Float or Sink? The Millstone of the "Social Market" in Germany

Behaviour supposed to defend against some danger, but in fact making the danger more threatening and the defence ineffective, is worryingly frequent among groups that decide their conduct collectively, for example by majority vote. Job protection is a classic case. It is not hard to get a majority to vote for “workers’ rights”, including a worker’s right to his job that he should only lose under the most compelling circumstances. In Germany, it is left to the courts to say whether there are really compelling reasons for allowing this, and cases can drag on and on. Only firms with less than 5 employees have a relatively free hand, (which provides a good reason for not expanding beyond that size). Comparable “job protection” measures have cropped up in other European countries over the last quarter century, and have mostly been tightened up as unemployment started to become endemic.

German businessmen now say that if you hire at all, you must know that you hire for the very long term and as long as an employee chooses to stay with you, you must pay him, rain or shine. The employer carries the risk that it will rain and not shine, and to cover this risk among many others, he must mentally add a risk premium to the wage he must pay. It is hardly surprising that the effect of “job protection” is to reduce the number of jobs that should be protected. Like the man trying to keep his head above the water, the German job market has been sinking at an accelerating rate; the latest unemployment figure is 10.6 per cent, and the latest growth forecast is 0.1 per cent per quarter for the current year, (the only-just-positive number showing a naïve faith in the precision of statistical output and income measurement).

Needless to say, job protection is not the only, nor even the main cause of the appalling performance of the once mighty German economic machine. “Be assured, my young friend,” (as Adam Smith famously remarked) “that there is a great deal of ruin in a nation”, and it took more than just a few manifestly counter-productive measures to bring about stagnation. The ever heavier millstone of the world’s most elaborate welfare state was carried with growing difficulty as Germany progressively emerged from the fiercely energetic and productive era of post-war reconstruction and settled into bourgeois comfort. The loss of buoyancy finally got the best of the “social market economy” that left-of-centre world opinion used to applaud as the living proof of the “European social model”, the Third Way, social and market all rolled into one!

Like in other European countries where Left and Right outdo each other in being “social”, many horror stories circulate in Germany about how much it really costs to employ the average worker. Some employers claim that it costs them 300 euros in all the various statutory deductions, health, disability, unemployment and pension contributions to give their employee a pre-tax take-home pay of 100. Aggregate national income statistics tell a less lurid, but still fairly preoccupying story. A pre-tax take-home pay of 58 must be topped up by employers’ and employees’ various social insurance contributions of 48, raising the total cost to the employer to over 100. To this must be added about 20, representing the contributions of the general taxpayer to the various social services. All in all, the total cost of a worker to the German economy is a little more than twice his take-home pay.

Many economists now believe that German labour has become too expensive and this is the root cause of high unemployment. The labour unions, whose power in Germany is still great because of the monopoly role labour legislation reserves for them in wage bargaining, furiously refute this. German wages are in fact too low, they argue, for if they were not, the country would not have a visible trade surplus year in, year out. Once again, here is proof that a little economics is worse than none, for the trade balance depends on many other things, and depends on them more strongly, than on domestic wages. Nevertheless, like the argument of the illiterate that if jobs are menaced, the lawmaker must protect them, the trade balance argument is widely believed to show that wages are not too high and the unions are responsible corporate bodies, exercising statesmanlike restraint in wage bargaining.

Cornered and finally persuaded that “something must be done”, Germany’s social democratic government is now proposing to turn against its own parliamentary supporters and introduce a long overdue reform of the “social market economy”. It has a majority of only 8 seats in the lower house, and two-thirds of its legislators are union officials or union members. To pass reform legislation, it needs some support from the opposition, much of which is just as “socially” minded and, if only for sound electoral reasons, may refuse to curtail “workers’ rights”. As a result, the proposed reform package is decidedly timid. Some say it is just bandage on a wooden leg, though others think that the very fact of a socialist government at last repenting is good news in itself.

A few items in the reform are significant. Entitlement to full unemployment pay is reduced from 32 to 12 months, a fixed tariff is proposed for severance pay, and the obligation to engage in industry-wide wage bargaining is somewhat relaxed. If they pass, these would be useful measures. Much of the rest is little more than cosmetic. All in all, however, they are far too weak and far too anxious not to hurt, to restore the natural buoyancy of the economy.

Any but the boldest and widest-ranging reform is up against a force greater than itself, the dynamics of the advanced welfare state that acts as a giant automatic de-stabilizer. The incipient welfare state begins with social services absorbing under 20 per cent of GDP. With the economy growing fairly briskly, more can be afforded, and bidding for votes ensures that “social” spending rises to the neighbourhood of 25 per cent. In fact, by 1990 the 15-country European average was 25.4 cent and Germany’s spending was exactly the same as the average. This level seemed sustainable though, from the point of view of productivity growth, probably not desirable. Some items of expenditure grow autonomously whatever you do; health service and pay-as-you go state pensions are of this kind. Others grow when the economy starts doing less well; unemployment pay does this. The upshot is that the slower is economic growth, the more of GDP is absorbed in social spending.

By 1996, German social expenditure as a share of GDP passed the 30 per cent mark, beaten only by a short head by France and the Scandinavian countries. After a slight easing in 1999-2000, the percentage continued its trend rise and as we write it probably exceeds 32 per cent.

Believers in socialist or communitarian doctrines will take it that this chunk of expenditure on all that is “social” rather than “market”, apart from its morally attractive aspect, is really a stabilizer. If things go awry on the market side, they are rescued by the rocklike solidity of social spending that, in addition, makes people feel safer and more willing to spend. I will not try and answer the claim of moral worth except to wonder about the moral worth of forcing workers to spend half or more of their gross wages on compulsory social insurance. Extortion is extortion even if it is “in your best interest”. However, let that pass.

Regarding the effect of a high and rising social service overhead on the course of the economy, to contend that it acts as a stabilizer is tantamount to saying that fewer incentives produce more jobs and more growth. Though such beliefs cannot be categorically disproved, they are very, very unlikely to be true. The commonsense view is that poor economic performance augments the relative share of social spending, and a higher share of social spending leads in turn to poorer economic performance,—and so we go on until something totally unforeseen breaks this circle. Until then, thrashing about without quite sinking is probably the best the “social market economy” could hope for.