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There's a Right Way and a Wrong Way to Deal With a Jobs Crisis -- Why Is Germany Doing It So Well?

Germany's success indicates that one way to fight unemployment would be some modest efforts to give U.S. employers incentives to cut hours, not workers.

The Great Recession hit harder in the United States than in most of the rest of the world. Among the world's rich economies, we experienced the third largest increase in unemployment, trailing only Spain and Ireland. Most advanced economies saw substantially smaller increases in unemployment and one --Germany-- actually saw its unemployment rate decline.

Can we learn anything from countries that weathered the Great Recession better than we did? The experience of two countries --Denmark and Germany-- seems particularly informative. Denmark had a model labor market before the downturn, but ironically, offers a cautionary tale. Germany's economy has been up and down since unification in the early 1990s, but points one way out of our mess.

For most of the 2000s, Denmark had what was arguably the best labor-market performance in the world. Unlike most European countries, unemployment rates were at, or even below, US levels, and employment rates (the share of the population holding a job) were well above those here. Denmark managed this while offering high wages and comprehensive benefits such as health care, paid sick days, paid family leave, and union representation.

Denmark's success is widely attributed to its "flexicurity" system, which provides flexibility to employers and security to workers. Flexibility comes in the form of limited job protections for workers. In the United States, private-sector workers have almost no legal rights to their jobs and, absent a union contract, can legally be fired for almost any reason. In Europe, however, workers have a range of legal protections against dismissal. Denmark has more protections than we do here, but noticeably less than workers in the rest of Europe.

Danish workers accept less job security because they know that national unemployment benefits are generous and the system spends real money getting unemployed workers into new jobs. This is the "security" half of the "flexicurity" system.

A key part of this system is a set of programs that provides training, education, job-search assistance, and other services and incentives to unemployed workers. Even before the Great Recession, the Danes spent over one percent of GDP on these activities. In the United States, we spent less than one-tenth of 1 percent of GDP on comparable programs.

Flexicurity worked well when the Danish economy was booming. Training, education, and help matching the jobless to vacancies work well when there are plenty of jobs. These same policies, however, have limitations when there just aren't enough jobs: the unemployment rate in Denmark, which was just 4.0 percent in 2007, has been rising steadily since 2008, and now stands at 7.8 percent.

The Danish experience is a cautionary tale for the United States because it has become fashionable here to argue that our current unemployment is "structural." That is another way of saying that high unemployment is largely the fault of the unemployed themselves, either they lack the necessary skills or are unwilling to relocate to where the new jobs are.

But, Denmark already does far more than we could ever hope to do here to provide training, education, and other supports to the unemployed. If unemployment were "structural," the Danish response would be near perfect. Their approach has not made a noticeable dent, however, because unemployment there, like here, is the result of deficient demand, not a deficient workforce.

There is an economy, however, that has figured its way around the Great Recession. Unemployment in Germany is lower now than it was before the downturn (not to mention lower than in Denmark, now, too).

Germany has done well because its labor-market institutions encourage employers to cut hours not workers. Instead of laying off 20 percent of workers, say, a firm can instead lower the average hours of its employees by 20 percent. Both accomplish the same goal, but from a social point of view, cutting hours is much better because it shares the pain more equally and keeps workers tied to their jobs.

The German system gives employers many incentives to cut hours instead of workers. The most obvious is their "short-time work" system, which pays partial unemployment benefits to workers who have their hours reduced. German workers who lose one day of work per week are entitled to receive unemployment benefits equal to one-fifth of the usual weekly unemployment check.

Other aspects of the German system also help. Legal protections against dismissal make it cheaper for employers to reduce hours than to fire workers. And many Germans are covered by union contracts that allow flexibility around the length of the work week and the spread of hours throughout the year.

Together, these systems helped reduce the total number of hours worked in Germany by about 4 percent between 2008 and 2009. Over the same period, total employment remained unchanged. Essentially all of the adjustment to the Great Recession in Germany fell on the average hours worked by existing employees and none fell on laid-off workers. By contrast, two-thirds of the adjustment to the downturn in Denmark and the United States fell on employment and only one-third on the average hours worked.

German successes suggest that one way to fight unemployment --at a relatively low cost to the federal government-- would be some modest efforts to give US employers incentives to cut hours not workers.

Expanding the small programs already in place in 20 states to allow "part-time unemployment benefits" --sometimes called "work-sharing"-- is an obvious place to start. Implementing a new tax credit to employers that expand paid time off --paid sick days or paid family leave, for example-- is another route.

Germany used variations on these kinds of policies to lower the unemployment rate during the Great Recession. Imagine how different the world would be if the unemployment rate in the United States today were, say, 4 percent, not 9 percent.

John Schmitt is a senior economist with the Center for Economic and Policy Research.
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