October 19, 2003

Needed: A Two-Handed Approach

The Economist thinks that Germany's Chancellor is serious about reforms to remove shackles on aggregate supply. But there is a problem:

Economist.com: Will Mr Schröder’s labour-market reforms have any discernible effect on Germany’s unemployment crisis? The cut in the duration and value of benefits may do something to improve the supply side of Germany’s labour market, encouraging people to look for jobs rather than subsisting on state pay-outs. In this respect, they are of a piece with Mr Schröder's ambitious plans to turn the Federal Labour Office, which administers unemployment benefits, into a giant temping agency, finding work for those who say they can't find jobs themselves. On Friday, Wolfgang Clement, Germany's minister for economics and labour, claimed that this measure alone would cut unemployment by as much as 20%. But no supply-side reform, however ambitious, can work until demand picks up and the economy starts creating jobs. The unemployed will not be cajoled into work if there is no work to be found...

To remove the shackles from aggregate supply without boosting aggregate demand does little good: it simply changes classical unemployment into Keynesian unemployment. Schroeder thus needs the active and immediate cooperation of the European Central Bank to lower interest rates and boost aggregate demand. But I don't see how he is going to get it.

Posted by DeLong at October 19, 2003 05:47 PM | TrackBack


hey, I think I can answer that one.
(1) labour-market reforms were necessary anyway. The Federal Labour Office was essentially just writing files on people instead of promoting them. Efficient storage doesn't sell a product/good.
(2) German workers are sluggish compared to the US. That means, demand for labour was unlikely to be met with the competition you'd expect based on the rate of unemployment. Bluntly speaking, if offering a job is met with only a lukewarm response, you're not keen on doing it again, creating pent up demand for labour in the form of overtime etc.
(3) tied to (2) is the idea of increasing the dynamics of the market, e.g. by support for start-ups and small business. The idea here is that high potentials who would otherwise just sit and wait after loosing their jobs. (Wait for the economy to pick up again or finding a wholly suitable job again) With the changes, these people are more likely to consider starting up their own small business because the usual substitute to a demand for jobs, unemployment benefits, is no longer as readily available.
(4) It's a psychological measure, signalling that German's are ready and willing to work and killing some sacred cows. This is supposed to create a more investment friendly environment.
(5) cutting unemployment benefits now (a) helps pay for the current system (without raising taxes or debt) and (b) "Germany’s manufacturers, who still provide around 20% of German jobs, struggle under the burden of social-insurance contributions and payroll taxes that add almost a quarter to their labour costs" and the reform is supposed to signal that the government tries to bring that 20% number down, again creating a more corporation-friendly environment.

That said, the general point about the lack of labour demand is certainly correct, I know nothing about economics except for your courses 1-6 (I know I'm behind schedule), and Clement is exaggerating. OTOH, I think the reforms are the best that can be done under the circumstances. In fact, I think one might even make the case (without denying the principal effect of lower interest rates) that deregulation is more effective right now. Going out on a limb (of ignorant speculation) I'm inclined to think that lower interest rates only exert their effect on labour demand if the market is sufficiently flexible. I believe a good case can be made that there is unmet demand for labour in Germany due to structural reasons (the classical example being firms refusing to hire people because it is too tricky to fire them again, or in the case of small businesses, because you have to follow a bunch of regulations once you cross a threshold number of employees). I'm wondering whether the firm belief in managing unemployment through interest rates only is not an artefact of the American system.

Details on reforms :Labor Market Reforms Spelled Out and The Road Ahead for Labor Market Reforms from Deutsche Welle.

Posted by: markus on October 20, 2003 03:05 AM

will these links work?
http://www.dw-world.de/english/0,3367,1432_A_988029,00.html - Labor Market Reforms Spelled Out
http://www.dw-world.de/english/0,3367,1704_A_1000610_1_A,00.html - The Road Ahead for Labor Market Reforms

Posted by: markus on October 20, 2003 03:29 AM
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