Minimum wage and pension reform in Germany: A headwind for growth?

Key components of the coalition agreement between Merkel’s CDU and the Social Democrats are the adoption of a nationwide minimum wage and the introduction of new pension benefits, in particular early retirement at 63. The introduction of the minimum wage follows a heated debate which gained importance ahead of coalition talks last September. The grand coalition is now governing since December and the two legislative projects advance quickly. We want to summarize the development of both projects and to review the ongoing public debate over potential consequences on the German economy, particularly in light of a report published on 9th April by four leading economic Institutes.

On 15th January, the German government presents its pension reform plan, hammered out under the leadership of SPD Labour Minister Andrea Nahles, which would allow some employees to retire on a full pension at 63, provided they have worked for 45 years without claiming jobless benefits for more than a short time. The reform also includes higher pension benefits for mothers which had been demanded by the CSU. With extra costs rising to EUR 160 billion in 2030, the reform is likely be the most expensive single measure of the legislative period. The Bundestag is due to pass the law in May so that the new rules apply by July.

On 2nd April, the cabinet of Ministers adopts a draft bill which would introduce Germany’s first national minimum wage of EUR 8.50. It would be phased in from January 2015 and be fully in place from 2017, taking into account currently valid collective wage bargaining agreements in some sectors. Negotiators agree only on a few exceptions such as for minors, apprentices, interns, voluntary workers or long-term unemployed in the first six months after finding a new job. The first reading of the bill in the Bundestag is due in June, with the draft bill to be voted through in July.

On 9th April, four leading German economic Institutes published their bi-annual report “Joint Economic Forecast Spring 2014” on the German economy. They raise their German growth outlook for 2014 to 1.9 percent from last October’s prediction of 1.8 percent, and predict a further pick-up to 2 percent in 2015. The joint statement is, however, critical of key policy initiatives of the grand coalition. In particular, early retirement at 63 and the introduction of a minimum wage would create a headwind for growth.

“The entitlement to a full pension as of 63 years is a step in the wrong direction” in view of Germany’s ageing population. The pension at 63 jeopardizes the sustainability of fiscal policy and is questionable with regard to inter-generation fairness. It “counteracts efforts to adapt pension entitlements to rising life expectance and will instead serve to curb production potential.”

The minimum wage “will tend to reduce the employment prospects of low-skilled workers overall and – since transfers are reduced – it will hardly help to reduce poverty at all.” The Institutes estimate that some 4 million people would be affected and that around 200 000 jobs would be lost. Those jobs, however, “have comparably low productivity levels”, and, therefore, only a tenth of a percentage point will be shaved off Germany’s annual GDP. Despite the jobs lost, the Institutes predict that the overall jobless rate in 2015 will remain steady at 6.7 percent. The authors, however, acknowledge that the economic implications of a minimum wage are difficult to assess. “Such state intervention in the German labour market is unprecedented to date. “ Plus, drawing on experiences of other countries is of little use, since the German institutional framework has specificities that do not exist in other countries, such as the mini-job.

One of the Institutes does not share some assessments, particularly regarding the implications of the minimum wage. The German Institute for Economic Research (DIW) Berlin believes that the significance of the uncertainty related to the estimation of the impacts of the minimum wage is higher than assumed by the other Institutes. Therefore, by no means the introduction of the minimum wage will necessarily lead to negative long-term effects on the economy.

The report has to be seen in the context of an ongoing public debate over the consequences of the minimum wage and pension reform. In an interview to the FAZ on 13th April Labour Minister Nahles says she doesn’t believe in important job losses after the introduction of the minimum wage by referring to positive experiences with minimum wages already in place in some sectors in Germany and to other European countries. Nahles defends the introduction of pension benefits at 63 by saying that the reform doesn’t withdraw the pension at 67. Not only young generations, but also pensioners will pay for the reform.

Business organisations regularly voice concerns about the minimum wage deal. For instance, the President of the German Chambers of Commerce and Industry (DIHK), Eric Schweitzer, expects hundred thousands of additional unemployed because of the minimum wage. He says it looks like the grand coalition wants to “give a hard time to German companies” and, therefore, asks to stop the pension reform: “The pension project is completely wrong.”

Stefan von Borstel writes in Die Welt that the government has abstained from any economic expertise when concluding the minimum wage deal – which may lead to “catastrophic consequences”. The age limit of 18 years is set too low and the fact that companies will be able to pay wages below the minimum wage when employing long-term unemployed during the first six months will provide them with incentives to substitute them for other long-term unemployed. Furthermore, he criticises the nationwide dimension of the minimum wage which ignores regional productivity differences and the level of EUR 8.50, which is too high for many sectors and regions. Moreover, the first evaluation is foreseen in 2020 – too late according to Von Borstel. By then, already hundreds of thousands of jobs may be destroyed.

Stefan Bielmeier writes in the Wirtschaftswoche that the “new generosity of the government will cost a lot of money and will destroy many jobs. The minimum wage as share of median wage would be around 62 percent in Germany in 2015, the highest in Europe. As a consequence, Germany might await the same scenario as France, where the high minimum wage (60 percent) and the strong dismissal protection are main causes for high youth unemployment according to Bielmeier. Furthermore, higher wages will lead to higher costs for businesses which may eventually deteriorate their competitiveness.

The Hamburg Institute of International Economics writes in a report that the current plan of the grand coalition to allow employees to retire at 63 is a “fatal signal”. “In Germany, the various early retirement options and generous pension schemes of the 70s and 80s have created a society that, at the age of 50, is already mentally prepared to receive a pension.”

Klaus Zimmermann, Director of the Institute for the Study of Labour (IZA) believes that this reform will put further pressure on younger generations, which will have to pay on the long run. Michael Hüther, head of the Cologne Institute for Economic Research, says firms had so far countered the skilled labour shortage by keeping older employees on for longer and that lowering the pension age sent out “completely the wrong signal”. He says that “A longer working life and a higher retirement age are the best tools we have to counter the demographic change and a skilled labour shortage”.

In an article on the FAZ on 13th April, Christoph Schmidt, Anabell Kohlmeier and Lars Feld write that the coalition parties follow with the pension reform a clientele policy at the expense of Germany’s competitiveness. Moreover, the reform will put at stake the sustainability of the German pension fund ensured by previous reforms as the extra costs cannot be solely paid by reserves of the pension fund.

Rainer Dulger, head of metal and electrical employer’s association Gesamtmetall says that “Pension contributions and taxes will inevitably rise at the expense of ever fewer contributors, so young people will have to pay for these presents knowing full well that they will never get as much as themselves”.

Former SPD chancellor Gerhard Schröder says“It’s absolutely the wrong signal, especially in view of our European partners, from whom we’ve rightly been demanding structural reforms”, Schröder writes in a new book, an excerpt of which was published in Bild on 29th January. The extra costs to the pension system will mean employee and employer pension contributions will have to be raised in a few years, he says, adding: “There are simply not enough workers who can finance the growing group of pensioners”.

Die Welt writes that the pension reform has the advantage that its costs will be paid by those who currently don’t vote, namely the future contributors. Those responsible for this reform do either not understand the demographic challenge Germany is facing or act cynically according to the motto “After us, the deluge!” Both SPD and CDU have to watch out not to lose sight of young generations in the contest over the favour of pensioners according to the Welt.

Wolfgang Weimer writes that the reform is a revenge Nahles’ for the 2005 Agendapolitik and one needs to look back to understand: In 2005, there was a “brutal power struggle” between SPD-Chairman Franz Müntefering and Nahles which “declares war” to Müntefering by running for secretary general of the SPD. She wins and Müntefering throws in the towel. Since 2005, the SPD is traumatized. Since then, Nahles states that the misery of the SPD comes from Schröder’s reforms and the increase of pension age to 67. Weimer writes that the current pension reform bears the markings of personal coping with a trauma, which will cost billions. Nahles wants to reverse Agendapolitik of Schröder and Müntefering. The introduction of the minimum wage will break-up the second cornerstone of the Agendapolitik. Nahles doesn’t worry about the low-qualified who will lose their job chances, or about the thousands of jobs that will be destroyed in Eastern Germany. Neither Müntefering nor the entire republic merits that a campaign of vengeance becomes a governmental policy.