Nova Scotia Can Learn From Germany’s Labour Market Reforms

The Ivany Commission’s section on economic development goals pin points increasing firm’s participation in export trade by 50%, a 3% increase in labour force participation, and tackling our unemployment problem as all priorities. Reaching these goals, as the report puts it, would be “transformative” but not impossible.

That sounds like a tall order, but Germany represents an important precedent in understanding how the right policy mix can fuel that transformation, and usher in an era of booming employment, wage and export growth that can change our self-attitude in the process.

The Sick Man of Europe

Throughout the 1990s and into the 2000s Germany was widely regarded as the “sick man of Europe”. East and West unification contributed to the country’s rising structural unemployment and growing wage disparity within the country, leading to fears of a looming dependency on equalization transfer payments. Demographics meant Germany faced a rapidly shrinking working-age population, while worsening competitiveness due to high unit labour costs led to a receding manufacturing sector and major plant closures. The East struggled especially hard to foster its own engines for growth. As a result, workers migrated West in droves.

Sound familiar? Migration to West Germany has slowed in the decades since the wall came down, but qualified workers continue to relocate. The reason is simple. Contemporary West German workers make about 30% more on average than workers in the East, despite similar quality of education. This is comparable to the 40% premium for an Albertan job relative to Nova Scotia.

Wage gaps arise from labour productivity gaps. In Germany’s case, the East is roughly 73% as productive as the West. This is identical to Nova Scotia’s labour productivity gap relative to the Canadian average. Despite high unit labour costs, PEI, Nova Scotia and New Brunswick are much less productive than other provincial economies (see Figure 1).

unitlabourcost

It is what economists call the “place premium,” determined by a multitude of factors common to both countries, such as the West’s greater urbanization, capital investment intensity and larger firm sizes.

The Right Policy Medicine

A key difference is that, unlike in Atlantic Canada, the East and West German wage gap is narrowing. After years of high unemployment, between 2003 and 2005 a series of major labour market reform packages known as the Hartz plan transformed the stagnant German economy into the superstar we think of today, helping the more rural, less productive East to play catch-up.

The reform’s main effects were to dramatically liberalize short and temporary work arrangements, expand a system of wage subsidies for low skill workers, and to incentivize return-to-work by reducing unemployment benefit claims for the long term unemployed. The reforms increased the labour force (Figure 2), boosted employment across the country, and helped spur an export manufacturing take-off. Consequently, Germany’s unemployment rate has fallen from its high of 10.5% in 2005, to 5.1% as of March 2014.

hartz 2

The Hartz liberalization followed earlier negotiations with Germany’s powerful labour unions that helped decentralize collective bargaining agreements, bringing on a decade of wage restraint. This combined with the liberalizations to suppress unit labour costs and strengthen German competitiveness, leading to a surge in export manufacturing activity that has bucked the trend in all other advanced economies. These measures introduced so much flexibility and matching efficiency to the German labour market that they traversed the global recession with increasing employment and productivity rates.

The Mittelsand Miracle

With Nova Scotia’s minimum wage currently at $10.40 an hour, someone working full time for 45 weeks a year would make around $18,000. This minimum income is 58% of Halifax’s median income, and 75% of Yarmouth’s. Should there be any surprise that rural unemployment in Nova Scotia tends to be 3 to 5 points higher compared to HRM, or that rurally based, labour intensive firms continue to shut down?

Between 2006 and 2011, business counts by employee size have fallen or stagnated in every range except the 5-9 employee category, which added 900 new businesses. If this trend continues, small firms will be practically the only firms Nova Scotia has left.

Once again, the German case-study proves relevant. Besides Germany’s large auto companies, the explosive growth in export manufacturing has been driven almost entirely by small and medium sized manufacturing companies known as Mittelstand. Small employers benefit disproportionately from a flexible labour market because they are more likely to require workers on a temporary basis, and lack the economies of scale to cover high unit labour costs.

hartz 3

Today, Mittelstand companies employ 70% of Germany’s workforce, usually based in small rural communities. They tend to be export oriented with a focus on high value products that connect to markets around the world. The lead advisor to the Obama Administration’s Auto Industry Task Force has gone so far as to describe the last decade as Germany’s “Mittelstand Miracle”.

Of course, if similar reforms were to take place in Nova Scotia they would look quite different. Relative to Germany, we give a weaker role to organized labour, and place greater reliance on direct regulations like minimum wages and occupational licensing. Germany, for instance, does not regulate its engineers, who after receiving their degree do not require licenses or work experience to practice.

Regardless, the main point is not that Nova Scotia should emulate the particulars of the German case, but that we can in principal achieve similar boosts in labour market efficiency and competitiveness by being equally as bold. The alternative – demographic fatalism and resenting the success of the West – were dead ends in Germany, and they will be dead ends here, as well.

Samuel Hammond is an AIMS on Campus Student Fellow who is pursuing a graduate degree in economics at Carleton University. The views expressed are the opinion of the author and not necessarily that of the Atlantic Institute for Market Studies

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