Real wages and unemployment in Weimar Germany

"This paper is a contribution to the debate on the causes of unemployment in inter-war Germany. It discusses the literature which attributes the rise in unemployment in the depression of 1929-32 to adverse demand factors, such as the cutting off of external capital flows and the weakness of domestic aggregate demand. It goes on to consider the argument of Borchardt that supply-side factors, in the form of high real wages, caused unemployment during the late 1920s and early 1930s. Upward pressure on wages was the outcome of the process of wage determination, which was set up by the Weimar regime. We also consider the factors contributing to the reduction of unemployment in the economic recovery under the Nazis. Unemployment was reduced by the growth of government spending, while on the supply-side the pegging of the level of the nominal contract or tariff wage may also have assisted recovery. The issue has been stated succinctly by Borchardt (1991: p175): “Neither economic theory nor empirical evidence appears to me to have delivered clear criteria for answering the question as to whether continuing unemployment [in Weimar Germany] was a case of weakness in demand or whether this was a case of classical real wage unemployment, or perhaps both factors played a part.” Our aim in the paper is to resolve this issue using an extension of the model developed by Layard et al (1991) for examining the causes of post-war unemployment in OECD economies. The model has been applied to the analysis of British unemployment in the inter-war period in Dimsdale et al. (1989). It is extended here to model the determination of the tariff wage and so allows the widely differing wage policies of the Weimar and Nazi regimes to be examined. The model is set out and the underlying theory is explained in Dimsdale et al (2004). Estimates of the employment equation show that demand shocks, in the form of changes in real share prices, capital inflows and changes in government spending, had an impact on employment. The importance of share prices in affecting demand has been emphasized by Voth (2003), while the influence of capital inflows has been noted by Ritschl (1998) and Eichengreen (1992). Real earnings have a major effect on employment as also found by Broadberry and Ritschl (1995). Real import prices were less important than in Britain, but they had the expected sign in that a rise real import prices raised the bargained real wage. In the basic model the equilibrium level of unemployment is the outcome of an interaction between the wage setting decisions by trade unions and arbitrating bodies and the price setting decisions of firms. These factors are modelled in the wage and price equations. The equilibrium level of unemployment is determined where the upward pressure on the real wage is offset by the level of unemployment, giving rise to a real wage which is consistent with the pricing policies of firms. In the absence of trade unions lower unemployment may still generate a higher real wage because of efficiency wage factors. The estimated wage equation shows that real earnings were strongly affected by the real contractual or tariff wage as well as economic variables, such as labour productivity, the level of unemployment benefits, the rate of unemployment and real import prices. Real wages were sticky so that an unexpected change in prices affected on the real wage. In particular a fall in prices would cause a rise the real wage due to this effect, known as nominal inertia. In its turn the tariff wage was determined largely by political rather than economic factors, as argued by Borchardt. It responded to upward pressure under the Weimar republic and downward pressure under the Nazis. The price equation shows that prices were set as a constant mark –up on wages, which was not responsive to demand conditions. The wage and price equations are combined to show that in the slump of 1929-32 the rise in unemployment can be explained by both demand and supply-side influences. Adverse demand shocks, which were transmitted to the labour market through nominal inertia, and the increases in the real tariff wage both raised unemployment. During the recovery of the 1930s there were positive demand shocks through fiscal expansion, which reduced unemployment. In addition the Nazi policy of holding down the tariff wage had the same effect, supporting Temin’s (1989: p120) argument that the low wage policy of the Nazis assisted recovery. Thus demand and supply-side forces reinforced each other in affecting unemployment in both slump and recovery. The results of the analysis are illustrated by diagrams. It should be noted that the results for Germany differ from those found for inter-war Britain, where demand shocks predominated in both the decline and the recovery."