The Sick Man of the Euro

A decade after reunification, Germany had become the slowest-growing large economy in Europe — averaging just over 1 percent growth between 1995 and 2003 against 2.5-3 percent for the EU-15. It had a growing unemployment crisis fuelled by a dysfunctional welfare system built for the post-war boom.

A Reform Programme Outsourced to a Commission

In February 2002, Schröder appointed a fifteen-person commission chaired by Peter Hartz, the then personnel director of Volkswagen, to redesign German labour market policy. The commission included not only representatives of German business, but also prominent figures from the trade union movement and the SPD.

Schröder and the Hartz Commission understood that Germany's unemployment crisis could not be solved by moving five million people directly from welfare into stable, long-term employment. The skills mismatch was too deep, the cost of hiring too high, and employers too cautious. The political task was therefore twofold: create a lower-cost entry point into the labour market and do so in a way that could survive the inevitable opposition from the trade unions and the SPD's own left wing factions.

“There is no right to laziness in our society.”

— Gerhard Schröder, Bild, April 2001

Agenda 2010: liberalising the labour market

Hartz I and II, enacted in January 2003, restructured how unemployed people were supported into work and dramatically liberalised the terms on which employers could hire them. The centrepiece of Hartz II was the reform of “mini-jobs”: the previous social contribution thresholds, which had been punishingly high for low-hours work, were raised significantly, and a new category of “midi-jobs” was created with even higher earnings thresholds for social contributions.

“Either we modernise, and I mean as a social market economy, or we will be modernised, and here I mean by unchecked market forces that push social considerations to the margins.”

— Gerhard Schröder, speech to the Bundestag, 14 March 2003

Schröder paid the ultimate political price

The Social Democratic Party of Germany (SPD) lost North Rhine-Westphalia, its heartland since 1966; Lafontaine quit to lead the new Left party alliance; and Schröder called early federal elections, which the Christian Democratic Union and the Christian Social Union (CDU/CSU) narrowly won. But the Hartz architecture was retained in full — Merkel publicly credited Schröder for Germany's recovery, locking both major parties into the settlement.

But the reforms endured and delivered

While Schröder may not have succeeded politically, his reforms fundamentally reset Germany's economic trajectory. German unemployment rate fell from a peak of 11.7 percent in 2005 to 6.9 percent by 2013, a decline of nearly 5 percentage points in just eight years.

The reforms also allowed Germany to enter the 2008-09 global financial crisis with a labour market built for flexibility. The Kurzarbeit short-time work scheme, expanded in 2009, kept approximately 1.4 million workers employed who might otherwise have entered unemployment. German unemployment rose by only 0.5 percentage points during the crisis, compared to increases of 5-10 points in many peer economies.

The Hartz reforms also played a role in boosting German business competitiveness, especially in exports.

Twenty years after Hartz IV's enactment, every attempt to modify it has operated within its basic framework. No party has proposed returning to the pre-2005 system of open-ended, earnings-linked welfare. The architecture has become the floor on which all subsequent policy is built.

Political Lessons from Germany