From Sick Man of Europe to Economic Superstar

In the late 1990s and into the early 2000s, Germany was often called “the sick man of Europe”. Today, after the Great Recession, Germany is described as an “economic superstar”. Germany’s number of total unemployed fell from 5 million in 2005 to about 3 million in 2008, and its unemployment rate had declined to 7.7 percent in 2010. Germany’s exports reached an all-time record of $1.7 trillion in 2011, which is roughly equal to half of Germany’s GDP, or 7.7 percent of world exports.  

How did Germany, with the fourth-largest GDP in the world (after the United States, China, and Japan) transform itself from “the sick man of Europe” to an “economic superstar” in less than a decade? In a recent paper published in the Journal of Economic Perspectives (Dustmann, Fitzenberger, Schönberg and Spitz Oehner, 2014; also available as CReAM Discussion Paper No. 06/14), we argue that:

• The astonishing transformation of the German economy is due to an unprecedented process of decentralization of wage bargaining that led to a dramatic decline in unit labor costs and ultimately to an increase in competitiveness of the German economy.
• The process of wage decentralization was made possible by the specific governance structure and autonomy of the German labour market institutions, not rooted in legislation, but laid out in contracts and mutual agreements between employer associations, work councils, and trade unions. In times of challenging economic circumstances, Germany’s labor market institutions thus proved far more flexible than previously thought.
• The “Hartz” reforms (2002-2005) played no essential role in improving the competitiveness of German industry, as the process of decentralization of wage bargaining started in the mid-1990’s, nearly a decade before.

The findings provide a new view on the role of policy in the dramatic resurgence of Germany’s economy. The authors don’t believe that the political process alone—had the autonomy of wage bargaining not existed—would have been able to achieve a similar degree of wage decentralization in Germany, which ultimately led to the significant improvement in competitiveness that we have witnessed. 

The research has important consequences for what Europe’s ailing Southern European countries can learn from the German experience. Other countries, such as Italy and France, have far more centralized and legally anchored labour market institutions than Germany, and reform will have to rely more on the political process. Whether similarly radical changes can be achieved in these countries remains therefore an open question, so the authors conclude.

The German experience does therefore not provide support for recommending the type of political reforms Germany implemented in 2003 (the “Hartz” reforms). Rather, Germany’s experience focuses attention on reforms that target the system of industrial relations by decentralizing bargaining to the firm level while keeping workers representatives involved. 

• Christian Dustmann, Professor of Economics and Director of CReAM, the Centre for Research and Analysis of Migration at UCL.
• Uta Schönberg, Reader (Associate Professor), UCL Economics
• Professor Bernd Fitzenberger, University of Freiburg
• Professor Alexandra Spitz-Oener. Humboldt University

References:

Dustmann, C., Fitzenberger, B., Schönberg, U., Spitz-Oener, A. (2014): From Sick Man of Europe to Economic Superstar: Germany’s Resurgent Economy. Journal of Economic Perspectives 28(1), pp. 167-188; also available as CReAM Discussion Paper No. 06/14