any or with reduced social security contributions to take up employment in low wage sector• “Minijobs”/ “Midijobs”

Restructuring of the benefit-system • Reduction of unemployment benefit levels and durations• Eligibility for subsistence allowances according to a person's ability to

work rather than according to previous contribution payments • Possibility of benefit sanctions and reductions

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Threefold Reform Approach (3/3)

Stimulating employment demand by deregulating the labor market

Deregulation of the temporary work sector

Introduction of exemptions from restrictions on fixed-term contracts and dismissal protection

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Overall Reform Effects: Evolution of the German Labor Force (1992-2007)

45%41% 40% 38%

7%8% 10% 11%

4%3% 3% 3%

4%

6% 8% 7%7%

25% 25% 24% 21%

5%4% 4% 5%

2%6%

6%7%

0%

25%

50%

75%

100%

1992 1997 2002 2007

Inactive

Unemployed

Unemployedwith jobSelf-employedMarginal /irregularAgency work

Temporary

VocationaleducationPermanentpart-timePermanentfull-time

Source: SOEP

Decrease in the share of permanent full-time employment

Decrease in the share of inactive individuals

Growth of flexible jobs

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Growth of Flexible Jobs:OECD EPL Index (1985-2008)

0

0,5

1

1,5

2

2,5

3

3,5

4

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

Regular Contracts Temporary Contracts Source: OECD

Continuous deregulation of temporary contracts

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ALMP: Lessons from the Mandatory Evaluation

Only a small part of the German ALMP effectively improves individual reemployment probabilities:

1. Training programs

2. Start-up subsidies

3. Wage subsidies

4. Placement vouchers

... but further evaluation needed to assess long-term effects

► Reduced range of ALMP

► Focus on programs with proven positive effects

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Lessons learned? ALMP Expenditures in Germany have decreased by about one-third (2002-2006)

0

5.000

10.000

15.000

20.000

25.000

2002 2003 2004 2005 2006

Promotion of self-employment

Wage subsidies

Programs for disabled people

Youth programs

Training programs

Job search assistance

Job creation schemes etc.

Other measures

20,97019,679

18,249

16,04014,978

Source: Eichhorst and Zimmermann (2007)

(in million €) Expenditure increased:►Start-up subsidiesExpenditure decreased:►Training programs►Job creation schemes►Wage subsidies

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Further Results of the Mandatory Evaluation

• Re-organization of public employment services mainly successful – counseling and placement were intensified in the course of the reforms – with the exception of outsourcing of services

• Re-designing training programs seems to have improved their effectiveness

• Significant positive effects of the redesigned wage subsidies and start-up subsidies

• Job creation schemes continue to be detrimental for participants’ employment prospects

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The Example of Training Programs: Training Vouchers and Stricter Selection Criteria

Overall finding:

The effectiveness of training programs for the unemployed has increased after the reforms

... but which features of the reforms have caused this increase – and to what extent?

1. Introduction of training vouchers

Job seekers are free to select their training provider in the market (previously this choice was made by the caseworker)

2. Stricter selection criteria

Stricter selection of the participants by the caseworkers based on the expected reemployment probability

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Decomposing the Reform Impact on the Effectiveness of Training Programs

► Introduction of vouchers increased the effectiveness of training programs in Germany

► Stricter selection does not improve effectiveness

Voucher Effect Selection Effect

Source: Rinne, Uhlendorff and Zhao (2008)

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Conclusions: How to effectively design labor market policy?

• Two elements of passive labor market policy:

1. Maintaining the worker‘s social status during unemployment(for a predetermined, finite period)

2. Providing a safety net as a last resort

• Systematic approach towards active labor market policy:

1. Evaluate the programs‘ effectiveness

2. Focus on programs with proven positive effects

• Activating the unemployed:

1. Principle of ‘rights and duties’

2. Efficient placement services(but networks in general more efficient)

Flexibility AND Security

Klaus F. ZimmermannIZA, DIW Berlin and Bonn University

IZA, P.O. Box 7240, 53072 Bonn, Germany

Phone: +49 (0) 228 - 38 94 0Fax: +49 (0) 228 - 38 94 180E-mail: zimmermann@iza.org

www.iza.org