Germany vs. US: Two Different Approaches to the Recession

In many past commentaries I attacked labor markets in Western Europe as being too rigid regarding layoffs and hires, and for providing too generous unemployment compensation often for very extended periods. That rigidity explained why unemployment rates in the 1990s and the first 6-7 years of this decade were much higher there than in the United States. Responding to the facts of high unemployment and long durations of unemployment, and to criticisms of their labor market policies voiced by economists, many countries of Western Europe began to reform their labor market policies to make them more flexible, and to limit the duration of government support of unemployed workers.

The case of Germany is one of the most interesting, only partly because Germany is the largest economy of Europe. Under the long reign by the conservative Christian Democratic Union, little was done to reform the German labor market. In a reminder again of the "Nixon going to China" doctrine, the socialistic Social Democrats, led by Gerhard Schroder, introduced various labor market reforms in 2003 after being elected to power in 1998. He cut the length of the period of eligibility for unemployment compensation, extended the age of retirement and reduced retirement pensions, and made it a little easier for companies to layoff workers. In good part as a result of these policies, while Germany unemployment had been close to 10%, it fell to 7.5% prior to the onset of the recession, perhaps mainly due to these reforms.

Germany was hit hard by the worldwide great recession as world GDP took a nosedive, mainly because Germany is the world's second largest exporter after China. Its GDP fell by over 5 percentage points in 2009, and is expected to rise by about 2% this year as world GDP recovers, and because the euro has fallen by about 10% relative to the dollar since the euro peaked at about $1.5 per euro. The German economy as measured by GDP was during the first quarter of 2010 still somewhat below comparable numbers for the first quarter of 2008.

What happened to German employment and unemployment is even more interesting. Employment fell only slightly, but part time work increased sharply as jobs were spread. Unemployment rates increased only a little. Unemployment is now down to its 7.5% pre crisis level, and employment is back at its earlier peak, and part time work is declining, as the German economy continues to recover.

Contrast this with the American economy. On the one hand, the US financial system was hit much harder than the German system. On the other hand, the German economy is far more dependent on exports than is the American economy. The net effect of these differences is not completely clear, although US GDP fell by a lot during the first year after the recession hit, but then began to recover at a moderate rate. Whereas Germany's unemployment rate grew by very little during the recession, the US unemployment rate grew by over 5 percentage points.

This difference in employment and unemployment behavior between Germany and the US may be mainly the result of the fact that the American labor market is still far more flexible in most respects than the German labor market. However, if that were the main explanation, then the jobs recovery in Germany should have been slower than in the US, but that has not been the case. Total jobs in Germany are about at their pre-crisis level, whereas the number of Americans employed is still several million below its peak in 2008.

Germany was criticized because it did not have a big enough stimulus and did not run large enough fiscal deficits to stimulate the economy. In early 2009, Germany introduced a 50 billion euro stimulus package after much urging from intellectuals and some economists. That is about 1.6% of its GDP, with about one-third earmarked for infrastructure improvements, and the other two thirds going to tax cuts, child allowances, and social benefits. Even more important from the traditional "stimulus" analysis, Germany's fiscal deficit is expected to hit between 5-6% in 2010, smaller than the fiscal deficits in many euro-zone countries.

Contrast these numbers with those for the United States. The American stimulus package of about $800 billion-by no means as yet all spent- is 6% of American GDP, about four times as large relative to GDP as the German stimulus. Even more telling is that the fiscal deficit during 2009 and expected during 2010 amount to about 12% of American GDP, far larger than the fiscal deficits Germany has been running. Germany has recently taken actions to cut spending and raise some taxes, while the US government continues to think of ways to increase government spending, as if the huge fiscal deficit is not enough.

Let it be clear that I am not claiming that US employment and unemployment has been very sluggish in recovering to pre crisis levels mainly because the US has had a large stimulus package and large fiscal deficits. They probably have been factors, but the evidence is still too uncertain to reach such a judgment. But it is clear that the stimulus package completely failed relative to the explicit predictions of the Obama administration and its Council of Economic Advisers about what would happen to unemployment. They predicted unemployment would decline by about 1.5 percentage points from a much lower peak, whereas so far the total decline from the higher unemployment peak of 10.2% is only 0.7 percentage points.

I continue to believe that the biggest factor in the sluggish employment recovery of the US is that many of the actual new and proposed anti-business legislation, as well as the large fiscal deficits, made businessmen and investors cautious about taking on new workers. These proposals and laws include the health care bill, the pro-union bias and anti-business rhetoric of Congress and the president, suggested increased taxes on higher earners, changes in anti-trust laws to be less pro-consumer, and the endlessly complicated and largely misplaced financial "reform" law. Germany, by contrast, has continued with the same coalition government headed by the mainly pro-investment, pro trade Christian Democrats. Germany surely made various mistakes during this recession, but the US has made many more.