Wages and Employment Across Skill Groups

West Germany experienced a sharp increase in unemployment during the 70’s and 80’s. While real wages increased moderately during the economic recovery of the 80’s, unemployment rates have remained on a high level ever since with the exception of the unification boom (1990–1992). The problem of high and persistent unemployment rates has been discussed intensively by the economic policy debate in Germany for many years, see the recent reports of the German Council of Economic Experts (1994, 1995, 1996). The discussion often points to the high level of wages in international comparison, the insufficient degree of wage differentiation, and the impact of labor market institutions and governmental regulations as the reasons for the dismal unemployment experience in West Germany, see Paqué (1995) or Siebert (1995a, 1997).

The stylized view of the labor market in West Germany during the 70’s and 80’s considers West Germany to be a high-wage and high-productivity economy with a fairly compressed wage structure and resulting insufficient employment growth. In particular, wage floors set by the prevailing wage bargaining system result in a lack of jobs for low-skilled workers (refer to the two-sides-of-the-same-coin hypothesis discussed in chapter 1). This view is“confirmed” by descriptive evidence showing that the distribution of wages has been stable or even“continued to become more compressed” in situations of considerable unemployment and imbalances in the distribution of unemployment across different groups of workers (see Abraham and Houseman, 1995, Kraft, 1994, Paqué, 1995, Pischke, 1998, Steiner and Wagner, 1998, OECD, 1993, 1996, or Fitzenberger and Kurz, 1997). This evidence is based either on aggregate data for different groups of workers or on micro datasets such as the German Socioecomic Panel or the Qualifications and Careers Survey (“Qualifikation und Berufsverlauf”, data collected by the Federal Institute for Occupational Training (Bundesinstitut für Berufsbildung, BiBB) and the research institute of the Federal Employment Service (IAB). On the employment side, West Germany exhibited modest employment growth (small compared to the United States) with a continuous trend towards skill upgrading of the labor force (see figure A.1 in the appendix).

Many commentators view the wage structure in West Germany as particularly stable or even as becoming more compressed over time. The descriptive evidence in the previous chapter shows that such a simple view is not warranted in light of the fairly complex trends during the time period from 1975 to 1990. However, mere descriptive evidence on trends in wage dispersion provides only a limited basis for an evaluation of the two-sides-of-the-same-coin hypothesis that the lack of wage flexibility in West Germany has resulted in a disproportionate increase of unemployment among low-skilled workers. This is true because of prevalent composition and selection effects which are likely to influence aggregate wage measures. In this context, a typical composition effect could be that the share of low-skilled workers at older age increases over time, since younger cohorts tend to obtain higher education levels. Assuming an age-earnings profile with positive slope reflecting increased productivity at higher age, average wages for lows-killed workers might exhibit a disproportionate increase relative to other skill groups even though wage ratios between equally productive workers (after controlling for age) have not changed. This example can also be used for an illustration of two possible selection effects. On the one hand, if it is the case that abilities are equally distributed across generations and education as an investment in human capital is positively correlated with unobserved ability, a trend towards increasing education levels among the younger cohorts due, for instance, to an exogenous reduction in the cost of education is likely to imply that the average ability level among the low-skilled workers (if a low-skill level is measured by educational attainment) is decreasing for younger cohorts. On the other hand, a second selection effect emerges, if a lack of wage flexibility or an ongoing wage compression fosters a rise in unemployment among low-skilled workers such that the ability distribution among the low-skilled workers improves. This is the case if the likelihood of becoming unemployed is negatively correlated with the unobserved ability level.

West Germany experienced a considerable trade surplus until 1990 and was viewed as an “export champion” by many commentators. Even though the trade surplus of unified Germany plummetted after 1990, it has been improving continuously since 1991. Nevertheless, the economic policy debate today views gobal competition as one of the great economic challenges for Germany¹ and often considers the German labor market problems (especially concerning unemployment of low-skilled workers) as being aggravated by international competition from low-wage countries resulting in a loss of competitiveness of the German economy. Correspondingly, it is discussed intensively whether the high level of unemployment is due to the general wage level being too high and due to a lack of flexibility in the German wage structure caused by the prevailing wage bargaining system. A considerable increase in earnings inequality since the early 80’s has been observed for various industrial countries, the most prominent being the United States, see OECD (1993, 1996). Compared to the United States, the latter study (based on a fairly small set of descriptive statistics) shows that West Germany exhibits an exceptionally stable wage structure since the mid 80’s. Trends in international trade differ between West Germany and the United States, with the United States facing a large trade deficit since the early 80’s and West Germany a considerable trade surplus. And also trends in wage bargaining institutions differ between West Germany and the United States. The former did not experience the decline in unionism observed for the latter. Thus, West Germany provides a polar case to the developments in the United States in various aspects. The goal of this study is to analyze links between trade developments and the West German labor market and to explore what can be learnt from the differences to the United States, where the latter case is well documented in the literature.

In a simple demand and supply framework, the pervasive reduction in employment ratios between unskilled and skilled labor seems to offer only two alternative outcomes. In Krugman’s (1994, 1995) or Freeman’s (1995) characterization, either the US scenario of increasing wage dispersion in order to mitigate the adverse employment effects for the low-skilled or the European scenario of a rigid wage structure and ever increasing unemployment. This chapter provides a theoretical and empirical analysis of the determinants of the structure of labor demand across skill groups in West Germany for the time period from 1975 to 1990. The analysis has two goals: First, to determine the driving forces behind the“unfavorable” labor market trends for low-skilled workers. And second, to investigate whether and to what extent the structure of labor demand reacts to changes in the wage structure. This allows to analyze whether increased wage flexibility could also mitigate the unequal distribution of unemployment in West Germany following the stylized view of the US labor market mentioned above.

Despite its alleged importance for skill specific labor market trends in West Germany, explicit empirical modelling of union wage bargaining has rarely taken place (the comprehensive recent survey on unions and unemployment from a German perspective in Jaeger, 1996, does not even mention this issue). In the Phillips-Curve or the Wage-Curve tradition, there have been some attempts to proxy the outcome of wage bargaining by postulating separate wage setting relations for the different skill types of labor depending upon group specific unemployment rates (see Nickell and Bell, 1995, and Beißinger and Möller, 1998). This chapter tries to go further in the empirical modelling of wage bargaining by developing an empirically operational structural model of wage bargaining and employment determination in West Germany which can be put directly to the data. Wage bargaining is assumed to set average wages and wage dispersion for each of the two different skill groups (U = low-skilled“unskilled”) and (M = medium-skilled). Management at the firm level has free discretion to decide on employment. This“right-to-manage” assumption corresponds to the prima facie view of wage setting in West Germany: Wage bargaining occurs at the sectoral level between trade unions and employers’ associations such that it appears impossible to implement efficient contracts imposing wages and employment at the firm level (see Franz, 1996, chapter 8, and Jaeger, 1996).

This study analyzes wages and employment across skill groups in West Germany during the 70’s and 80’s. Before discussing the overall conclusions and putting the main results into perspective, I should mention several distinctive features of this study: First, the study attempts a balanced mixture of descriptive evidence and structural estimation. Chapters 2 and 3 provide a comprehensive view on wage trends. Chapter 2 describes also employment trends. Chapter 4 investigates empirical implications of trade theory on the relationship between pertinent endogenous variables. Using instrumental variable techniques, Chapters 5 and 6 estimate structural models of the skill structure of labor demand or of a complete wage bargaining model. Second, all chapters but one take account of wage dispersion both between and within skill groups. Chapters 2 and 3 analyze wage trends for different quantiles in order to encompass both dimensions of wage dispersion. Chapters 5 and 6 suggest a heuristic method to measure the impact of both dimensions on the skill structure of labor demand. And the utility function of the union in chapter 6 is assumed to depend upon both dimensions in order to allow for distributional goals. Third, using three skill groups of labor, the study allows for non-monotonous results across skill groups. In contrast, a considerable part of the international literature is restricted to two skill groups. Fourth, except for the mere descriptive analysis in chapter 2, modelling the specific wage trends for females is beyond the scope of this study. Therefore, the remaining chapters are restricted to wage trends either for males alone or for all workers together. Fifth, inference in chapters 3, 5, and 6 is based on a block bootstrap procedure allowing for heteroskedasticity and fairly general correlation structures in the error term of the estimated relationships. This new inference procedure is introduced in appendix A.2. Sixth, for the empirical analysis, I constructed an industry level dataset merging national accounts data with the IAB-Beschäftigtenstichprobe (an extensive micro dataset on wages and employment which has only become available recently for the time period from 1975 to 1990). In addition, pertinent data from various other sources are added to the basic dataset. In constructing the database, I had to overcome various shortcomings in the data sources (see data appendix A.3).