Why Germany can't create jobs

In a sputtering economy, Niles Werke shows how to get the German locomotive running again. The century-old machine-tool company is at the top of its field. Sales are expected to rise by 10 percent this year. "We expect 2005 to be another good year," says Frank Reichel, director of its Berlin plant.

Defying a lagging economy, Germany's flagship engineering sector is booming. But despite plants that hum at capacity, companies like Niles aren't hiring.

Its failure to create jobs is miring Germany in a political and economic crisis, making the country ground zero in a growing debate over Europe's economy. At a meeting in Brussels Tuesday, European Union leaders - who want to make Europe the world's most competitive economy by 2010 - are expected to renew calls that Germany, like other countries in Western Europe, reform its labor protections and social welfare systems to boost growth.

When Chancellor Gerhard Schröder took office in 1998, 3.9 million Germans - 10.2 percent of the workforce - couldn't find jobs. Last month, that number reached 5.2 million - 12.6 percent.

Mr. Schröder's center-left government, which campaigned on a pledge to create jobs, has issued bold economic and social welfare changes, including tax cuts, expanded shopping hours, healthcare and pension reform, and a controversial cut in unemployment benefits intended to encourage people to get back to work. But none of those steps have improved Germany's chronic job crisis.

Fearing continued voter backlash in key state elections, the German government last week held a "jobs summit" with opposition leaders. It emerged with a plan to slash the corporate tax rate to 19 percent, from 25 percent. And it pledged relief for mid-sized companies and increased public investment in infrastructure and education.

The new set of proposals are motivated as much by politics as by economic reality. Schröder's party, the Social Democrats, suffered a setback in a state election this month and fear losing their traditional stronghold, North Rhine-Westphalia, to the opposition Christian Democrats in a state election later this month.

The government can point to some improvements. Booming exports amid a sluggish economy testify to the improved competitiveness of German companies. Indeed, economists at ABN Amro, a global banking group, report that German companies are more competitive than their rivals in Italy.

European Commission statistics show that Germany's unit wages, which have been among the highest in the 25-nation bloc, have fallen 10 percent compared to the EU average in recent years.

"What we need is flexibility," says Reichel. "Our main problem is the job protection laws and regulation. Sooner or later, business will slow down again and when that happens we can't have too many people on the payroll."

The problem, say analysts, is that the government, which is closely allied with labor unions, is unwilling to deregulate the labor market to the extent that economists say is necessary to boost investment and job growth. Because Schröder didn't seek further labor-market reform, response to job summit was muted.

"The summit did not produce any psychological signal to start investing more," said Ludwig Georg Braun, head of the German Chambers of Industry and Commerce, in a statement.

Jürgen Michaels, an economist at Citigroup in London, sees the job summit as a sign that the government is possibly back on the reform track, but doesn't expect the measures announced to make a dent in unemployment.

"Substantial changes in labor market regulation are unlikely," he says.

Current German labor laws make it difficult for companies to reduce staff during weak business periods.

Some business leaders say German politicians and commentators are giving the country a bad rap by emphasizing what's going wrong instead of encouraging people to be more industrious.

"It's really regrettable that we talk everything down in Germany," Gunther Thielen, the CEO of media giant Bertelsmann AG, said at a news conference in Berlin last Thursday. "We have absolutely no reason to say that nothing works in Germany. You just have to convince people that they have what it takes to make a difference."

At Niles, managers like Reichel are finding ways to become more flexible in the marketplace. With its plants operating at capacity, Niles needs staff.

But instead of hiring, Niles and many other engineering companies are getting around Germany's rigid job protection laws by turning to Manpower-type temporary work services. They take on temporary workers for up to a year.

Germany's labor unions praise the regulations for warding off what they call "American conditions" creeping into the German economy.

Reichel defends using temporary staff.

"We've found a way to stay flexible," he says. "In Germany it's just not possible to react quickly to changing business conditions."