Germany’s messy approach to minimum wages

Recent news in Germany has once again brought the ongoing discussion about the introduction of minimum wage to the newspaper headlines. After unions and the federal postal services agreed upon the introduction of a sector-wide agreement which is to be declared mandatory by early-2008, a private sector competitor announced 1,000 in staff layoffs and is most likely to enter bankruptcy procedures in late 2007 or early 2008.

In this piece, we are not going to argue the general cons and pros of minimum wages per se – on which evidence in inconclusive anyway – but rather highlight that Germany’s approach to declare sector-wide agreements under special circumstances as mandatory is messy and will most likely lead to unintended consequences such as restricting product market competition.

Let us start with some basics: In contrast to most other industrial countries, Germany does not have a tradition of minimum wages. The standard approach has so far been that there were a) strong unions in sector-wide collective bargaining agreements and b) social assistance payments which effectively set a floor for wages. The latter condition has been changed as part of the labour market reforms introduced by the Schroeder government as part of the Hartz reforms. This is a good arguing point in favour of a nation-wide minimum wage. We will return to that point later.

Unfortunately though, this is not the line of thinking the political debate has taken. In their coalition agreement the Christian and the Social Democrats have agreed to make some wage agreements mandatory for the entire sector. I.e. there is a legal exception to the rule that it is up to the employer to decide whether or not being subject to a collective bargaining agreement. In case of an agreement that is declared mandatory the employer is subject to such an agreement whether he likes it or not.

The Social Democrats’ homepage is a good starting point to where the discussion currently stands: there is talk about declining union influence and wage levels below the poverty line as stated reasons for the support of a minimum wage.

Economically, neither point is viable. First of all, the government should take a hands-off approach to union power. If the private sector – in form of both employees and employers – were to decide to change the rules of wage setting, so be it. Second, wage policies are not a very efficient way to deal with social problems. For example, it would not be very helpful to grant spouses of high income earners higher pay levels in general just because they happen to earn a low wage themselves. Third, and from my perspective the most important point, once you grant a union the power to bargain wages for an entire sector even if a majority of employers has decided not to enter negotiations with that union, rent sharing behaviour will go rampant. Let us just take the case of the postal workers’ union which recently agreed on a contract with the former postal office monopoly provider. What happened was that in the end both sides agreed on a contract that was relatively sure to price any competitor out of the market as it would be neigh on impossible to compete on labour costs. Something very similar is bound to happen in other sectors, too. So in effect, Germany’s approach of letting social partners set sector-specific minimum wages paves the way for rent-sharing and reducing product market competition. That is certainly not the way to do it.

In contrast to the sector specific approach, there could be an economically well-argued approach for the introduction of a general minimum wage, however.

Part of the Hartz reform package introduced by the Schroeder government was an intentional move towards a form of negative income tax. Low paid workers can augment their income by drawing on social assistance. The rate at which these additional payments from the public purse are reduced with rising income has been lowered considerably relative to the status-quo before the reforms. In effect, this amounts to a government subsidy for low paid work. As a result employers and employees could now agree on wage levels that leave overall income of workers relatively unchanged and reduce labour costs considerably. That this model has become quite popular can be seen from the government statistics of people drawing social assistance while in work. At the start of 2007 their number was up by 62% to 1.3 million relative to 2005, almost half of these (675,000 in total) are working in full-time jobs.

It can hardly be in the interest of the public to induce workers and employers to maximise their overall income at the expense of government finances by ever widening wage subsidies. So the government could set a cap on the additional payments out of the public purse by introducing a general minimum wage that applies to all sectors. This would also forestall agreements intended to achieve rent sharing. The general crux with general minimum wages is, of course, that if left to politicians, they most likely start to meddle. My personal favourite – rather than having yet another independent council of wise men – is to tie the level of the minimum wage to the full-time pay equivalent of Hartz IV benefits. Currently, that would add up to an hourly minimum wage of 4.40 EUR/hour. The main advantage of doing it this way would be that any increase in the minimum wage would directly translate into expenditure increases for the federal budget thus limiting the willingness to use the minimum wage level as a short-term policy tool.

3 Responses to "Germany’s messy approach to minimum wages"

  1. Ulrich Fritsche   December 21, 2007 at 11:02 am

    David, good and thoughtful post. Indeed a clear selling argument for a country-wide minimum wage is the concept of a negative income tax. The concept would fit with other proposals quite well. I personally would opt for increasing both Hartz IV as well as the minimum wage a bit — due to the dramatic increase in poor Hartz IV households as reported in the last DIW Wochenbericht — but this is far from being disputable in political circles at the moment.

  2. David F. Milleker   December 22, 2007 at 1:48 am

    Ulrich, Thanks hope to see you in Kochel after a splendid x-mas.

  3. mheck82   January 11, 2008 at 1:03 pm

    unfortunately such good ideas will never happen. There are too much people in the parliaments in Germany. Making a law which has not to be changed every 2 years would make too many of them unemployed. As well even 5 Euro will not make it in terms of public acceptance.Thanks for good suggestions and the free trial of the full page anyhow.