ZEW President Wolfgang Franz on Germany as a Business Location – Cost Benefits

The Minister President of North Rhine-Westphalia and vice-chair of the conservative party CDU, Dr. Jürgen Rüttgers, was quoted as saying: The belief that tax cuts will lead to more investment and more jobs is wrong. The same holds for the statement according to which German wages are too high. In other interviews, however, Rüttgers took a more nuanced view, warning against claims or generalisations that gain a momentum of their own and referring to these as the “lies of life”. The “usual suspects” – maybe you know who I mean – were, however, quick use these statements as evidence to attack “neoliberal” ideas. Against this background, some further clarification may be necessary.

When it comes to the corporate tax burden, Germany remains a high-tax location, which has been illustrated in calculations conducted by ZEW and German Council of Economic Experts on the basis of cross-country comparison of effective corporate tax burdens. Why do so many local companies prefer to make investments in low-tax countries, thereby creating jobs in other countries instead of here? Because Germany is characterised by such a low tax burden and labour costs?

While there are other factors that play an equally important role in the extent to which companies make foreign direct investments – like market penetration or customer service, – the cost benefits are a major reason why firms shift these activities abroad. After all, it is no it is no coincidence that these countries use this argument to attract foreign companies. The government has recognised the fundamental need for action and aims to improve the attractiveness of Germany as a business location, but the measures proposed so far are hardly convincing. German labour costs have seen a moderate development in the past years, but they started at a very high level. Depending on your mood, you might find the fact that the base year for the calculation of wage costs is chosen strategically in order to hide competitive disadvantages – or even praise locational advantages – either amusing or insulting.

In relevant publications, analyses are often based on unit labour costs, which is a measures of the labour cost per unit of labour productivity. These publications, however, often withhold the information that German labour productivity is often overestimated due to redundancies, whereas unit labour costs tend to be underestimated. Instead, the relevant actors tend to discredit these arguments by deeming the term “redundancy productivity” as the “non-word” of the year. There is hardly anyone who holds the view that wage cuts provide immediate relief in terms of creating new jobs, no matter what the circumstances are and which companies are involved. This is just as far-fetched as the opposite view. When macroeconomic demand is actually low as a results of a recession, a general cut in wages provides no relief. In Germany, this is and has not been the case in the past years. Here, it is mainly the disturbances on the supply side that cause problems. From a microeconomic perspective, there could – at least in the short term – be limits to using labour cost advantages to create new jobs, if production is characterised by a high level of capital intensity. In the long run, however, low labour costs are likely to result in a reduction of capital intensity in, for instance, young companies. Finally, it may be necessary to be patient until this moderate approach to wage policy translates into job creation, as the experiences in other countries like the Netherlands – our neighboring country and the competitor of North Rhine-Westphalia – have shown.