1. Lessons from German Labor Market Policy Klaus F. Zimmermann IZA, DIW Berlin and Bonn University September 25, 2009 Chinese University of Hong Kong

2. 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. 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. 4 Unemployment in Germany (1960-2009) 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 German reunification Post-war economic boom Dotcom bubble Hartz reforms

5. 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. 6 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

7. 7 Post-Unification Germany: Extensive Use of Job Creation Schemes and Public Training Programs Source: Federal Employment Agency.... but both „traditional“ ALMP measures in Germany lost importance in recent years

8. 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)

9. 9 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

10. 10 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

11. 11 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

12. 12 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

13. 13 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“

14. 14 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

15. 15 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

16. 16 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

17. 17 Overall Reform Effects: Evolution of the German Labor Force (1992-2007) Source: SOEP Decrease in the share of permanent full-time employment Decrease in the share of inactive individuals Growth of flexible jobs

18. 18 Growth of Flexible Jobs: OECD EPL Index (1985-2008) Source: OECD Continuous deregulation of temporary contracts

19. 19 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

20. 20 Lessons learned? ALMP Expenditures in Germany have decreased by about one-third (2002-2006) Source: Eichhorst and Zimmermann (2007) (in million €) Expenditure increased: ►Start-up subsidies Expenditure decreased: ►Training programs ►Job creation schemes ►Wage subsidies

21. 21 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

22. 22 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

23. 23 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)

24. 24 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

25. Klaus F. Zimmermann IZA, DIW Berlin and Bonn University IZA, P.O. Box 7240, 53072 Bonn, Germany Phone: +49 (0) 228 - 38 94 0 Fax: +49 (0) 228 - 38 94 180 E-mail: zimmermann@iza.org www.iza.org