How To Destroy Germany's Economic Gains

Includes: DBGR, DXGE, EWG, FGM
by: Acting Man

Coalition Agreement May Lead to Legislated Minimum Wage

Back when the German election results came in, we wrote an article entitled "Germany Elects Mama – The Real Winner is Socialism". We tried to clarify why, in spite of a 'conservative land-slide victory' in Germany's election, more socialism was likely on its way. We mentioned the broader historical context of the post-war German relationship with free market capitalism, as well as the fact that unfortunately, not one of the parties that can be regarded as embracing a classical liberal (or libertarian in U.S. terminology) outlook managed to garner enough votes to enter Germany's parliament, due to the inane 5% hurdle.

Since the conservative CDU/CSU block (the pro free market credentials of which are very much open to question anyway) didn't gain enough votes for a parliamentary majority, it is therefore forced to hold coalition talks with one or more leftist parties. Among those, the SPD (Germany's social democrats) was always the most likely choice. We actually doubt the CDU/CSU is unhappy about having to enter a grand coalition with the SPD. Since the euro area's economic and fiscal crisis is far from over, its leadership surely reckons that both the right and the left should take responsibility for future hard decisions (which will be unavoidable).

Unfortunately, this also means that it will have to make concessions to the SPD, some of which are sheer madness. A recent Reuters article asks: Will a minimum wage destroy German jobs?Our first reaction to this was: 'Surely this is a rhetorical question?' Apparently that is considered open to debate by some. From the article:

“As Chancellor Angela Merkel seeks to form a new coalition government, she appears to be on the verge of throwing out some of the very policies that underpin the export boom of the past decade.

Most controversially, the new government to be formed is likely to introduce a minimum wage, a novelty for Germany, and a move that both symbolically and in reality would herald the end of the tough wage restraint that has characterized the past decade. A range of social policy changes, including a possible reduction in the retirement age, are also being discussed, as is higher government spending.

It’s not clear whether such shifts would provide the boost to domestic spending that the U.S. and Germany’s other critics are demanding. But their very prospect is sending chills down the spines of German business leaders. Ulrich Grillo, president of the Federation of German Industries, warns that “Germany can’t afford a grand coalition of election gifts,” and says that the politicians are acting as though Germany’s continuing prosperity is a given, rather than something that needs to be worked at. Deutsche Bank says flatly in a research report that the proposed minimum wage is “the wrong policy choice.”

The shifts in economic policy are coming about as a result of political necessity. Merkel scored strongly in the September 22 parliamentary elections, but her Christian Democratic Union party didn’t win enough votes to govern alone. The party’s top officials have spent the past few weeks locked in negotiations with the opposition Social Democrats over the shape of a coalition government, and they have already given way on a number of points, including the introduction of a minimum wage of 8.5 euros per hour (about $11.50 at current exchange rates).

Germany is unusual in that it doesn’t currently have a national minimum wage; pay scales for different industries are traditionally fixed by management and union organizations, in regular rounds of negotiations. Two elements of the planned minimum wage are notable. The first is the level being proposed, which is 45 percent above the U.S. minimum wage — considerably higher than that in some other European countries such as Spain, although below France and the Netherlands.

The second notable element is its expected broad application, across the whole of Germany, East and West, and including new entrants to the job market. This amounts to a rollback of the stringent policies put in place by Merkel’s predecessor Gerhard Schröder, starting in 2002, at a time when the German economy was struggling to digest the impact of reunification after the fall of the Berlin Wall.

Schröder, a Social Democrat, worked together with the former head of human resources at Volkswagen, Peter Hartz, to devise policies that created jobs, in part through the introduction of low-paid “mini jobs” that were exempt from social security charges. These were designed to get hard-to-employ people back into the workforce. The result has been spectacular: Germany’s current unemployment rate, of just over 5 percent, is half what it was a decade ago, and far below the 12.2 percent average jobless rate in the euro zone. And German productivity gains since then have far outstripped the modest rise in unit labor costs, propelling the current export boom.


For their part, advocates of the minimum wage argue that similarly dire gloom-and-doom scenario predicted in Britain back in 1998, when the government of Tony Blair introduced one, have failed to materialize.”

(emphasis added)

In short, Germany is about to throw out the very reforms that everybody agrees were at the heart of its transformation from the 'sick man of Europe' to Europe's economic powerhouse. Brilliant idea!

Theory vs. Statistics

We don't know whether Deutsche Bank's estimate – that the minimum wage will cost between 500,000 and 1 million jobs – will prove to be accurate. It may well be an underestimate.

What we do know is that there can be no question that the minimum wage will raise institutional unemployment, even if it will always be impossible to tell with certainty how big a portion of the total unemployment rate it represents. All the workers whose productivity is valued below the minimum wage in the market will no longer be employable and will therefore lose their jobs. Note that a minimum wage law is also an assault on individual freedom: workers who want to work for less than the legislated minimum wage won't be able to do so. This legislation will create an army of new dependents who will need government assistance to survive.

The argument that no "gloom-and-doom scenario emerged in Britain after 1998" overlooks that statistics only show us what can be seen, but not what cannot be seen. It is not possible to prove with statistics what would have happened in Britain absent the minimum wage. However, we can answer this question apodictically with the help of sound economic theory: unemployment would have been lower than it actually was.

As Ludwig von Mises writes in "Human Action":

The very essence of the interventionist politicians' wisdom is to raise the price of labor either by government decree or by violent action on the part of labor unions. To raise wage rates above the height at which the unhampered market would determine them is considered a postulate of the eternal laws of morality as well as indispensable

from the economic point of view. Whoever dares to challenge this ethical and economic dogma is scorned both as depraved and ignorant.”


The market wage rate tends toward a height at which all those eager to earn wages get jobs and all those eager to employ workers can hire as many as they want. It tends toward the establishment of what is nowadays called full employment. Where there is neither government nor union interference with the labor market, there is only voluntary or catallactic unemployment. But as soon as external pressure and compulsion, be it on the part of the government or on the part of the unions, tries to fix wage rates at a higher point, institutional unemployment emerges.

While there prevails on the unhampered labor market a tendency for catallactic unemployment to disappear, institutional unemployment cannot disappear as long as the government or the unions arc successful in the enforcement of their fiat.

If the minimum wage rate refers only to a part of the various occupations while other sectors of the labor market arc left free, those losing their jobs on its account enter the free branches of business and increase the supply of labor in them. When unionism was restricted to skilled labor mainly, the wage rise achieved by the unions did not lead to institutional unemployment. It merely lowered the height of wage rates in those branches in which there were no efficient unions or no unions at all. The corollary of the rise in wages for organized workers was a drop in wages for unorganized workers. But with the spread of government interference with wages and with government support of unionism, conditions have changed. Institutional unemployment has become a chronic or permanent mass phenomenon.

Writing in 1930, Lord Beveridge, now an enthusiastic advocate of government and union meddling with the labor market, pointed out that the potential effect of "a high-wages policy" in causing unemployment is "not denied by any competent authority." In fact, to deny this effect is tantamount to a complete disavowal of any regularity in the sequence and interconnectedness of market phenomena.”

(emphasis added)

And that is precisely the point: to deny that minimum wage laws raise unemployment is tantamount to denying the existence of economic laws. In fact, it amounts to the denial of the most basic tenets of value and price theory.

Naturally we do actually have plenty of evidence that in countries with excessive labor market regulation and very high minimum wage rates, institutional unemployment is indeed extremely high. Even if we cannot determine the precise extent to which the unemployment rate is raised due to such legislation, it should be obvious that there must be a reason for why some countries have permanently high unemployment rates. Involuntary unemployment does not just drop from the sky, it is not the result of an act of God. It is the result of the economic policies pursued by the governments of the countries concerned.

France, which has a very high minimum wage rate, has just seen its unemployment rate reach a new record high. Of course the country is currently suffering from an economic downturn and is chafing under the crazy regulatory and taxation policies of a socialist government, but as the chart below shows, even in "boom times", its unemployment rate doesn't fall below 7.5%. In the modern age of doctored government statistics this is an appalling record:

France's unemployment rate over the long term – via Tradingeconomics. Even at the height of a boom, its unemployment rate didn't manage to fall below 7.5%. If this were the U.S., the Bernanke-led Fed would probably print $200 billion per month.


Germany's socialists probably genuinely believe that they are doing people a favor by insisting on a minimum wage. As Mises said, this fallacy has become so ingrained that those who dare question it are “scorned both as depraved and ignorant”. In reality, they will condemn the poorest strata of the labor force – unskilled workers whose labor is valued below the new minimum wage by the market – to unemployment henceforth. The German economic miracle may well be history once this legislation is enacted. At first, it may not be noticed (just as was the case in the U.K.), as the ECB's current monetary policy is creating boom conditions in Germany. But it is foreseeable that once the boom inevitably falters, unemployment will rise to a much higher level than would have been the case otherwise. No matter what politicians and their courtier economists say, economic laws cannot be suspended by fiat.

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