The Secrets of German Prosperity

 

    

The German economy has outperformed the American economy for most of the last seventy years. Americans like to think this is because of our Marshall Plan which helped them rebuild after the end of World War II. This is because Americans like to think their economy is the best in the world. We fantasize that nobody performs well without either imitating the Americans or having American help. However, one aid program from the late 1940’s can only go so far. Germany had lower unemployment than we did for most of the last half of the twentieth century and throughout the twenty first century as well.

    

The table below shows German and American unemployment rates from 1960 to 2019. There is the irksome complexity that Germany was divided into West Germany and East Germany from 1945 until the Fall of the Berlin Wall in 1989.  It is best to ignore the East German economy. That system was Communist. The East Germans artificially created low unemployment through the use of make-work jobs. 

    

West Germany had thriving industrial capitalism. For years where the two Germanies co-existed, when possible I provide data on both Germany as a whole and West Germany alone. After 1989, all that matters is reunified Germany.

Unemployment Rates, Germany and the United States: Selected Years

    

The numbers in the table tell an unambiguous story. Germany has nearly always had lower unemployment than the United States. It does not matter if you look at Germany as a whole or Capitalist West Germany by itself. There was one exceptional period, around the year 2000, when the Germans were having a hard time dealing with the aftereffects of closing the old inefficient East German factories. This created a lot of surplus workers in East Germany and unemployment rose as a result. But this was a one-off short-term problem. By 2010, Germany was back to its old winning ways. It was outperforming the United States, just as it always had since 1960.

    

What is the secret of low German unemployment?

It is difficult legally to lay off German workers. Laws and policies concerning the ability of employers to shed labor have changed substantially in the last seventy years. There has been more labor market flexibility in the last twenty years than was previously the case in the late twentieth century. That said, German workers enjoy a level of employment security that is far greater than that experienced by American workers.

a. In highly unionized settings – which is much of the economy – employers are bound by codetermination laws. Management and stockholders get to appoint only half of the board of directors of companies. The rest of the board of directors is appointed by the union. In America, the board of directors acts only in the interest of management and stockholders. In Germany, half of the directors are advocates of workers. Not surprisingly, they tend to resist any attempt to lay off workers or to close factories. This does not mean that staff cannot be reduced. But it does mean that management has to have a very good case – so good that it can convince its own union representatives. This prevents kneejerk, spur of the moment mass layoffs as a quickie fix for issues in short term profitability. It also eliminates layoffs when other solutions might exist that might keep a factory open.​

 

b. Technological decisions have to be approved by works councils in factories. Works councils are staffed by union representatives. The works councils will generally reject putting in new machinery or procedures that would eliminate employment. This does not mean Germany is technologically retrograde. German manufacturing is known for its superlative engineering. But if management wants to upgrade its production process, it has to have a plan in hand for what it intends to do with the extra workers.

 

c. Legal impediments increase the cost of dismissing workers. Same-day surprise layoffs are illegal. One-month notice is a minimum for non-probationary employees; longer periods of six months to a year are not uncommon. Terminations for any reason can be challenged in labor court. A worker can both challenge both firings based on non-performance of duty and collective layoffs for cost-cutting purposes. Frequently, employers have to pay substantial severance payments to forestall staff reductions being tied up in court. The result is that laying workers off can be extremely expensive. This lowers its attractiveness as a response to short term profit pressures.

 

d. Knowing that workers are hard to get rid of, employers train their workers in many, many specialties. If an American auto company is using fewer parts that use machine lathing and using more parts that require on-site software programming, they will lay off their lathe workers and replace them with software specialists. A German company will begin training its lathe operators when it can foresee that more programming will be needed. Then it transfers the surplus old-technology workers to the new-technology positions. The old workers get to keep their jobs.

 

e. The unions work to keep wage rates low. German workers are realistic about the fact that Chinese factories can underprice a lot of German products. To protect German workers from foreign competition, the unions keep wage rates under control. They also cooperate with management to insure that German factories use the most productive technologies and that German products are simply of higher quality than are those made in East Asia.

 

f. Following this quality strategy, German industry concentrates in the upscale sector. The Germans have no problem with the Chinese selling inexpensive merchandise to Walmart. They have no problem with Walmart selling at rock bottom prices. The German plan is to make products that are so advanced, that the Chinese and Koreans would have a hard time attaining German levels of quality. As East Asian engineering manufacturing gets better and better, this is a harder and harder strategy to execute. However, Germany makes the Mercedes-Benz. They still make the BMW. China for all of its manufacturing skill has not been able – yet – to crack the market for luxury automobiles.

 

Could the Americans do any of this? Very doubtful.

Do the Americans have strong unions that could insist on legal limits on layoffs and half of the seats on company boards of directors? American unions are lucky if they can get pay to go up during economic booms.

Could America go into the upscale quality sector where they could afford to have all of these limits on employee dismissal? A very large percentage of American manufacture is mass manufacturing – where we produce huge amounts of goods in very large factories hoping to use economies of scales to make those products cheap. Germany makes BMWs. We make Chevrolets.

However, even our upscale sectors do not have any particular limits on employer’s right to hire or fire workers as they please. America enjoys absolute excellence and technological supremacy in the area of computer games. Computer game programmers enjoy wonderful pay rates and spectacular working conditions. However, games companies can dismiss anyone they want on the spur of the moment. Many games companies do just that at the end of product cycles.

The German system is superlative for what it is. However, you will never see this system implemented in the United States any time soon. We scramble by as best we can.

But this is a reminder that the United States can be outperformed by other countries who do things differently than we do.

    

If we wish to solve our persistent problems, it might be a good idea to study those nations who are outperforming us in our areas of weakness. You never know if one of those nations may have a solution that we could learn from and modify for our own use.

For More Information

A short accessible introduction to the German system can be found in the Economist July 8-14, 2017. The article has the not-at-all-helpful title “Vorsprung Durch Angst.” Pp. 18-20 The title translates into “Advance Through Fear” which is a ridiculous title given what the article actually says. The Economist has a strong free-market bias and tends to express skepticism about everything German except tight monetary policy. This is absurd given that the German economy outperforms the British economy in most years. That said, this particular article is friendlier to German institutions than are most Economist articles, even though they have to work in a few digs at the end.

For a long difficult to read, but brilliant introduction to the German economic miracle, see Wolfgang Streeck’s Social Institutions and Economic Performance – particularly Chapters 5 and 6. 

Much of Japan’s economic success comes from instituting employment and technology policies similar to those of Germany. It is no accident that Germany and Japan were closely allied in World War II. Japan has long used Germany as a model for how to attain rapid enduring economic growth. For a book that discusses common German and Japanese policies, see Wolfgang Streeck and Kozo Yamamura’s edited collection Origins of Nonliberal Capitalism.

For a guide to German employment law see Pascal Kremp’s “Employment and Employee Benefits in Germany: an Overview” on the website Thomson Reuters Guide to Practical Law: https://content.next.westlaw.com/3-503-3433?transitionType=Default&contextData=(sc.Default)&__lrTS=20191023045252835&firstPage=true&bhcp=1