In the past 10 years Germany as gone from being the “sick man of Europe” to the star of the eurozone. This partly reflects the strong job creation that preceded the recession, perhaps due to the labor market reforms of 2003. However the post-2007 performance is even more amazing. There was almost no increase in unemployment during the recession, and the unemployment rate has fallen to relatively low levels during the recovery. Here’s some data for the US and Germany between the last quarter of 2007 and the last quarter of 2013:

Country ——- United States – Germany

Real GDP growth: +6.3% /// +4.0%

Nom. GDP growth: +16.3% /// +12.8%

Un. rate change: +2.2% /// -3.2%

Employ. change: -0.7% /// +6.0%

Total labor comp: +12.2% /// +19.2%

Labor comp./GDP: -3.6% /// +5.7%

Ave. weekly hrs: -0.4% /// -1.1%

[Update: Marcus Nunes pointed out that NGDP growth for the US was misreported in the original post.]

Let’s start with the two GDP numbers. The US did a couple points better, but we also had modestly higher growth in our working age population. The US population age 16 to 64 grew by 3.2%, while the German working age population declined a few tenths of a percent (quarterly data is not available.) Thus in per capita terms Germany did 1 or 2 points better. But the real action lies elsewhere.

Initially I thought that the sharp fall in the German unemployment rate might have reflected falling German productivity and slow population growth. But that doesn’t explain the NGDP figures. Germany actually created far more jobs than America, despite lower NGDP growth.

The next step is to look at compensation per worker. I couldn’t find hourly compensation data for Germany (outside manufacturing) but if one compares total compensation to total employment it looks like compensation in Germany rose by just over 12% per worker. The US figures appear to be just under 13% per worker. So it does not look like the German employment miracle was caused by low wages.

So what is the explanation then? As far as I can tell, the only plausible explanation (at least in an accounting sense) is a breakdown in my “musical chairs model.” In this model the level of hours worked reflects the interaction of NGDP and (sticky) nominal wages. It is assumed that total labor compensation is a stable fraction of NGDP. Arnold Kling found this assumption so reasonable that he once called the model an “identity.”

In this case, however, the share of income going to labor behaved very differently in Germany and America. Let’s start with Germany. If NGDP rose by only 12.8%, and compensation per employee rose nearly as much, then how could employment have increased substantially? The answer is simple. Workers grabbed an extra 5.7% of national income (up from 48.7% to 51.5%.) That roughly explains the 6% rise in total employment in Germany.

In the US, NGDP grew a bit faster than compensation per employee. Thus one might have expected a small increase in total employment. Instead employment actually fell by 0.7%, as workers grabbed a 3.6% smaller share of NGDP (from 54.5% to 52.5%.)

Are there any lessons here? Yes, but not the ones you might imagine. The “solution” is not to try to increase the share of national income going to workers. Why not? Because the most likely methods (higher minimum wages, stronger unions, etc) are also likely to boost compensation per employee. So any gains flowing from labor receiving a higher share of NGDP will be offset by losses in jobs from higher wage rates.

Instead, the lesson is that NGDP in America should have grown faster than 14.2% 16.3% over those 6 years. A few years back Bill Woolsey recommended reducing the trend rate of NGDP growth from 5% to 3%, in order to stabilize prices. But even Woolsey’s proposal (viewed as being quite conservative at the time) would have meant considerably more than 14.2% 16.3% NGDP growth over 6 years. Had his proposal been followed, unemployment in America today would likely be closer to 5%.

In Germany, the 6% rise in employment was partly reflected in a lower unemployment rate, and partly in a higher labor force participation rate. The labor market reforms encouraged the creation of many low wage jobs (Germany has no minimum wage) and helped low income workers with wage subsidies. It is interesting that the one shining labor market success of the 21th century occurred in a “social market economy” like Germany. Even more interesting is the fact that this approach (enacted by the Social Democrats) has almost no support among American progressives, who tend to prefer the more rigid southern European labor model.

Is it possible that (paradoxically) the flexible-wage German model actually boosted the share of income going to labor? Yes, but it’s equally possible the increase occurred for some unrelated reason. In any case, the focus should be on jobs, jobs, jobs, not the share of income going to labor. To get there you need stable growth in NGDP (or total labor comp.), no artificial wage floors, and generous subsidies for low wage workers. It’s a pity that there is no one touting that model anymore. Even the Germans have decided to abandon the labor market reforms of 2003 and adopt a minimum wage.

Indeed even Hong Kong now has a minimum wage. America recently increased the minimum wage by 40%, and there are calls for another 40% increase–at a time of slow NGDP growth and high unemployment.