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Compliance Study: Germany

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"...we pledge to carry out practical reforms, consistent with the specific situation in each of our countries, aimed at achieving a high level of employment and widely-share prosperity: these include tax and social system reforms to ensure that "work pays," particularly for the least well-off; lowering social security charges which place a burden on low-skilled jobs, in countries with high indirect labour costs; and improving public employment agencies."

There is an increasing awareness that the institutional structure of the German labour market, which worked well in the past, is unable to provide the flexibility required to cope with an unemployment rate that has continued to trend upwards. It averaged 9.4% in 1995, 10.3% in 1996 and reached almost 11% at the start of 1997. The difficulty is not only the cyclical but perhaps more the structural unemployment. The government has therefore started to probe labour market deregulation but has met stiff opposition. The matter is still very much under debate and there is still no clear picture of a coherent policy framework. Even so, the government is given a high score in this area for starting to address the issue and for starting to move in the right direction.

At 10.5% the unemployment rate in 1996 was well below the 6.9% average for the G7. The source of the high unemployment rate in Germany is not due to low employment rates but due to a high participation rate. In 1996, the German employment rate (proportion of the working age population employed) at 61.6% is on a par with the 61.5% average for the G7 and significantly higher than in France (the other high unemployment economy in Europe). In contrast, though, the labour force participation rate in Germany at 68.6% was several percentage points higher than the 66.1% G7 average and yet higher again than in France.

(a) Labour supply - Score: +1

The government has started to undertaken measures to satisfy this commitment. These measures shift the opportunity cost in favour of entering the labour force and which consequently can be expected to lead to an increase in the labour force.

It is widely recognized that social security taxes in Germany are amongst the highest in the world. As part of its longer term plan to reform social security, the government announced its intention to reduce social security taxes from 41.9% of labour income to below 40% and then to below 36% of labour income by 2000. The pension funds contribution rate was increased from 19.2% to 20.3% of eligible income at the start of 1997. Public health care contribution rates were reduced by 0.4 percentage points. The reduction in the social security taxes levied on the worker can be expected to increase the opportunity cost of not working. This can be expected to increase the supply of labour to the extent that it increases the benefits of additional labour input for those already working and increases the benefits of entering the labour force for those not yet in.

The 1997 federal budget package included measures to reduce unemployment benefits. The main focus was to reduce access and eligibility rather than to reduce dollar benefits. This will have the effect of pushing unemployed individuals more quickly back into the labour force to look for work.

The 1997 budget also increased child tax benefits. This can be expected to have a positive impact on the participation rate of the working poor, especially single mothers, for whom child care is a high cost of entry.

The plan to reform social security has included a provision to increase the female retirement age in 2000 from age 60 to 65. Aside from reducing the burden on the pension system, this will also increase source population from which the labour force is drawn. To the extent that the labour force participation rate for elderly females between 60-65 is more than zero this will also increase the labour force. However, since elderly females also have a lower labour force participation rate than the average for all females, this will also likely reduce the measured female labour force participation rate.

(b) Labour demand - Score: +1

The government has undertaken a number of measures which reduce the effective cost of labour and which can therefore be expected to have a positive impact on the demand for labour.

As commented above, security taxes in Germany are very high and the government has announced intention to reduce social security taxes. At lest in the short term, social security taxes increases the cost of a worker to the employer and inhibits labour demand. Consequently, a reduction in these taxes should provide a boost to the demand for labour. In the longer term, matters are less clear and much depends on where the incidence of the tax falls. To the extent that the incidence of the tax ultimately falls on the worker, social security taxes are more of a constraint on labour supply than on labour demand.

The German labour market is heavily regulated with strong protection for the employee against dismissal. This works against employment since it increases the cost of an inappropriate hire. The government has now relaxed the rules for dismissal but only for small companies.

Labour market regulations in Germany legislate the provision of generous benefits for the employee. Until recently, this included statutory sick pay that was equal to 100% of earnings. The 1997 budget has now reduced this to a statutory minimum of 80% of earnings. To the extent that this reduces the cost of labour to the employer, this will increase the demand for labour and is likely to do so in the short term.. However, in the longer term as with social security taxes, a portion of the cost of these benefits is ultimately passed onto the worker in the form of reduced wages. In the longer, the reduction in sick pay benefits is therefore more likely to affect labour supply.

(c) Labour institutions - Score +1

Until a couple of years ago, the government held a monopoly of the labour market agencies. This sector has now been deregulated to allow the operation of private sector employment and placement agencies.

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