Photo credit: Marius Serban
After several years of stagnation, Germany’s economy is expanding again. Following near-zero growth last year, third quarter GDP is up by about 1.3% year over year and the year-end figure for 2026 will be in the same ballpark. Yet Germany’s unemployment rate has continued to tick up marginally and is at a six-year high, while employment has fallen. You might now think this is AI-related, but we will show that it mostly isn’t. Instead, it’s an inherent feature of the German labor market, which has been built around institutions that separate employment trends from GDP fluctuations. During downturns, firms tend to hold on to their workers, which explains weak hiring in the subsequent recovery.
Growth is back, jobs aren’t
Even as the economy has defied the oil price shock and expanded at a rate well over 1% throughout the year, the unemployment rate increased to 6.4%, its highest level since 2020. Total employment has fallen by roughly 400,000 since its peak, a contraction of about 0.9%, continuing a decline that started in mid-2024. And despite the solid growth outlook for next year, the German government doesn’t expect the unemployment rate to improve until 2028.
Why output and employment don’t always move together
The link between GDP growth and the unemployment rate is called “Okun’s law.” In some countries — typically those with flexible labor markets — that relationship is strong. In the U.S., for example, there is little employment protection, and companies are quick to lay off workers during downturns.
But when hiring and firing costs are high due to regulations and jobs are union-protected, companies cannot adjust headcount that easily. Instead, they typically implement short-time working arrangements, keeping employees on payroll. Because the adjustment happens via working hours, the relationship between output and employment is much weaker.
Germany is is a textbook case. Even in 2009, when GDP plummeted by more than 5%, unemployment rose by less than one percentage point. More than 1.1 million workers were put on “Kurzarbeit” — a short-time work scheme. The reduction in working hours lowers employers’ wage costs, while workers temporarily receive state support.
But even without the government scheme, businesses have an incentive to hoard labor in rigid labor markets. The reasons: Layoffs are costly, and keeping staff helps firms avoid shortages once the economy recovers and talent markets tighten again.
Hoarding cushioned the downturn — now it’s unwinding
Data from the European Commission shows that hoarding was an essential feature of the recent economic downturn. The percentage of managers who expected output to decline but employment to be stable more than doubled throughout 2021 to 2022 and peaked at 13.5% in industry and 15% in services. As the economy contracted, firms decided to keep staff, which cushioned the labor market downturn initially. It was only when the downturn deepened that layoffs rose.
Now that demand is back, labor hoarding has more than halved and is currently at less than 6% and 7%, respectively. Firms have therefore started putting workers to fuller use again. But this also means that employment barely reacts to higher economic activity at first. Recruitment will only respond more forcefully when most of the idle labor is used up. With hoarding near its 2021 lows, we might reach this point soon.
What it can’t fix: structural decline
Adjusting working hours instead of headcount is a rational decision in Europe’s more rigid labor markets. It only works, though, if dips are temporary. It cannot halt structural decline. Germany’s car sector is a prime example. The industry is facing various challenges — excessive labor and energy costs, increased competition from China — and has become uncompetitive. The sector has already lost more than 100,000 jobs over the last three years, with more headcount reduction in the pipeline (through early retirement schemes and voluntary departures as well as dismissals).
The Institute for Employment Research (IAB) expects German manufacturing to lose 160,000 jobs this year and another 130,000 in 2027, with the auto industry being a big contributor to the decline. Meanwhile, public services, education, and healthcare are projected to grow, largely offsetting the job losses elsewhere.
The first signs of hiring: staffing firms
But there are several signals showing that labor demand might be picking up. Business surveys show growing confidence among staffing and recruitment firms as the outlook improves. Both demand and hiring expectations jumped from around −15 in the spring to roughly 27, the highest since 2023. During the first stages of recovery, employers typically rely on flexible labor before committing to permanent hires. That’s why temporary staffing usually turns first.
Ifo’s employment barometer, which tracks German firms’ hiring plans, seems to confirm that a turnaround is in the making. The index reached a bottom earlier this year but has steadily risen since and is now at its highest since mid-2024.
What does this mean for recruiters?
Economies typically recover in the following sequence: First, productivity rises as firms make use of idle labor. Second, hours expand as companies aim to meet demand without adding staff. Next, temporary and contract staff increase, and finally, permanent hiring rises.
In Germany, temporary staffing is already picking up because spare capacity is mostly used up. With the government’s fiscal stimulus building into 2027, future growth will have to rely on new hires. Competition for talent in growth sectors — defense and infrastructure but also healthcare — will return quickly. Moreover, due to demographics, the labor force is shrinking this year for the first time in decades. So, don’t read too much into the 6.4% unemployment rate — the German definition is much more inclusive, and the internationally comparable rate is closer to 4%. With the economy expected to grow above its long-run potential next year, talent shortages will soon become binding again. This means rising recruitment costs in the near future, and companies should prepare accordingly.