Which hurts worse, to fire or furlough?

March 22, 2011, 9:28 PM UTC

At a time when economies around the world still face high unemployment following a very deep global recession, policy makers are debating the best way to handle downsizing. A recent study by the Brookings Institution highlights the question, suggesting that the U.S. might have something to learn from Germany.

Germany’s employment fell by just 0.5% during the recession, while U.S. employment saw some of its steepest declines in decades, dropping 5.6%, according to the think tank. Among the world’s advanced economies, only Spain and Ireland had bigger job cuts from 2008 to 2009 than the U.S. And only Australia, which experienced no recession, fared better than Germany.

So exactly what was Germany’s secret sauce?

Unlike the U.S., Germany widely trimmed workers’ hours instead of laying off employees. The Brookings study found that while that wasn’t the primary reason for Germany’s relatively better jobs picture, it’s one key factor that helped keep employment from plunging too steeply — a lesson for the U.S.

Germany’s work policies encourage employers to cut hours as opposed to bodies, the study notes, by way of higher firing costs and lengthy severance notice periods. Because it’s tougher to fire, it also makes it tougher for employers to hire even when times are good. The study found that the primary reason for lower layoffs in Germany when the global economy plunged into a recession was that employers had hired far fewer workers than the U.S. when things were booming.

By contrast, worker layoffs in the U.S. cost relatively little for employers and are generally viewed as big cost-savings measures. As a result, quite the opposite happens when the economy goes awry. Whereas U.S. employers hired liberally pre-2007 and then were forced to lay off many more workers when times got tough, Germany didn’t have to cut as deep and reduced worker hours instead.

Though layoffs in America’s private sector have begun to stabilize, troubled finances in the public sector this year will likely lead local and state governments to trim at least another 250,000 jobs, according to UBS. The bank forecasts that this could push the unemployment rate back up slightly, by 0.1% to 0.2% in the worst-case scenario.

The long-term effect of unemployment

A system favoring furloughs over outright job cuts could spread the pains of a weak economy, lessening the pain for certain individual workers. Long-term unemployment has shown crippling effects not only on lifetime earnings of workers, but on the earnings potential of their children, says Heidi Shierholz, economist with Economic Policy Institute. Shierholz, who specializes in U.S. wages and employment, says that workers would be better off keeping their jobs, even at reduced hours, than being laid off. Also, staying employed helps keep workers’ skills current and generally makes them more attractive to other employers looking to hire.

But it’s not all positive news. In the German experience, even while employment barely fell during the recent downturn, the economy actually contracted more than it did the U.S.

And the outcome might be different if the U.S. were to follow Germany’s jobs model, since wages would undergo further pressure. Between 1989 to 2010, U.S. productivity grew by 62.5%  — far outpacing wages, which grew by only 12% during the same period, according to a study Shierholz co-authored for the Economic Policy Institute.

No one is immune to wage stagnation in the U.S. From 1989 to 2010, real wages for high school-educated workers in the private sector grew by just 4.8%, compared with 2.6% in state government. For college graduates in the private sector, wages grew 19.4%, compared with 9.5% in state government during the same period. Shierholz adds that the situation is unlikely to improve, given expectations of a weak jobs market in 2011.

To furlough or fire is not an easy question to answer, and neither Germany nor the U.S. emerged from the recession without pain and suffering. But spreading the pain of a few across a larger portion of the population might lessen the damage for all of us.

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