Another interesting paper, worth a read: Krebs, Tom and Scheffel, Martin, "Macroeconomic Evaluation of Labor Market Reform in Germany" (February 2013). IMF Working Paper No. 13/42.
Back in 2005 Germany undertook a massive reform of social welfare systems, known as Hartz IV reform. This "amounted to a complete overhaul of the German unemployment insurance system and resulted in a significant reduction in unemployment benefits for the long-term unemployed".
The IMF paper used "an incomplete-market model with search unemployment to evaluate the macroeconomic and welfare effects of the Hartz IV reform". The model was calibrated to German data before the reform followed by simulation of the calibrated model to identify the effects of Hartz IV.
"In our baseline calibration, we find that the reform has reduced the long-run (non-cyclical) unemployment rate in Germany by 1.4 percentage points. We also find that the welfare of employed households increases, but the welfare of unemployed households decreases even with moderate degree of risk aversion."
For all the debate about the merits of such reforms, it is pretty darn clear that Hartz IV-styled reforms - currently being advocated by the IMF and the EU for the peripheral states - cannot take place in the environment of protracted and structural Euro area-wide and national recessions and especially in the presence of other exacerbating factors, such as debt overhangs, insolvency regime breaks, dysfunctional banking sector, monetary policy mismatch, etc.
Put simply, in 2005, German economy was into its second year of (anaemic at 0.7% in 2004 and 0.84% in 2005) growth with unemployment at an uncomfortable 11.2% still leagues below the current rates in the peripheral state. German government deficit in 2005 was at relatively benign 3.42% compared to the deficits in the peripheral states, with structural deficit at even lighter load of -2.6% of p-GDP and primary deficit at 1.0%. German debt/GDP ratio on Government side was at 68.5% of GDP. All of these parameters clearly indicate that Germany was in a much better starting position for consolidating social insurance systems than the peripheral states find themselves today.
