The German "Minimum Wage" Proposal: "Who ordered that?"
By Stephen Silvia

When the heavy electron known as the muon was accidentally discovered in the late 1930s, Nobel physicist Isidor Isaac Rabi famously remarked, "Who ordered that?" The same thought crossed the mind of many observers of the German economy in early April when legislation designed to set a series of wage floors suddenly landed front and center on the agenda of the Schröder government. The last thing an economist would recommend for a country like Germany with high unemployment, a heavily regulated labor market and an underdeveloped service sector would be to create a set of statutory wage floors, yet the proposal to do just that has gained considerable political momentum in the space of a few short weeks. This essay explores origin, content and prospects of that draft legislation.

Currently, Germany has no nationwide minimum wage legislation. Instead, article five of Germany's 1949 Collective Bargaining Act (Tarifvertragsgesetz) permits the federal government to issue a "declaration of general applicability" (Allgemeine Verbindlichkeitserklärung, or AVE) to serve as a wage floor when deemed necessary. An AVE extends the coverage of a sectoral collective bargaining contract to all businesses in the bargaining district, including firms that are not members of the employers' association. Since declarations of general applicability extend collective bargaining provisions, they set a much higher standard. In other words, an AVE is a much closer relative to prevailing wage legislation, which commonly sets compensation standards for public sector construction in the Northeastern United States, than a minimum wage. On the other hand, AVEs have a far more limited scope than minimum wage legislation. Article five states that a collective agreement must cover at least a majority of employees in the bargaining district in question for it to be eligible to be declared generally applicable. This excludes most bargaining districts in eastern Germany, since membership in employers' associations and unions is much lower than 50 percent in most sectors there. In practice, AVEs have never set compensation for more than 5 percent of the labor force. As membership in both employers' associations and trade unions has declined throughout Germany in recent years, the number of requests for AVEs has dropped, which has led trade unionists to look for alternatives.

Recent developments have exacerbated concerns regarding wage competition at the low end of the wage scale in Germany. The eastward expansion of the European Union in 2004 has generated an influx of workers from Central and Eastern Europe. These migrants have been willing to work for considerably less than most Germans and well below the collective bargaining rates in most sectors. In a few instances (e.g., hotels and meat packing), migrant employees have moved into the labor market in such large numbers that they have stoked fears of "wage dumping" dragging down pay throughout the sector. Moreover, several components of the Hartz IV labor market reform act, which went into effect in 2005, may also contribute to the downward pressure on wages. Hartz IV greatly scaled back the right of an unemployed person to continue to collect benefits after refusing a job that pays less or requires fewer qualifications than the person's previous position (Zumutbarkeitsreglung). Hartz IV also cut the size of long-term unemployment benefits, instituted a public-service work requirement for many receiving long-term unemployment benefits (the so-called "one euro" job), and transferred welfare recipients onto the ranks of the long-term unemployed.

German trade unions did not respond at first to these labor market developments because they were divided. In the fall of 2004, labor leaders from two service sector unions, Ver.di and NGG, proposed instituting a nationwide minimum wage. Their colleagues from the manufacturing unions rejected the idea, fearing that a minimum wage could inadvertently serve as an anchor, dragging down all wages. Skeptics within the labor movement also worried that a statutory minimum wage would undermine collective bargaining autonomy and the attractiveness of union membership. Union officials agreed to negotiate with each other to try to reach a common position regarding some sort of mechanism for setting minimum compensation rates. In March 2005, to the surprise of many, the unions hammered out a common position. German labor leaders called for an extension of a law that sets a minimum wage in the construction sector to be expanded to cover the whole economy.

The 1996 Employee Posting Act (Arbeitnehmer‑Entsendegesetz) extends the government's power to issue an AVE to include collective agreements containing minimum wages in the construction sector, including the employees of foreign-based construction companies operating in Germany. The Employee Posting Act lets the collective bargaining parties, rather than the government, set the actual minimum wage rates through collective bargaining. In essence, the union's compromise proposal amounts to a dramatic expansion of the scope of AVEs. It would permit the collective bargaining parties in each sector of the German economy to set a sectoral prevailing wage, which would then be applied to all firms in that sector nationwide.

The issue of a wage floor picked up additional momentum in early April when the vice-president of the employee wing of the opposition Christian Democratic Union (CDU), Karl-Josef Laumann, announced that the CDU was "ready to discuss" the introduction of a nationwide minimum wage. Bavarian Minister-President Edmund Stoiber seconded this, but added that he did not support the unions' prevailing wage proposal. The embrace of a minimum wage by Laumann and Stoiber was widely judged to be an exercise in political "triangulation" in the lead-up to the May 22 election in North Rhine-Westphalia. Still, the statements from the opposition have provided the Red-Green government with an opportunity to give trade union officials something, after having pushed through the Hartz IV reforms over labor's objections. On April 14, the Schröder cabinet began developing draft legislation to set a wage floor largely along the lines of labor's prevailing wage proposal.

It is by no means certain that the government will be able to convert its draft legislation into law. German business was slow to react to the wage-floor proposals. It appeared to be caught by surprise. Eventually, however, the president of the Bundesvereinigung der Deutschen Arbeitgeberverbände, (BDA, Federal Organization of German Employers' Associations), Dieter Hundt, responded. Hundt argued that extending prevailing wage legislation beyond the construction sector was "well meaning," but that it would create more bureaucracy and was potentially an unconstitutional encroachment on the autonomy of collective bargaining. Prevailing wage legislation requires Bundesrat approval. Once the German business community lobbies against the government's draft proposal with full force, support for it is likely to dwindle, particularly among opposition politicians. It is likely that the government and opposition will be unable to find a mutually acceptable compromise needed to secure passage in the Bundesrat, and the proposal will die. Still, such an outcome is by no means assured.

The answer to the question "Who ordered a wage floor?" is politicians from across the political spectrum, responding to the fears of constituents and operating within constraints imposed by organized labor. Regardless of whether the Schröder government's prevailing wage package becomes law, the larger lessons of this episode are instructive. The complete inconsistency of the prevailing wage legislation with the Hartz acts indicates that a large segment of the German political class has not absorbed the underlying logic of recent labor market reforms, but instead is relying on the political logic of the focus group and poll. Fears of an influx of migrant labor from Central and Eastern Europe and wage dumping are quite powerful in Germany. Political support for labor market reform remains quite fragile in Germany and could easily be reversed through appeals to hot-button issues, such as immigration, until the reforms actually begin to produce jobs. Thus, it is imperative that the Hartz reforms bear fruit sooner rather than later if they are to survive. The German government must take the additional steps necessary to increase labor demand -- such as the enactment of substantial payroll tax reductions accompanied by a transfer of funding for social programs to general revenues to reduce labor costs -- in order to achieve tangible results in the labor market. Otherwise it risks a reversal of much of the progress it has made so far.

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This essay appeared in the April 21, 2005, AICGS Advisor.