Since the mid seventies, with raising unemployment rates, labour market policies have been on top of the agenda in almost every political election in Germany. As excessive wage growth is assumed to be one of the factors explaining unemployment, a major issue of dispute has been whether something should be done in the way wages are determined. The most recent active step towards creating more jobs is the so called ’Kombilohn’ reform. Heavily criticized by many of the leading economists in the country for being too costly, this reform tries to provide incentives for companies to hire formerly unemployed persons by a subsidy that in principle should equal the difference between the new employees` productivity and his reservation wage.
As in the rest of the world nowadays is also the German economy performing very well. Big companies can report large surpluses and for the first time in over three years did the unemployment rate drop below 10 per cent in October 2006. This has made the trade unions to demand their share of the cake, and as a consequence, moderate wage growth does now not longer seem like the most likely outcome in the upcoming wage negotiations. That the employees deserve a wage increase in line with the growth in productivity is also something supported by the trade unions’ main ally on the political arena, the Social Democratic party (SPD), which together with the two conservative parties, CDU and CSU, forms the government. Another debated issue, which has caused some controversies within the government, has been whether a minimum wage should be regulated by law. Not surprisingly, SPD is in favour of such an arrangement.
This thesis does not try to investigate the success of specific political measures with respect to the operating of the labour market in Germany, nor does it try to give a final answer as to why the country has been struggling with high unemployment rates. Its main objective is to look at what can be the main forces in determining wage levels. Is a flexible labour market, giving individual firms large scope for single-handedly setting wages in response to various economic conditions, always favourable compared with more centralized bargaining systems? Would for instance more employment protection lead to higher wages with the most likely consequence being higher unemployment? A commonly held view among many in Germany is that the trade unions only care about the welfare of their relatively few members, a kind of insider behaviour, a central question in the empirical section is whether this is true. Moreover, the German economy is said to be very open with a large exporting sector. Usually this leads to the assumption that companies within the country have little market power and behave in more or less a ‘price taking’ manner. This is a question that the empirical section seeks an answer on.
The thesis is organized as follows. Section 1 gives a brief introduction to the German labour market. Attention is primarily paid to the major institutions and the way wage negotiations are conducted, in addition to tendencies observed during the last decade. Section 2 presents some selected theories for explaining wage levels. A highly debated theory in the economic literature has been Calmfors and Driffills (1988) hump-shaped relation between degree of centralization in wage negotiations and wage levels. Their main line of argument is on the internalization of externalities and market power. The most important reason why economies perform better than others is the way wage negotiations take place according to them. While wage negotiators at the intermediate industry level neglect the consequences of their action on the aggregate level, this no longer holds when say one bargaining cover all workers in the country. Here the employees` union will recognize that a wage increase would only lead to higher prices and higher unemployment as firms become less profitable. In the completely decentralised level the firm has less market power, something that most likely cause workers to demand more moderate wage increases in fear of losing their jobs. A popular theory for explaining wage levels and thereby the occurrence and persistence of unemployment has been the insider-outsider model. A brief presentation of this theory is provided in section 2.
The last section consists of the empirical analysis. A three dimensional cointegrated VAR-system (VECM) is estimated with nominal wages, producer prices and gross value added output per hour as the endogenous variables. The focus in this section is if the data support the notion of a constant wage share (nominal wages divided by gross value added product in current prices), and whether producer prices and productivity can be treated as weakly exogenous, implying that they are decided outside the system of interest. Since the German economy is characterized to be very open with a large exporting sector, one would, a priori, assume that the analysis should confirm that these two variables can be treated as weakly exogenous. Also searched for is the effect of unemployment. Has more unemployment been followed by more moderate wage growth, or is it true, as some claim, that the unions have demanded wages that more reflect the profitability in the industry than the interest of the outsiders?