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Germany's Slump Explaining the Unemployment Crisis of the 1990s

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  • Ludger Lindlar
  • Wolfgang Scheremet
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    Abstract

    According to a widespread view, Germany's unemployment crisis is caused by rigid labour markets, low profitability and increasing international competition. We argue that this view does not provide a convincing explanation for the dramatic rise in Germany's unemployment rate since 1989, first because no distinction is drawn between the situation in the Eastern part of Germany and that in the Western part of Germany, and second because supply-side conditions in the Western part of Germany have not generally deteriorated. We argue that Germany's slump is the result of a series of adverse supply and demand shocks since unification. Supply shocks dominated in the East, demand shocks in the West. These shocks were mainly policy-induced. The adoption of an extremely overvalued exchange rate and rapid wage increases in East Germany magnified the general problems of transition, resulting in a loss of employment of more than a third and a sustained structural weakness of its economy. The wage explosion was made possible by the government's failure to create a proper institutional framework for wage negotiations. The unification shock to the East added at least 2.5 percentage points to Germany's overall unemployment rate, as measured by the OECD definition. We attribute some 1.5 to 2.5 percentage points of the present unemployment rate to the weak economic growth of the last several years and the impact of the increasing tax wedge on the wage level. Weak growth has been largely the consequence of uncoordinated, contradictory and procyclical macroeconomic policies that have been adopted since unification, while the increasing tax wedge has been mostly driven by the decision of the government to finance unification partly through the social security system. Econometric evidence suggests a structural break in aggregate wage-setting in West Germany, with increased nominal flexibility in recent years and insignificant persistent effects since the 1980s. Hence, aggregate wage setting in the Western part of Germany is highly responsive to unemployment, while in the Eastern part, it is not.

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    Bibliographic Info

    Paper provided by DIW Berlin, German Institute for Economic Research in its series Discussion Papers of DIW Berlin with number 169.

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    Length: 58 p.
    Date of creation: 1998
    Date of revision:
    Handle: RePEc:diw:diwwpp:dp169

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    Keywords: German economy 1989-97; unemployment; unification;

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    References

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    1. Franz, Wolfgang & Gordon, Robert J, 1993. "German and American Wage and Price Dynamics: Differences and Common Themes," CEPR Discussion Papers 777, C.E.P.R. Discussion Papers.
    2. Blanchard, Olivier J, 1986. "The Wage Price Spiral," The Quarterly Journal of Economics, MIT Press, vol. 101(3), pages 543-65, August.
    3. Klodt, Henning & Maurer, Rainer & Schimmelpfennig, Axel, 1997. "Tertiarisierung in der deutschen Wirtschaft," Open Access Publications from Kiel Institute for the World Economy 959, Kiel Institute for the World Economy (IfW).
    4. Winston, Clifford, 1993. "Economic Deregulation: Days of Reckoning for Microeconomists," Journal of Economic Literature, American Economic Association, vol. 31(3), pages 1263-89, September.
    5. Eli Berman & John Bound & Stephen Machin, 1997. "Implications of Skill-Biased Technological Change: International Evidence," Boston University - Institute for Economic Development 78, Boston University, Institute for Economic Development.
    6. Katharine G. Abraham & Susan N. Houseman, 1993. "Job Security in America: Lessons from Germany," Books from Upjohn Press, W.E. Upjohn Institute for Employment Research, number kagsnh1993, December.
    7. Sinn, Gerlinde & Sinn, Hans-Werner, 1992. "Kaltstart. Volkswirtschaftliche Aspekte der Deutschen Vereinigung," Monograph, Mohr Siebeck, T├╝bingen, edition 2, number urn:isbn:9783161459429, February.
    8. Layard, Richard & Nickell, Stephen & Jackman, Richard, 1991. "Unemployment: Macroeconomic Performance and the Labour Market," OUP Catalogue, Oxford University Press, number 9780198284345, September.
    9. Estrella, Arturo & Mishkin, Frederic S., 1997. "The predictive power of the term structure of interest rates in Europe and the United States: Implications for the European Central Bank," European Economic Review, Elsevier, vol. 41(7), pages 1375-1401, July.
    10. Assar Lindbeck, 1993. "Unemployment and Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262121751, December.
    11. Maurice Obstfeld & Kenneth S. Rogoff, 1996. "Foundations of International Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262150476, December.
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