The situation prior to reform

The basic characteristics of the traditional German labour market model can be summarized as follows: a ‘dual apprenticeship’ system combining part-time education at a vocational college with on-the-job-training; relatively strong job protection, particularly with respect to individual redundancies; a high coverage of collective bargaining, especially in the western part of Germany; the strong role of social partnership and workers’ codetermination; a strong and predominantly contribution-financed social security net, including relatively generous benefits for the long-term unemployed (high replacement rate plus long entitlement period); and the dominance of the ‘male bread-winner model’ (for example, tax splitting between spouses).

These factors go in hand with certain outcomes, which are characteristic of the German economy: the importance of human capital specific to a particular company; the strong role played by the manufacturing sector; a low level of industrial conflict; high social security contributions; fairly low external flexibility (high protection against dismissal); comparatively high internal (inner-company) flexibility; and relatively low wage dispersion compared to other countries.

Following the fall of the Iron Curtain – and in combination with a rapidly rising financial burden due to German reunification and increased competition from low-wage countries – these structures contributed to a significant deterioration of the labour market during the 1990s. Low economic growth, combined with low rates of job creation, led to a rapidly rising level of structural unemployment, particularly in eastern Germany. In 2005, unemployment reached a peak of nearly five million people.

The ‘Hartz reforms’

Between 2003 and 2005, and in response to the increasingly gloomy labour-market outlook, the “Red-Green” government under Chancellor Gerhard Schröder implemented a fundamental reform of the German labour market, known as the ‘Hartz reforms’. The central idea was to increase the flexibility of employment and to encourage – or activate – the unemployed to find employment. Key elements of the reform package included:

  • a lower level of job protection, especially within small and medium-sized firms;
  • an overarching deregulation of agencies providing temporary work;
  • a reduction in the maximum period for receipt of unemployment insurance, particularly for older workers;
  • a tightening of job acceptance rules for the unemployed;
  • the merging of unemployment assistance and welfare benefits into a uniform benefit – the so-called ‘Hartz IV’;
  • and an overarching reform of the Federal Employment Agency.

Developments since the Hartz Reforms

Since the middle of the 2000s, the labour market has improved dramatically: unemployment in Germany sank from 5 to under 3 million. It thus became possible to reduce long-term unemployment and to increase the employment level significantly – in sharp contrast to other OECD countries (see figure).

Created with Highstock 5.0.11Employment/population ratioEmployed persons as a percentage of the populationGermanyOECD average (without Germany)19971998199920002001200220032004200520062007200820092010201120122…201360657075Source: OECD, own calculations. © IAB

The Hartz reforms proved to be an crucial cornerstone for the strengthening of the labour market from the middle of the 2000s. Germany’s employment boom was helped on the one hand by a strong world economy, and on the other, by wage-restraint over a number of years.

Research by the German Institute for Employment Research (IAB), which is part of the Federal Employment Agency (BA),  shows that employment is now far less determined by economic cycles than was the case a decade ago. Instead, factors other than economic growth have become significant for the labour market: reforms have made the labour market stronger and more flexible, leading to a faster filling of vacancies and a reduction in unemployment; the service sector has expanded largely independently of economic cycles; labour scarcity has led employers to hoard labour and increase employment even in situations where this would not normally be required under current production trends; the number of part-time jobs has steadily increased; immigration and increasing participation are still increasing labour force potential despite demographic change domestically; and moderate wage growth has boosted the demand for labour. Whilst employment has become uncoupled from the business cycle, the recovery of the labour market has in itself now strengthened consumption growth in Germany.

In contrast to the short-lived economic upsurge around the millennium, the positive developments in the labour market have this time proved to be more sustainable. Neither the economic and financial crisis nor the weaknesses in the German economy between 2012 and 2014 have led to significant setbacks in the labour market.   The labour-market impacts of the deep recession of 2008 and 2009 – including an unprecedented drop in demand for German export goods – was limited by a combination of the Hartz reforms, and a prudent response from political decision-makers, companies, and trade unions

However, along with successes, a booming labour market also has its downsides – for example, the strong expansion of the low-wage sector and an increase in wage inequality. These developments, which had already started to bed in in the 1990s, were partially reinforced after the Hartz reforms. Thus, Germany today exhibits a wage rate which is amongst the lowest in Europe.

The number of atypical working relationships (such as part-time work, temporary agency work and ‘minijobs’) has grown sharply. On the one hand, these forms of employment meet the requirements of a flexible economy and a workforce seeking more flexible working patterns. But they are often only taken up by employees who have no better alternative. This is particularly problematic when the job offers little in the way of stability, training, and opportunities for advancement.

Current and future Challenges

Substantial future improvements in the German labour market will not happen of their own accord. In addition to the risks posed by economic and political instability in Europe and beyond, the German labour market is facing four major challenges at home:

Reducing long-term unemployment. The growth in employment has brought a core of persistent unemployment more clearly into view. Increasingly, vacancies and applicants’ skills sets do not match each other. The long-term unemployed are hindered by low qualifications, health problems or a lack of language skills. It is therefore increasingly important to offer training, new qualification opportunities, and in the case of young people, tailored vocational and career counselling.

Improving upward mobility and raising the quality of employment. Low wages and unstable employment can become problematic when particular groups are locked into these working conditions over the long term. For this reason, it is important to improve the quality of employment at the lower end of the labour market, without making it difficult for people to take up lower-paid jobs. Here the legal minimum wage introduced in 2015 could make a difference, although at present it is too early to assess the long-term impact of this change. In addition, it is crucial to increase the career-advancement opportunities for people in atypical working relationships and low-paid jobs, especially through on-the-job- or part-time training.

Managing the impacts of demographic change and ensuring the availability of qualified staff. The fact that the German labour market is shrinking and getting older is becoming more apparent as employers’ demand for labour – particularly skilled labour – increases. It is crucial to manage this demographic risk by engaging more people in the labour market, and increasing the quality of skilled labour. This includes encouraging women and older people to stay in employment; having an active immigration policy; and improving the integration of immigrants into work.

The integration of refugees into the labour market. Since 2014, the number of asylum seekers and refugees from crisis- and war-torn regions has risen dramatically. In total, Germany expects to have received more than 1 million new refugees in 2015 alone. The main barriers to their integration into the labour market are low qualifications and lack of German-language skills. It is therefore vital to provide this group of people with timely and comprehensive support. In the long run, the new cohort of immigrants could make a considerable contribution to strengthening domestic labour supply in Germany.


Overall, the German labour market is in good condition. This is evidenced both by domestic developments over the last ten years and through international comparison. Nevertheless, substantial challenges remain.

A major challenge is the high number of refugees coming to Germany from war and crisis zones. Barriers to their integration into the labour market include insufficient qualifications and lack of German-language skills. For this reason it is essential to support newcomers as early – and as comprehensively – as possible. From a long-term perspective, this could contribute considerably to strengthening Germany’s domestic supply of labour.

Not all people in Germany have profited from the successes of the recent past. For low-skilled workers in particular, the labour market sometimes offers only limited opportunities. This applies on the one hand to people who have become unemployed and whose chances of getting back into work have diminished with the duration of their unemployment. On the other hand, attention should also be paid to people who may indeed be in employment but who work in unstable or badly paid jobs. Here, improving the chances of upward mobility are a priority.

Policymakers can make a valuable contribution to mastering these challenges. First of all strengthening those skills which employers require should be the main aim of labour market policy measures. Here the focus is mainly on offers of (further) training. In addition to this, more flexible and affordable offers of childcare and care for the elderly create a better framework for gainful employment amongst those with caring responsibilities. In this way, the compatibility between professional and family life can be improved.

At the same time, the number of people who are available on the labour market will decrease as Germany’s population ages. For young and well-educated workers this will result in good employment opportunities; but it is nevertheless crucial that employers’ demands for labour are met, as shortages of skilled staff can slow down economic growth. A crucial means for dealing with this shortage is the targeted opening of the labour market to skilled workers from abroad.

The approaches for solving these challenges complement each other: a sustainable re-introduction into the labour market can do much to counteract the petrification of long-term unemployment. Education and further training help to facilitate the transition to stable and well-paid working relationships. In this way, not only can individuals’ life circumstances be improved, but employers’ basic requirements for skilled staff can also be met.