CREDIT: Johannes Ries, and NordNordWest (<a href="" target=_blank>CC</a>).
CREDIT: Johannes Ries, and NordNordWest (CC).

Policy Innovations Digital Magazine (2006-2016): Commentary: Open Labor Markets Are Right Signal for Europe

Feb 2, 2007

By Christian Drenth

Several European Union states, including Britain, France, Germany, and Spain, have imposed labor restrictions on new EU members Bulgaria and Romania. As a concerned EU citizen living in Germany, this news made me wonder if it would be better for my children’s future to emigrate to North America or Asia. It's unfair to welcome these countries to be part of the EU while denying their workers the right to take part.

With the highest GDP in the European Union and representing the biggest part of intra-EU trade, Germany should be the engine of the European economy. It is time for Germany to take proper responsibility and light the way for other countries to follow. There is some good news coming from a Handelsblatt Business-Monitor International survey that says that top managers from Austria, Britain, France, Germany, Italy, and Switzerland view Germany as the most competitive among those countries.

Reasons given for German competitiveness include companies' restructuring and cost structures, and the new government is also credited for this positive view. The conclusion of the Handelsblatt survey indicates that the current German economic growth of 1.5 percent might rise to 3 percent by the end of this decade. Given that the standard of living doubles after 40 years of more than 2 to 3 percent growth, there is reason to be optimistic. Under such circumstances there is no need to adopt labor restrictions.

Economists have shown that there is a negative relationship between medium-term growth performance and the burden of regulation. Germany is one of the most regulated markets in Europe and has one of the highest unemployment rates. France is even more regulated and has an even higher unemployment rate. During the last enlargement of the European Union in 2004, Britain did not impose restrictions on entrance into its domestic labor market, and neither did Ireland or Sweden. In the period 2004 to 2006, these countries’ average unemployment rates were respectively 4.9 percent, 4.4 percent, and 4.8 percent. Compare this to the 8.6 percent average unemployment rate of the Eurozone countries that imposed restrictions.

As for economic growth, Britain, Ireland, and Sweden displayed an average GDP growth of respectively 2.4 percent, 4.5 percent, and 3.3 percent from 2004 to 2006. In the Eurozone countries that imposed restrictions, a 1.8 percent average GDP growth was achieved in the same period. As for Germany, the average GDP growth was 1.3 percent. The openness to cheap labor in Britain, Ireland, and Sweden did not harm GDP or unemployment. The negative relationship between regulation and growth as well as unemployment is undeniable.

Is more labor at a lower cost and more wealth for all a contradiction in terms? For governments, it is politically correct to say to the electorate that they will be protected against cheap labor on their doorstep. But it is nonsensical to prevent people from accepting a job at a salary they will accept. Unless a minimum wage regulation is established, the economy with all its participants will profit at least in the long run.

Governments are tasked to create a framework favorable to the creation of wealth. By hiring Bulgarian and Romanian employees, German companies can hire labor at lower cost. Companies can keep marginal costs and their average cost level down, allowing for an increase in production at lower sales prices. German consumers benefit from these lower market prices and will consume this extra production. Unemployment will decrease and German economic growth can develop at its full potential and be the engine of the European economy again.

What about the fairness of low wages? Fairness is a multi-faceted stone: Unions will argue that low wages are unfair competition to local employees; governments worry about unemployment; social organizations may say that these people are getting exploited; companies will stress their fairness to employees.

Let’s start with the unions and their argument of unfair competition to the local workers. In what is sometimes called the insider-outsider phenomenon, insiders in this case are the unions and their members. Outsiders are the Bulgarian and Romanian newcomers. The unions are perceived by the public as defending the interests of the workers. But in fact they represent the interest of people meeting the requirements for being employed and, more important, being a member of the union. Unions therefore prefer wages not to fall, since angry members might lead to a decreasing income for the union and to negative headlines.

But assume that the positive economic growth from open labor markets for Germany becomes reality—demand for products increases. By protecting existing wage levels, the labor market will not find equilibrium at a higher level of employment. If the labor restrictions are put in place, companies cannot increase production at the existing wage level and will not hire additional people, and unemployment may actually increase. For example, companies may relocate to search for cheaper labor to meet the demand for extra production. Unions will claim the high ground and demand tougher regulations to fight unemployment, a vicious cycle.

As for social organizations fearing the exploitation of the newcomers, I would argue that it is not in the interest of companies to lower wages to a socially unbearable low level. Although companies are looking for profit maximization, they are concerned with their employees' motivation to work for them. By continually lowering wages, people will leave for the next best offer. The labor market, like any market, is subject to the law of supply and demand. The best workers will leave first, and the market will preclude companies from driving down wages to the extreme.

The fear of many governments that unemployment will increase when accepting the newcomers is justified, but only if minimum wage regulations are in place since companies will not be able to hire more people. But should the government intervene in order to make sure that disparity between poor and rich is not increasing? Western European countries are famous for their social systems and will continue to provide their role of social security.

The German government should not implement these labor market restrictions, which come close to minimum wage regulations in their effect. Opening the labor market to the newcomers will send the right signal to the rest of European Union and light the way for strong economic growth for the next 40 years. I would be relieved to see a bright future for my children in good old Europe.


"German business confidence soars, Ralph Atkins," Financial Times, December 19, 2006.

"German investor sentiment rebounds," Ralph Atkins, Financial Times, December 12, 2006.

"Romanian and Bulgarian workers drive wedge in EU," Laitner & Wagstyl, Financial Times, December 27, 2006.

"Deutsche Unternehmen strotzen vor Kraft," Doris Hess, Handelsblatt, January 2, 2007.

"Europäer in Siegerlaune," Doris Hess, Handelsblatt, December 29 2006.

L’Economie expliquée à ma fille, André Fourçans, Editions du Seuil, 2006.

The Economics of Business Strategy, Lipczynski & Wilson, Prentice Hall, 2004.

"Financial markets and flexibility of the Labour Market," Philippe d’Arvisenet, Conjoncture, February 2003.

Economic Analysis, Prof. Radu Vranceanu, ESSEC, 2006.

Economic Outlook, OECD, November 2006.

External and intra-European Union trade 1958-2005, Eurostat, Edition 2006.

Euro Area GDP, Eurostat Euro-Indicators, January 11, 2007.

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