From 'Sick Man' to 'Miracle': Explaining the Robustness of the German Labor Market During and After the Financial Crisis 2008-09

Abstract

While many of the advanced economies are still reeling from the financial crisis and struggle with high rates of unemployment, Germany’s unemployment rate has improved to well below the OECD average despite experiencing the worst economic downturn since World War II. What explains this labor market robustness given Germany’s long-standing reputation as one of the “sick men” of Europe? Contrary to conventional accounts that emphasize employment protection legislation or government action (i.e. short-time work), this paper argues that actions by firms - embedded in ever-changing coordinative institutional structures - were most crucial in explaining this robustness. Firms chose to keep rather than shed labor; this strategy was induced by (i) the availability of a “toolkit” of flexible labor market instruments that had evolved incrementally over the past thirty years with the decentralization of collective bargaining; (ii) wage restraint and successful internal restructuring of firms during the past decade, fueling an export boom before the crisis. Firms thus had some margin for maneuver, using internal flexibility to protect their comparative advantage and skilled workers. We also show that past institutional changes driven by firms reflect a process of successful adaptation to external economic challenges, but did not undermine the nature and strength of Germany’s coordinated capitalism. The result is not a new German model that was purposefully designed; instead German firms slowly discovered new ways to cope with economic challenges.

Keywords: Financial crisis, institutional change, varieties of capitalism, German miracle, collective bargaining, coordinated market economy, internal flexibility, wage restraint