Summer 2023

Overheated labour markets and population growth in Germany

Germany’s government is stuck between the contradicting objectives of low inflation, low unemployment, a generous social safety net and sound public finances, while suffering from sluggish growth, writes Gunther Schnabl, professor of economic policy and international economics at University of Leipzig.

Germany’s heyday seems to be over. Where Chancellor Angela Merkel used to stress the unprecedented wealth of the Germans, her successor Olaf Scholz has promised a new economic miracle thanks to ecological transformation. But due to erratic economic policy, high inflation, low growth, declining purchasing power and gloomy business expectations, there is growing unease among the population.

Despite this, the labour market boasts some good news. The number of those unemployed has declined from 4.9m in mid-2005 to about 2.6m (Figure 1). In the same period, the number of those employed has increased strongly, from 39.3m to about 45.7m (Figure 2). The challenge of high unemployment, Germany’s largest economic policy battle since the 1970s, seems to be under control.

Figure 1. Number of those unemployed and officially reported vacancies in Germany


Source: Deutsche Bundesbank.

Figure 2. Number of employed people in Germany


Source: Eurostat.

But there is an underside to this good news. The rising number of officially recorded open positions heralds a shortage of both skilled and unskilled labour, which threatens to strain production and growth. From firms and public institutions to restaurants and stores, everyone is having trouble finding staff.

Germany’s fitful demographics are widely regarded as the cause of such shortages. With the country’s birth rates as low as they are – about 1.58 children were born per women in 2021, which is substantially less than in France (1.84) – a dramatic scarcity of labour is expected.

As a solution to the labour shortages, government representatives have proposed increased immigration. In June 2023, Minister for Foreign Affairs Annalena Baerbock travelled to Latin America to campaign for the recruitment of skilled workers, such as caregivers and electricians. Monika Schnitzer, the head of the German Council of Economic Experts, has argued that Germany would need 1.5m immigrants per year to close the shortage of workers.

Historically, Germany has a longstanding record of attracting foreign workers. After the post-war economic miracle had led to full employment, West Germany hired millions of workers in southern Europe between 1955 and 1973. Although the contracts were regarded to be temporary, many stayed and many followed.

However, immigration to Germany is already high, with 2.7m people arriving in 2022. The population is up from 81.8m in 2010 to 84.4m in 2022. Scholz expects this to reach 90m as foreign workers are needed to sustain the public pension system – though housing has become scarce.

Hiring foreign skilled workers is highly bureaucratic and time-consuming. The labour market participation of immigrants is comparatively low, with the unemployment rate of foreigners being 15.2% compared to the 5.6% average. Many remain stuck in the social security system. The labour market participation of asylum seekers from countries such as Syria and Afghanistan, is particularly low as there is no necessity to work.

‘Germany’s government is stuck between the contradicting objectives of low inflation, low unemployment, a generous social safety net and sound public finances, while suffering from sluggish growth.’

On the other hand, the burden of taxes and social security contributions is high. The Organisation for Economic Co-operation and Development tax wedge – the ratio between the amount of taxes (and social security contributions) paid and the corresponding total labour cost for the employer – is 47.8% for an average single worker. This makes Germany unattractive for foreign skilled workers. This may explain why a growing number of people are leaving, specifically to Switzerland, where the tax wedge is 23.1%. As of 2022, 1.2m people have emigrated – 268,167 of which were German.

This shows the limits of Germany’s labour market and social policies. Germany’s generous social security system has been supported by the low interest rate policy and the extensive government bond purchases of the European Central Bank, which both boosted the economy and reduced the government’s interest obligations.

The total social spending could increase to roughly €1,200bn. Since 2010, fast-rising tax revenues allowed the creation of around 1.9m additional jobs in the public sector, which has become increasingly bureaucratic. Firms and banks need more manpower to comply with proliferating reporting requirements and regulation.

While inflation has risen far beyond target, with the overheated labour market adding fuel to the price pressure, the ECB is hastily increasing interest rates and has started to reduce its holdings of German government bonds. This puts a strain on government spending and growth. If the ECB continues its tightening, the demand on labour markets may decline in a time when the government has started to hire workers from abroad instead of using the domestically available labour force more efficiently.

Germany’s government is stuck between the contradicting objectives of low inflation, low unemployment, a generous social safety net and sound public finances, while suffering from sluggish growth. The dilemma can only be resolved by comprehensive structural reforms. Since this would require cutting social spending and downsizing the ambitious climate policy, more trouble lies ahead for the red-green-liberal government.

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