Squaring the circle

Despite a raft of reforms, Germany's labour market still excludes far too many people

HEADQUARTERS can reveal much about an organisation. The Bundesagentur fur Arbeit (BA), Germany's federal employment agency, based in Nuremberg, is a case in point: if the star-shaped formation of 1960s high-rise buildings were a housing estate, it would have been demolished long ago. Inside, the building is pure Kafka: long grey corridors that meet at strange angles, causing visitors to get lost.

Yet open a door on the 8th floor, and you suddenly arrive in the 21st century. The brightly lit room is filled with bulletin boards covered with hundreds of charts, most of them coloured in some combination of red, yellow and green. "We are using traffic-light logic to spot problems quickly", says Dieter Vollkommer, the former head of the BA's reform team.

This office is the war room for what may be the most ambitious reorganisation ever attempted in Germany: turning the BA, the country's largest bureaucracy with more than 90,000 employees, into a "customer-oriented service provider", as Mr Vollkommer puts it. The BA has put much effort into turning the dreaded Arbeitsamter--its local offices where jobseekers used to take a number and often wait for hours--into "customer centres", complete with crowd control and consultation cubicles.

The BA is a sure sign of Germany's will to reform: it is the most visible of a plethora of labour-market reforms that the government has introduced in the past two years. But there are doubts that it can really help Germany's new outsiders, the growing army of the long-term unemployed, who now account for more than half of Germany's jobless (see chart 4).

If Germany's education system was built specifically to protect insiders, its labour-market was meant to be all-inclusive. It managed well until the early 1970s, when the first oil crisis caused unemployment to rise. So the government sent hundreds of thousands of workers into early retirement, and trade unions pressurised employers into cutting working hours to 35 per week, mostly at the same pay as before, in return for relative industrial peace.

Wages were often set by "national peak-level bargaining": the IG Metall union, the biggest and strongest of them all, would negotiate a pay rise in one of its strongholds, which would then be adopted by unions and employers in other sectors. At the same time, wages at the lower end of the scale tended to rise disproportionately fast, making unskilled labour increasingly unattractive to employ.

The effect on labour costs was magnified by the way the country finances its welfare state: through a payroll tax with matching contributions from individuals and employers. Unemployment and early-retirement programmes pushed up these contributions, and the cost of labour with them. No wonder that the country keeps losing full-time jobs and their attendant social-security contributions. Contributions now add up to over 40% of gross income, compared with 27.6% in 1970.

Unification aggravated this vicious circle. Much of the cost of integrating the former East Germany was piled on to the social-security systems because it was politically easier than raising taxes. Worse, German unions and employers' associations, both dominated by westerners, quickly agreed to raise wages in the east close to western levels. The idea was to dissuade skilled easterners from moving to the west, but in effect it priced many low-skilled easterners out of the market.

Add the de facto minimum wage set by welfare benefits, along with strong protection against dismissal, and it is easy to see why Denis Snower, president of the Kiel Institute for World Economics, views Germany as a perfect example of his "insider-outsider theory". It turns on the concept of labour-turnover costs--in essence, all the costs associated with firing an employee and hiring a new one. The higher these rise, the lower the probability that they will actually be incurred--which is why the people in jobs, the insiders, have an interest in keeping them high.

There are cultural reasons, too, why low-paid services in particular, the main job-creation machine in other countries, are underdeveloped. Many Germans dislike the idea of working in services, thinking them demeaning. Women, who are still underrepresented in the workforce, tend to do their own housework rather than outsource it, and many men are do-it-yourself enthusiasts.

There is little doubt that long-term unemployment would have caused considerably more political uproar had the Federal Employment Agency not been there to smooth things over. Originally a combination of an insurance company and an employment agency, the BA has evolved into the organisation that looks after Germany's growing army of outsiders. In 2001, at its peak, it spent over two-fifths of its budget of euro52 billion on so-called "active labour-market policies", code for all kinds of training schemes and job-creation programmes.

The scattercash approach

The shocking fact is not that so much money was spent, but that most of it was wasted. The measures rarely helped the unemployed to find real jobs. Instead, it was unions and employers' associations that reaped most of the benefits. Billions flowed into huge training firms operated by both these groups. Critics point out that representatives of unions and employers in effect controlled the BA's federal and regional boards.

It was not without irony, then, that a scandal at the BA became the "PISA shock" that rattled Germany's labour market. In early 2002, it emerged that some agency departments had routinely faked job-placement figures. As it happened, the chancellor, Gerhard Schroder, badly needed a theme for the forthcoming election campaign. He asked Peter Hartz, then the personnel chief at Volkswagen, to head a commission to propose reforms.

Most of those proposals became part of Mr Schroder's reform package, Agenda 2010, and were implemented through a series of "Hartz" laws. Their purpose was threefold: to make the labour market more flexible by reducing job protection and lowering social-security contributions for certain part-time jobs ("mini-jobs"); to reform the Federal Employment Agency and equip it with better tools (for instance, the "Ich-AG", or "Me-company"); and to encourage the long-term unemployed to look for work by introducing a new flat-rate benefit ("Hartz IV").

All these reforms called for some new faces. Traditionally, the BA had been run by elderly politicians with expertise in social-security issues, such as Bernhard Jagoda, who had to resign after the job-placement scandal. The current president, Frank-Jurgen Weise, comes from a very different background: a former soldier, he co-founded a logistics firm and is an experienced financial controller. It may not be obvious, but this is exactly the right set of skills for the job.

When Mr Weise joined the BA as finance chief in 2002, he did not like what he found: in the absence of reliable data, the agency did not really know what it was doing. In particular, it had no idea whether the billions spent on retraining had any lasting effect. Just as with Germany's education system, it was the input that got the attention, not the output.

Mr Weise's most important task has been to create transparency. Training programmes are now evaluated and procured via central calls for tender, creating a real market. Local agencies operating in similar labour markets are competing with each other, and their performance indicators are compared every month. If an agency regularly falls short, heads may roll, but the main idea is to ensure that best practice spreads throughout the organisation.

The BA's new president already has some results to show for his efforts. Partly thanks to his cost-cutting, the government is now considering reducing the contribution to the unemployment-insurance scheme, currently 6.5% of gross income, by two percentage points next January. But Mr Weise knows that this will not be enough: unless he turns the BA into a highly efficient tool for policymakers, its enemies, who want to dismantle and privatise the bureaucratic behemoth, might yet have their way.

A visit to the local employment agency in Nuremberg's city centre reveals how much has changed, but also how much more needs to be done. The long queues have gone. The rule in the "entrance zone" is that it should take no more than 30 seconds to direct "customers". If they are newly unemployed, they have to fill in a lengthy questionnaire. If they have an appointment, they can go straight upstairs.

Yet the biggest changes are less visible. "We are now acting like a real company and are no longer engaging in much social policy," says Gisela Scherer, one of the agency's bosses. Costly long-term re-training schemes have been replaced by short internship-like programmes. And if an unemployed person is hard to place, the agency does not invest a lot of effort, explains Ms Scherer: he or she will get unemployment benefit for a year and "then be better taken care of downstairs".

"Downstairs" is where the local "Arge" has set up shop. This is short for Arbeitsgemeinschaft, or working group, but it is more than that. The Arge is a new type of organisation, set up in each German city or county to look after the long-term unemployed who receive the new flat-rate benefit under the Hartz IV law. In a way, Germany has outsourced all its outsiders to the Argen (it is unfortunate that "arg" also happens to mean "bad" in German).

The big question is whether these bodies will do a better job than the BA did. Their first task is to vet applicants for the new benefit, which is means-tested and paid only to those who are seriously seeking work. They are still sorting out their bureaucratic problems, so they have not had much time to spend on their second main job: to provide support for their clients.

What is already clear is that Hartz IV got its incentives entirely wrong. The state calculates the benefit on the basis of a Bedarfsgemeinschaft, an impossible-to-translate term which broadly speaking means the household in which the jobless person lives. A single person in west Germany gets euro345 a month(euro331 in the east) plus health insurance, rent and utilities paid for, which makes it attractive for jobless young people, for instance, to move out of their parents' home. Policymakers had expected 2.6m Bedarfsgemeinschaften, but are now faced with as many as 3.7m.

Yet for all the expense, reorganising an employment agency and introducing a new benefit does not create any extra jobs, says Stephan Doll, the boss of the Nuremberg section of the Deutsche Gewerkschaftsbund, the umbrella organisation for Germany's unions. He speaks from experience: unemployment in the city is about one percentage point above the national average.

"All the labour-market reforms were no more than empty promises", says Mr Doll, echoing the prevailing German mood. Many now argue that instead of introducing further reforms, the government should raise wages and start spending again--on infrastructure and education, and on developing the local economy. As it happens, the new government has recently announced a programme under which euro25 billion will be spent on such measures over the next four years.

Yet the next round of labour-market reforms also seems to be under way. During the election campaign last year, the parties outbid each other with proposals. The Social Democrats wanted to introduce minimum wages to stop wage dumping by east Europeans. The Christian Democrats were keen to weaken union power and job protection. In their grand-coalition agreement, the two parties made hiring and firing a little easier: new employees will in future have to wait for two years rather than the current six months before their job tenure is secure. Now the coalition is toying with something called Kombilohn, a combination of a low market wage plus a government subsidy.

Ulrich Walwei, deputy director of the Institute for Employment Research, the BA's think-tank, is sceptical about this flood of new ideas. First, he says, the earlier reforms have to be properly evaluated. Mini-jobs, with a maximum pay of euro400 a month and social-security contributions of only 25%, have certainly shown that lowering the cost of low-skilled work can create jobs: there are now nearly 7m of them. But outsiders do not seem to have benefited, and it is unclear whether these jobs have simply replaced full-time ones.

Weakening or even doing away with job protection, from which most insiders still benefit despite many changes at the margins, is certainly no silver bullet, says Mr Walwei; nor is the Kombilohn. For such a model to work, the de facto minimum wage would have to come down significantly, which would be tricky in the current climate. A better solution, he says, might be to cut social-security contributions for all low-wage jobs.

Whatever Germany does, it must reduce its army of outsiders, argues Mr Walwei, or it will be in trouble as the country's population starts to shrink. Contrary to conventional wisdom, he thinks that a smaller workforce is unlikely to solve the unemployment problem if the job-seekers do not match the specifications of the jobs on offer. "If we don't get supply and demand to match at that point, our economic dynamism will go down the tubes."

But a sclerotic labour market is not the only reason why unemployment remains high. Over-regulated markets are just as much to blame, as the next article will demonstrate.

Article forms part of a survey of Germany. Despite a raft of reforms, Germany's labour market still excludes far too many people.