A key question in labor market research is how the unemployment insurance system affects unemployment rates and labor market dynamics. A new IZA Discussion Paper by Benjamin Hartung, Philip Jung and Moritz Kuhn revisits this old question studying the German Hartz reforms. The study traces the German labor market miracle back to the reform of the German unemployment insurance system that took place in the mid-2000s and abolished long-term, wage-dependent unemployment benefits.
The analysis highlights changes in separation rates after the unemployment benefit reform as the quantitatively important channel through which the unemployment insurance system affects unemployment rates and labor market dynamics.
The results show that a decrease in separation rates after the reform explains 76% of declining unemployment. Existing studies on the German labor market miracle leave this empirical fact unexplained by focusing on changes in job finding rates. The reduction in separation rates is heterogeneous, with long-term employed, high-wage workers being most affected.
The Hartz reforms
The Hartz reforms in Germany consisted of four legislative packages (Hartz I – Hartz IV) that became effective between 2003 and 2005. The first two parts of the reform were enacted in 2003 and contained several steps: Hartz I changed the legal framework for temporary work, making it more attractive for firms to hire temporary workers by lifting restrictions. Hartz II changed the regulations for marginal employment and introduced an additional form of social security tax-favored employment (midi-jobs) and subsidies for unemployed workers starting their own business.
Hartz III was enacted in 2004 and restructured the federal employment agency. In particular, placement agencies (Arbeitsämter) and social security offices (Sozialämter) were combined into single institutions (Arbeitsagenturen). Newly created job centers were set up and case managers supported the job search of unemployed workers.
Hartz IV was enacted in 2005. This part of the reform constituted the large overhaul of the German UI system that is the focus of our investigation. It is also the publicly most debated and controversial part of the reforms because it substantially reduced unemployment benefits for several groups of workers by abolishing the system of unemployment assistance benefits (Arbeitslosenhilfe). Before the reform, unemployment assistance could be received for several years after unemployment benefits expired, depending only on some weak eligibility criteria. Net replacement rates were at 57% with dependent children and 53% without. Workers who were not eligible for unemployment assistance received a minimum subsistence level (Sozialhilfe) that included rent payments but was not linked to previous wages. Hartz IV abolished the wage-dependent benefits for the long-term unemployed so that after the reform they would receive the minimum subsistence level (Arbeitslosengeld II). Unemployment benefits (Arbeitslosengeld I) remained largely unchanged at a net replacement rate of 67% with dependent children and 60% without.
The duration of eligibility for unemployment benefits depends on past employment under social security legislation and changed simultaneously with the Hartz reforms. The changes became effective in February 2006. Before the change, workers were eligible for age-specific maximum benefit durations ranging from a maximum of 12 months for workers younger than 45 years up to 32 months for workers 57 years and older. The general rule was that two months of employment resulted in one month of benefit eligibility up to the maximum eligibility threshold. Hence, for most workers two years of employment guaranteed maximum eligibility. After the reform, the maximum bene t duration was set at one year, and three months of employment were necessary for one additional month of eligibility. For workers 55 and older, the maximum duration was cut to 18 months. We exploit this variation in our empirical analysis. The fact that this change only became effective in 2006 and the fact that additional grandfathering and hardship regulations were introduced motivate our reasons for introducing the reform with a transition phase in our quantitative model.
To summarize, the Hartz IV reform transformed the former three-tier system of unemployment benefits, unemployment assistance, and subsistence benefits into a two-tier system of unemployment benefits and subsistence benefits.