Monday, April 1, 2013

How to Reduce Unemployment

Lessons From Germany

Many of the pundits are once again celebrating the pick-up of the U.S. economy. Unfortunately this upturn, like prior ones, seems to exist more in their heads than in the data. The big bright spot being highlighted is the 200,000 monthly rate of job creation since October. This only sounds like good news for those who don’t remember that we created 240,000 jobs a month in the same five months last year.

While the economy is not about to slip into recession, there is little reason to think we will see a marked upturn from last year’s 1.7 percent growth rate. In fact, with the end of the payroll tax cut pulling money out of people’s pockets and the sequester leading to layoffs and further cutbacks, we are at least as likely to see the economy slowing as picking up steam.

This is bad news for tens of millions of people who are unemployed, underemployed, or have dropped out of the workforce altogether.
There is little prospect that the economy will grow enough to substantially improve their employment prospects any time soon. Nor is there much hope for any policy shift that will provide a boost to the rate of growth. This is why it is a good time to look to Germany.

The unemployment rate in Germany is 5.4 percent, more than two full percentage points below its pre-recession level. By contrast, even with the recent decline to 7.7 percent, the U3 unemployment rate in the United States is still more than three full percentage points above its pre-recession level.

The difference in labor market performance is even more striking if we look at the employment-to-population ratio (EPOP), which measures the percent of the population that is employed. Before the recession the EPOP for people between age 16 and 64 was roughly 5 percentage points higher in the United States than in Germany. In 2012 the EPOP for this age group in Germany was more than 5 percentage points higher than in the United States, making a total shift in Germany’s favor of more than 10 percentage points.

If you think this difference is explained by a booming German economy then you haven’t looked at the data. Growth since the beginning of the downturn has been almost identical in the two countries. From 2007 to 2012 Germany’s economy grew a bit more than 3.0 percent. The U.S. economy grew a hair less than 3.0 percent. The difference can’t come close to explaining the gap in labor market outcomes.

It is true that the United States has a more rapidly growing working-age population than Germany and therefore needs more growth to keep its unemployment rate stable. However this gap would still only explain a small portion of the difference in labor market outcomes.

The secret to Germany’s better outcomes is that the country has an explicit policy of pushing employers toward shortening work hours rather than laying off workers. A key part of this picture is the short work program, which is an alternative to unemployment insurance. With traditional unemployment insurance, when a worker gets laid off the government pays roughly half of the workers’ wages.

Under work sharing, if firms cut back a worker’s hours by 20 percent, the government makes up roughly half of the lost wages (10 percent of the total wage in this case). That leaves the worker putting in 20 percent fewer hours and getting 10 percent less pay. This is likely a much better alternative to being unemployed.

In addition to its formal short-work program, Germany also has a system of hour banks where workers put in extra hours during good times. During a downturn they can draw on these hours to maintain their pay even if they are putting in fewer hours. There are also many agreements between unions and management to reduce work hours to address a drop in demand. These can be more easily negotiated in a country like Germany, where the unionization rate is more than twice that of the United States.

This institutional structure makes it much easier for Germany to deal with a reduction in labor demand by cutting work hours rather than laying people off. Of course even before the downturn Germany had a much shorter average work year than in the United States. Under the law workers are guaranteed more than four weeks of paid vacation every year in addition to 10 statutory holidays, paid family leave, and paid sick days.

As a result, the average work year in Germany is almost 20 percent less than in the United States. As a matter of simple arithmetic, if everyone in the United States worked 20 percent fewer hours we would need 25 percent more workers to provide the same amount of labor. While the picture is more complicated in the real world, there is no escaping the logic that more workers and more hours per worker are alternative ways to meet a growing demand for labor. There are good reasons for preferring the more worker route to the longer hour route.

It is worth noting that the Congress and the Obama Administration did try to encourage work sharing when they passed a provision of the bill extending the payroll tax cut that has the federal government picking up the cost of state short work programs. Twenty-five states have short work programs as part of their unemployment insurance systems, including several large ones such as California and New York.

Unfortunately, the take-up rate continues to be very low. Apparently governors and legislators would rather make cutbacks in areas like education or raise taxes than try to encourage businesses to switch from layoffs to short-work so that they can take advantage of free money from the federal government. A little prodding from the public may go a long way in this area.