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A job half-done: Germany's state pensions system
FT, September 18 2000

Any day now, Walter Riester, Germany's labour minister, will announce proposals to rein in the escalating costs of the country's chronically overburdened state pension system. The measures represent the most important step yet taken by the centre-left government to address the structural weaknesses in Germany's labour market.

Few doubt that reform is needed. The seasonally adjusted unemployment rate of 9.5 per cent hides considerable variations. In Bavaria or Baden-Wurttemberg, in southern Germany, companies find it hard to recruit the younger workers they need; but in parts of former East Germany, joblessness still stands at 20 per cent or more.

Across Germany, there are about 1.6m unfilled vacancies, about a third of which are for low-qualified staff. Instead of workers being taken on or laid off according to the economic cycle, labour is a fixed cost to be avoided where possible. And, in areas of high unemployment, the generous social security system gives little incentive to move to where there is work. As Dieter Brauninger, economist at Deutsche Bank in Frankfurt, says: "The labour market is not functioning."

Mr Riester's pension reforms are an attempt to address some of these ills. But two doubts remain. First, will the changes go far enough? And second, how far will any benefit from the proposals be offset by other measures concerning short-term contracts and workplace consultation?

German business leaders are concerned. The labour market is a "very poorly patient", says Christoph Kannengiesser, head of the labour policy section of the German employers' association (BDA). "In the medium term, the current combination of medicines will have a more negative effect than positive."

At 19.3 per cent of gross wages (split equally between employers and employees) contributions to the state pay-as-you-go pension system account for a big part of non-wage labour costs - and would be still higher without subsidies from the federal budget. But the reforms proposed by Mr Riester would merely contain, rather than reverse, the explosion in costs resulting from the ageing of the population.

The minister envisages younger workers investing just 4 per cent of gross wages in private pensions (in addition to state pension contributions). State pensions would be cut back slowly. But with two pensioners expected for every three workers in 2030, compared with just one today, many doubt whether the government will succeed in its goal of holding state pension contributions below 22 per cent of gross wages until at least 2030. As Mr Kannengiesser puts it, the pensions bill may supply "the right medicine - but not in the right dosage".

Just as worrying for business are the concessions to the labour movement that Gerhard Schroder, Germany's chancellor, and Mr Riester, a former deputy leader of IG Metall, Germany's largest trade union, are expected to make in order to win support for pension reform.

The chancellor presents himself as a moderniser. But by instinct - and also to maintain his parliamentary majority - he nurtures contacts with the left wing of his Social Democratic party. "The left wing represents a clientele, the trade unions, that is very important to the SPD," says Thea Duckert, labour policy spokesman for the Green party, the junior member of the Berlin coalition that has been active in demanding structural reforms.

The government is likely partly to rescind measures introduced by Chancellor Helmut Kohl that make it easier to hire workers on fixed-term contracts. The BDA employers' association describes the original measure as "one of the most successful labour market instruments of the past two decades". More than half the 550,000 jobs created in the past year have been for a fixed period. But trade unions argue it has simply replaced permanent jobs with less secure employment; Mr Riester plans restrictions to clamp down on "abuse". In addition, he wants to give employees the right to work part time.

Mr Riester also plans to bolster the position of workers' councils, so they are not made irrelevant by the pace of industrial restructuring. Co-determination, the system that gives employees a say in working hours, hiring and firing and other workplace issues, has been in decline for some time; just 35 per cent of today's workers are represented by workers' councils, compared with more than 50 per cent in 1980.

Both measures are welcomed by German unions. "The ideology that says you just have to deregulate and jobs will fall from the skies is nonsense," says Ursula Engelen-Kefer, deputy chairman of the trade unions' association. "We don't want to copy the US or the Asian tiger economies."

But employers fear that the new legislation on workers' councils and fixed-contract workers will only exacerbate the problems of an excessively protected labour market. "Anyone who strengthens the law on workers' councils scares off investors," says Michael Fuchs, head of the Germany's wholesaler and foreign traders association. Dieter Hundt, head of the BDA employers association, warned in Brussels on Monday that the proposals on workers councils would leave Germany "fully isolated" within Europe.

At the same time Mr Schroder's government is reluctant to tackle another distortion: the disincentives to work built into the generous welfare system. Although unemployment has fallen, this year's budget for payments out of unemployment insurance funds has not been cut proportionately. A study earlier this year by the Cologne economic institute showed the three most important means-tested programmes - social, unemployment and housing assistance - were failing to provide a springboard to work. A couple on welfare with two children was entitled to a monthly disposable income of DM2,893 ($1,270). But if one parent took a job earning DM3,000 before tax, the family would be just DM181 better off.

"In Germany the feeling predominates that you can't force the unemployed [to work]," says Meinhard Miegel, head of the Bonn-based Institute for Economic and Social Research. "It is unreasonable to expect them to travel far or, when they have refused two or three jobs, to cut their unemployment pay". The measures introduced in the UK to encourage the unemployed into work would produce "an outcry," he adds.

Business leaders do not dispute that the economic climate has improved in other ways - and that some of the credit should go to the government. Wage settlements, at about 2-3 per cent, have been modest this year. Cuts in corporate and personal income taxes, approved by parliament in the summer, have reduced business costs and boosted confidence. Even the weak euro has helped exports. At 3.9m, seasonally adjusted joblessness is about 200,000 lower than when Mr Schroder took office in October 1998.

The problem is that the tax changes, while welcome, have not addressed the supply-side labour market reform that business leaders and many economists believe is most needed.

The structural weakness have been further masked by heavy spending on job-creation schemes. The budget for make-work programmes, training schemes and wage subsidies has increased from DM41.8bn last year to DM43.4bn this year. In addition, those out of work and aged 58 or over are entitled to unemployment benefit without actively seeking employment. Mr Schroder wants that limit cut to 55 in eastern Germany.

Set against the scale of reform required in Germany, Mr Riester's pensions bill looks a modest first step. As Mr Kannengiesser at the employers' association argues: "An inefficient labour market is an enormous brake on economic growth." If Germany wants to ensure long-term sustainable growth, "we have to step up the reforms of the labour market".

Margit Gennser om ATP

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