From Sick Man of Europe to Economic Superstar: Germany’S Resurgent Economy†

Home , Christian Dustmann, Germany, Sick man of Europe

Journal of Economic Perspectives—Volume 28, Number 1—Winter 2014—Pages 167–188

From Sick Man of Europe to Economic Superstar: Germany’s Resurgent Economy†

Christian Dustmann, Bernd Fitzenberger, Uta Schönberg, and Alexandra Spitz-Oener

n the late 1990s and into the early 2000s, Germany was often called “the sick man of Europe” (for example, Economist 2004), a phrase usually attributed I to comments by Czar Nicholas I of Russia about the troubles faced by the Ottoman Empire in the mid-19th century. Indeed, Germany’s economic growth averaged only about 1.2 percent per year from 1998 to 2005, including a recession in 2003, and unemployment rates rose from 9.2 percent in 1998 to 11.1 percent in 2005 (according to World Bank data). Today, after the Great Recession, Germany is described as an “economic superstar” (for example, in the movie “Made in Germany: Europe’s Economic Superstar,” http://fi lms.com/ItemDetails.aspx?TitleId=29218). lms.com/ItemDetails.aspx?TitleId=29218). Germany’s number of total unemployed fell from 5 million in 2005 to about 3 million in 2008, and its unemployment rate had declined to 7.7 percent in 2010 (according to data from Germany’s Federal Employment Agency, the Bundesagentur für Arbeit). In contrast to most of its European neighbors and the United States, Germany experienced almost no increase in unemployment during the Great Recession, despite a sharp decline in GDP in 2008 and 2009 (an episode discussed

■ Christian Dustmann is Professor of Economics, University College London, London, United Kingdom. Bernd Fitzenberger is Professor of Statistics and Econometrics, Univer- sity of Freiburg, Freiburg, Germany. Uta Schönberg is Associate Professor of Economics, University College London, London, United Kingdom. Alexandra Spitz-Oener is Professor of Economics, Humboldt University Berlin, Berlin, Germany. Fitzenberger is also Research Associate at ZEW Mannheim, and Schönberg and Spitz-Oener are also Research Associ- ates at the IAB, Nuremberg, Germany. Their email addresses are [email protected], bernd.fi [email protected],[email protected], [email protected],[email protected], andand alexandra.spitz-oeneralexandra.spitz-oener @wiwi.hu-berlin.de. † To access the Appendix, visit http://dx.doi.org/10.1257/jep.28.1.167 doi=10.1257/jep.28.1.167 168 Journal of Economic Perspectives

iinn MMölleröller 22010; 010; B Burdaurda andand HuntHunt 2011).2011). Germany’sGermany’s eexportsxports reachedreached anan all-timeall-time rrecordecord ofof $1.738 trillion$1.738 trillion inin 2011,2011, whichwhich isis roughlyroughly equalequal toto halfhalf ofof Germany’sGermany’s GDP,GDP, oorr 77.7 percent.7 percent ooff wworldorld eexports.xports. EEvenven tthehe eeurouro ccrisisrisis sseemseems nnotot ttoo hhaveave bbeeneen aableble ttoo sstoptop GGermany’sermany’s sstrengtheningtrengthening eeconomyconomy aandnd eemployment.mployment. HHowow diddid Germany,Germany, wwithith thethe fourth-largestfourth-largest GDPGDP inin thethe worldworld (after(after thethe UnitedUnited SStates,tates, China,China, andand Japan)Japan) transformtransform itselfitself fromfrom “the“the sicksick manman ooff EEurope”urope” toto anan ““economiceconomic superstar”superstar” inin lessless thanthan a decade?decade? OneOne commoncommon answeranswer pointspoints toto a seriesseries ooff llegislativeegislative llaborabor mmarketarket rreformseforms tthathat sstartedtarted iinn tthehe mmidid 22000s,000s, tthehe sso-calledo-called ““HartzHartz rreforms.”eforms.” AAnothernother eexplanationxplanation focusesfocuses oonn tthehe eevolutionvolution ooff GGermany’sermany’s eeconomyconomy aandnd ttraderade balancebalance inin thethe contextcontext ofof thethe eurozone.eurozone. However,However, wewe willwill argueargue thatthat thesethese ffactorsactors diddid notnot playplay a decisivedecisive rolerole forfor thethe transformationtransformation ofof thethe GermanGerman economy,economy, nnamelyamely tthehe restructuringrestructuring ofof itsits laborlabor marketmarket andand thethe increaseincrease inin competitivenesscompetitiveness tthathat hashas helpedhelped GermanGerman exports.exports. WeWe insteadinstead presentpresent evidenceevidence thatthat thethe specifispecifi c ggovernanceovernance structurestructure ofof thethe GermanGerman laborlabor marketmarket institutionsinstitutions allowedallowed themthem toto rreacteact fl exiblyexibly inin a timetime ofof extraordinaryextraordinary economiceconomic circumstances,circumstances, andand thatthat thisthis ddistinctiveistinctive characteristiccharacteristic ofof itsits laborlabor marketmarket institutionsinstitutions hashas beenbeen thethe mainmain reasonreason fforor GGermany’sermany’s eeconomicconomic ssuccessuccess ooverver tthehe llastast ddecade.ecade.1 WWee beginbegin byby arguingarguing thatthat thethe evolutionevolution ofof Germany’sGermany’s perper unitunit laborlabor costs—thatcosts—that iis,s, llaborabor ccostsosts rrelativeelative ttoo pproductivity—inroductivity—in bothboth tthehe mmanufacturinganufacturing ssectorector andand tthehe ootherther sectorssectors inin tthehe eeconomyconomy hhasas pplayedlayed aann iimportantmportant rroleole iinn tthehe ffavorableavorable eevolutionvolution ooff GermanGerman tradabletradable manufacturingmanufacturing industry.industry. WeWe thenthen investigateinvestigate thethe mechanismsmechanisms tthathat aallowedllowed fforor wwageage rrestraintsestraints aandnd tthehe ddramaticramatic ddecreaseecrease iinn rrealeal wwagesages aatt tthehe llowerower eendnd ooff tthehe wwageage ddistribution.istribution. TThehe specifispecifi c featurefeature ooff tthehe GGermanerman ssystemystem ooff iindustrialndustrial rrelationselations tthathat wwee sstresstress iiss thatthat itit isis notnot rootedrooted inin legislation,legislation, butbut insteadinstead isis laidlaid outout inin contractscontracts andand mutualmutual aagreementsgreements bbetweenetween tthehe tthree mainhree main actorsactors inin Germany:Germany: employeremployer associations,associations, ttraderade uunions,nions, aandnd wworksorks ccouncils.ouncils. TThehe iinstitutionalnstitutional ssetupetup ooff tthishis ssystem,ystem, wwhichhich iiss ddominatedominated bbyy iindustry-widendustry-wide wwageage bbargaining,argaining, rremainedemained bbasicallyasically uunchanged.nchanged. HHowever,owever, mmanyany iindi-ndi- ccatorsators ddemonstrateemonstrate tthathat iitt ddidid cchangehange iinn tthehe wwayay iitt ooperates.perates. FForor eexample,xample, tthehe ssharehare ooff GGermanerman wworkersorkers ccoveredovered bbyy aanyny kkindind ooff uunionnion aagreementgreement hhasas ssharplyharply ddeclined,eclined, aandnd tthehe nnumberumber ooff fi rm-levelrm-level deviationsdeviations fromfrom industry-wideindustry-wide uunionnion aagreementsgreements hhasas sharplysharply iincreasedncreased ssinceince tthehe mmidid 11990s.990s. OOverall,verall, tthesehese ggradualradual cchangeshanges wwithinithin tthehe ssystemystem lleded ttoo anan unprecedentedunprecedented ddecentralizationecentralization ooff tthehe wage-settingwage-setting pprocessrocess ffromrom tthehe industryindustry llevelevel ttoo tthehe fi rrmm llevel.evel. AAlternatively,lternatively, oonene mmayay rreferefer ttoo tthishis pprocessrocess aass aann iincreasingncreasing llocalizationocalization ooff GGermany’sermany’s iindustrialndustrial rrelations.elations. TThehe ddecentralizationecentralization inin wagewage settingsetting inin GermanyGermany isis inin contrastcontrast toto manymany ofof itsits nneighborseighbors wherewhere thethe statutorystatutory minimumminimum wagewage isis oftenoften highhigh (relative(relative toto produc-produc- ttivity),ivity), wwherehere unionunion wageswages andand workwork hourhour regulationsregulations applyapply toto allall fi rmsrms inin thethe

1 Our argument is similar in spirit to that of Carlin and Soskice (2008, 2009), who argue that it is restruc- turing by Germany’s private sector, using traditional German institutions based on employer-worker cooperation, and not government labor market and welfare state reforms that are to be credited for the German recovery. Christian Dustmann, Bernd Fitzenberger, Uta Schönberg, and Alexandra Spitz-Oener 169

iindustry,ndustry, andand wherewhere institutionalinstitutional changechange thereforetherefore requiresrequires broadbroad consensusconsensus alongalong tthehe ppolitical spectrum.olitical spectrum. WWee thenthen turnturn toto a discussiondiscussion ofof whywhy Germany’sGermany’s laborlabor marketmarket experienceexperience hashas bbeeneen soso ddistinctiveistinctive withinwithin continentalcontinental Europe.Europe. OnOn thethe oneone side,side, thethe ffallall ooff tthehe BBerlinerlin WWallall inin 19891989 andand thethe dramaticdramatic costcost ofof reunifireunifi cationcation burdenedburdened thethe GermanGerman economyeconomy iinn aann uunprecedentednprecedented way,way, leadingleading toto a prolongedprolonged periodperiod ofof dismaldismal macroeconomicmacroeconomic pperformance.erformance. OnOn tthehe ootherther sside,ide, iitt ggaveave GGermanerman eemployersmployers aaccessccess ttoo nneighboringeighboring EEastast EEuropeanuropean countriescountries thatthat werewere formerlyformerly llockedocked awayaway behindbehind thethe IronIron Curtain,Curtain, aandnd thatthat wwereere ccharacterizedharacterized byby lowlow laborlabor cost,cost, yetyet stablestable institutionsinstitutions andand politicalpolitical sstructures.tructures. TheseThese factorsfactors changedchanged thethe powerpower equilibriumequilibrium betweenbetween employeremployer andand eemployeemployee associationsassociations andand forcedforced thethe latterlatter toto respondrespond inin a farfar moremore fl exibleexible wayway tthanhan mmanyany wwouldould everever havehave expected.expected. Finally,Finally, wewe discussdiscuss thethe relationshiprelationship betweenbetween oourur aanalysisnalysis ooff tthehe fl exibilityexibility ofof Germany’sGermany’s laborlabor marketmarket institutionsinstitutions andand twotwo otherother eevents:vents: GGermany’sermany’s HHartzartz rreformseforms ooff 22003003 aandnd tthehe aarrivalrrival ooff tthehe eeurouro iinn 11999.999.

How Did Germany Improve its Competitiveness?

Relative Unit Labor Cost IInn FFigure 1,igure 1, wwee pplotlot tthehe ““relativerelative uunitnit llaborabor ccosts”osts” fforor a ccountry’sountry’s ooverallverall eeconomyconomy aadjusteddjusted forfor thethe changingchanging compositioncomposition ofof thethe marketsmarkets inin whichwhich itit competes,competes, forfor a sselectionelection ofof countries,countries, inin dollardollar terms.terms. ThisThis indexindex isis computedcomputed byby thethe OECDOECD basedbased oonn yyear-to-yearear-to-year cchangeshanges ooff uunitnit llaborabor ccostsosts aandnd sshowshows tthehe rrelativeelative cchangehange iinn tthehe uunitnit llaborabor ccostsosts ooverver ttimeime ((normalizednormalized ttoo 11995)995) ttranslatedranslated iintonto UUSS ddollarsollars aatt tthehe ccurrenturrent eexchangexchange raterate comparedcompared toto a wweightedeighted aaverageverage ooff a ccountry’sountry’s ttradingrading ppartners.artners. TThehe wweightseights ofof thethe tradingtrading partnerspartners adjustadjust annuallyannually toto changeschanges inin tradingtrading patterns.patterns. AnAn iincreasencrease inin thisthis indexindex indicatesindicates a deteriorationdeterioration ofof thethe competitivecompetitive position.position. A dropA drop iinn tthishis iindex—thatndex—that iis,s, aann iimprovementmprovement iinn ccompetitiveness—isompetitiveness—is ccausedaused bbyy ssomeome ccombinationombination ofof three factors:three factors: 1) a1) a decreasedecrease inin thethe wagewage perper workerworker (or(or perper hour);hour); 22) an) an iincreasencrease iinn pproductivityroductivity ((perper wworkerorker oorr pperer hhour);our); aandnd 33) a) a nnominalominal ddeprecia-eprecia- ttionion ooff a ccountry’sountry’s fforeignoreign eexchangexchange rrate.ate. SSinceince 11995,995, GGermany’sermany’s ccompetitiveompetitive ppositionosition hhasas ppersistentlyersistently improved,improved, whilewhile tthehe ccompetitivenessompetitiveness ooff ssomeome ooff iitsts mmainain EEuropeanuropean ttradingrading ppartnersartners hhasas ddeterioratedeteriorated ((SpainSpain andand Italy)Italy) oror remainedremained closeclose toto thethe 19951995 positionposition (France).(France). TheThe competi-competi- ttivenessiveness ofof thethe UnitedUnited KingdomKingdom hashas likewiselikewise deteriorated,deteriorated, althoughalthough itit improvedimproved ddramaticallyramatically betweenbetween 20072007 andand 20092009 duedue toto thethe sharpsharp depreciationdepreciation ofof thethe BritishBritish ppoundound againstagainst otherother currencies.currencies. TheThe USUS economyeconomy alsoalso lostlost competitivenesscompetitiveness rela-rela- ttiveive ttoo GGermanyermany iinn tthehe llateate 11990s990s aass tthehe UUSS ddollarollar aappreciatedppreciated iinn vvaluealue rrelativeelative ttoo EEuropeanuropean currencies,currencies, butbut improvedimproved consistentlyconsistently afterafter thethe 20012001 recession,recession, partlypartly aachievedchieved throughthrough a dollardollar depreciationdepreciation (for(for instance,instance, whilewhile thethe euro/dollareuro/dollar exchangeexchange rrateate waswas aroundaround 1 inin 2001,2001, itit hadhad depreciateddepreciated toto 0.80.8 inin 2009).2009). However,However, Germany’sGermany’s ggainsains iinn competitivenesscompetitiveness withwith regardregard toto France,France, Italy,Italy, andand SpainSpain cannotcannot bebe duedue toto ccurrencyurrency depreciationdepreciation (and(and inin factfact thethe euroeuro appreciatedappreciated relativerelative toto thethe currencycurrency ofof mmostost ttradingrading ppartners),artners), becausebecause thesethese countriescountries allall shareshare thethe euro,euro, andand soso itit mustmust 170 Journal of Economic Perspectives

Figure 1 Evolution of Competition-Weighted Relative Unit Labor Costs, Selected Countries, 1994–2012

1.4

1.3 Italy

1) 1.2

= United Kingdom 1.1 Spain

1.0 France United States 0.9 Index (1995 0.8 Germany 0.7 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Source: OECD Economic Indicators. Notes: This index accumulates the annual change in the relative unit labor costs of country i compared to a weighted average of its main trading partners where labor costs are translated into dollars and the weights are adjusted annually to the change in trade pattern. The annual change in logs is calculated t–1 as log( RULCit ) = log( ULCit e it ) – ∑ j≠i g ij log( ULCjt e jt) where ULC it = ( wit Lit )/ Yit is the unit labor cost for country i in period t, computed as the total wage bill w it Lit divided by the value added of the country’s industry Y it . The unit labor costs are translated into US dollars using the exchange rate eit . Both the unit labor costs and the exchange rates are defi ned as index relative to some base year. The t–1 weighting scheme g ij takes account of the structure of competition in both export and import markets of the goods sector of those countries, and it adjusts on a year-by-year basis. See OECD Economic Outlook (2012, Issue 2, No. 92) and OECD Economic Outlook Sources and Methods (http://www.oecd.org/eco /sources-and-methods) for details on the method of calculation. hhaveave arisenarisen becausebecause GermanGerman wageswages grewgrew atat a slowerslower pacepace thanthan productivityproductivity relativerelative ttoo tthesehese ootherther eeurozoneurozone ccountries.ountries.

Wage Trends and Wage Inequality FFigure 2igure 2 showsshows thethe evolutionevolution ofof realreal wageswages inin WestWest GermanyGermany sincesince 1990.1990. TheThe fi ggureure illustratesillustrates thethe dramaticdramatic developmentdevelopment inin wagewage inequalityinequality inin WestWest GermanyGermany ooverver tthehe ppastast 115 years5 years oorr ssoo ((Dustmann,Dustmann, Ludsteck,Ludsteck, andand SchönbergSchönberg 2009;2009; seesee alsoalso AAntonczyk,ntonczyk, Fitzenberger,Fitzenberger, andand SommerfeldSommerfeld 2010;2010; Card,Card, Heining,Heining, andand KlineKline 2013).2013).2 RRealeal wageswages atat tthehe 15th 15th percentilepercentile fellfell dramaticallydramatically fromfrom thethe midmid 1990s1990s onwards.onwards. FFromrom tthehe eearlyarly 22000s000s oonwards,nwards, mmedianedian rrealeal wwagesages startedstarted toto fall,fall, andand onlyonly wageswages aatt tthehe ttopop ofof thethe distributiondistribution continuedcontinued toto rise.rise. NoticeNotice thatthat allall wagewage fi guresgures thatthat wwee reportreport standstand forfor WestWest GermanyGermany (although,(although, henceforth,henceforth, wewe referrefer toto themthem asas ““Germany”),Germany”), becausebecause developmentsdevelopments inin EastEast GermanyGermany areare stronglystrongly affectedaffected byby thethe ttransitionransition aafterfter GGermanerman uunifinifi cation.cation.

2 Details on the wage data are in Appendix A available online with this journal at http://e-jep.org. From Sick Man of Europe to Economic Superstar: Germany’s Resurgent Economy 171

Figure 2 Indexed Wage Growth of the 15th, 50th, 85th Percentiles, West Germany, 1990–2008

.15

85th percentile

50th percentile .05

0 15th percentile Indexed wage growth

–.05

–.1 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Year

Notes: Calculations based on SIAB Sample for West German Full-Time Workers between 20 and 60 years of age. The fi gure shows the indexed (log) real wage growth of the 15th, 50th, and 85th percentiles of the wage distribution, with 1990 as the base year. Nominal wages are defl ated using the consumer price index (1995 = 100) provided by the German Federal Statistical Offi ce.

IIff tthehe iincreasencrease iinn wwageage iinequalitynequality aandnd tthehe mmodestodest ggrowthrowth iinn wwagesages ooverall—andverall—and iinn pparticulararticular thethe dramaticdramatic declinedecline inin realreal wageswages atat thethe bbottomottom ooff tthehe wwageage ddistribu-istribu- ttion—hasion—has ccontributedontributed toto thethe favorablefavorable evolutionevolution ofof unitunit laborlabor costscosts inin GermanyGermany rrelativeelative toto tthehe UUnitednited SStatestates aandnd ootherther eeurozoneurozone ccountries,ountries, tthenhen oonene sshouldhould eexpectxpect tthishis ddevelopmentevelopment toto havehave beenbeen particularlyparticularly pronouncedpronounced inin thethe tradabletradable manu-manu- ffacturingacturing sector—thesector—the backbonebackbone ofof thethe GermanGerman eexportingxporting industriesindustries accountingaccounting fforor 880 percent0 percent ofof GermanGerman exports.exports. ThisThis insightinsight turnsturns outout toto holdhold true,true, butbut inin anan uunexpected way.nexpected way. TToo ffurtherurther exploreexplore thethe increaseincrease inin wagewage inequality,inequality, wewe classifyclassify sectorssectors withwith eexportxport volumesvolumes belowbelow thethe 25th percentile25th percentile ofof thethe distributiondistribution ofof exportexport volumesvolumes inin 11995995 asas ““nontradablenontradable sectors,”sectors,” andand thosethose withwith exportexport volumesvolumes aboveabove thisthis thresholdthreshold aass “tradable“tradable sectors.”sectors.” “Tradable“Tradable manufacturing”manufacturing” areare allall thosethose tradabletradable sectorssectors thatthat bbelongelong toto thethe manufacturingmanufacturing sector,sector, andand “tradable“tradable services”services” areare allall otherother trad-trad- aableble ssectors.ectors.3 FFigure igure 3 breaksbreaks downdown thethe evolutionevolution ofof realreal wageswages alongalong thethe wagewage

3 Details on the construction of these categories can be found in Appendix A, available with this paper at http://e-jep.org. 172 Journal of Economic Perspectives

Figure 3 Indexed Wage Growth of the 15th, 50th, 85th Percentiles, West Germany, by Sectors, 1990–2008

A: Nontradable Sectors B: Tradable Manufacturing .1 .2 85th percentile 85th percentile .05 .15 50th percentile 50th percentile 0 .1

–.05 .05 15th percentile 15th percentile Indexed wage growth –.1 Indexed wage growth 0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 1990 1992 1994 1996 1998 2000 2002 2004 20062008

Year Year

C: Tradable Services .2 85th percentile .1

0 50th percentile

–.1 15th percentile

Indexed wage growth –.2 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008

Year

Notes: Calculations based on SIAB Sample for West German Full-Time Workers between 20 and 60 years of age. The fi gures show the indexed (log) real wage growth of the 15th, 50th, and 85th percentiles of the wage distribution, with 1990 as the base year. Nominal wages are defl ated using the consumer price index (1995 = 100) provided by the German Federal Statistical Offi ce. Panel A shows the evolution of these fi gures for the nontradable sectors, panel B for tradable manufacturing, and panel C for tradable services. We classify sectors with export volumes below the 25th percentile of the distribution of export volumes in 1995 as “nontradable sectors”, and those with export volumes above this threshold and that belong to the manufacturing sector as “tradable manufacturing.” The sectors above this threshold that do not belong to the manufacturing sector are classifi ed as “tradable services.” ddistributionistribution separatelyseparately forfor thethe nontradablenontradable sector,sector, tradabletradable manufacturingmanufacturing sectorsector ((henceforthhenceforth denoteddenoted asas manufacturing),manufacturing), andand tradabletradable servicesservices sector.sector. BByy tthishis mmeasure,easure, realreal wageswages inin thethe manufacturingmanufacturing sectorsector roserose atat allall percentilespercentiles ofof thethe wagewage ddistributionistribution untiluntil thethe midmid 2000s2000s andand afterwardsafterwards continuedcontinued toto riserise atat thethe medianmedian aandnd thethe 85th 85th percentile.percentile. Germany’sGermany’s realreal wageswages inin thethe nontradablenontradable sectorsector hardlyhardly iincreasedncreased atat allall atat anyany partpart ofof thethe wagewage distributiondistribution duringduring thethe 1990s1990s andand startedstarted toto ddeclineecline fromfrom tthehe eearlyarly 22000s000s oonwardsnwards eevenven aatt tthehe 885th percentile,5th percentile, bbutut pparticularlyarticularly ssoo aatt tthehe 115th percentile.5th percentile. TheThe sharpestsharpest increaseincrease inin inequalityinequality occurredoccurred inin thethe tradabletradable sserviceervice ssector,ector, wwherehere bbetweenetween 11990990 aandnd 22008008 rrealeal wwagesages ddidid nnotot sshowhow aann iincreasencrease aatt tthehe mmedian,edian, iincreasedncreased byby 12 percent12 percent atat thethe 85th percentile85th percentile andand declineddeclined byby almostalmost Christian Dustmann, Bernd Fitzenberger, Uta Schönberg, and Alexandra Spitz-Oener 173

15 percent at the 15th percentile. At first glance, these figures do not seem to lend support to the hypothesis that wage restraint in the manufacturing sector was an important factor in improving competitiveness in that sector.

Exports, Tradable Manufacturing, and Domestic Inputs The end product in manufacturing, however, contains a large share of inputs produced in other sectors: in Germany, the value added in manufacturing is only roughly one-third of the value of the end product, with the remainder of value added being contributed through inputs from other industries, either domesti- cally or from abroad (the literature so far has focused on Germany’s imports of intermediate products from abroad, see Geishecker 2006; Sinn 2006; OECD 2007, chap. 3; OECD 2012, chap. 3). Hence, the manufacturing sector may have benefited from low wages in other domestic sectors and from cheap imports from abroad. In addition, Germany’s manufacturing sector may have experienced increases in productivity which exceeded the increases in wages in the manufacturing sector. More detailed evidence suggests that both of these factors may be at play.4 In Germany, the manufacturing sector comprised 21.6 percent of all jobs in 1995, but 17.7 percent of all jobs in 2007, while the value added of this sector (in current prices) remained essentially unchanged at 22.8 percent of all value added in 1995 compared with 22.7 percent of value added in 2007. This pattern suggests larger productivity increases in the manufacturing sector than in the other sectors, where employment shares increased over the same period, with value added remaining roughly constant. This pattern is not uncommon across high-income countries.5 However, the share of manufacturing in output value (value of final products), as opposed to value added, rose steadily from 35 percent of all output in 1995 to 39.3 percent of all output in 2007. This pattern reflects that the manufacturing sector indeed relies to an increasing extent on inputs from other domestic sectors and on imported inputs (because the share in final products has increased while the share in value added has remained the same), and may thus have benefited from the low wage growth in other domestic sectors and from cheaper imports. Digging down into the more detailed data, shown in Table 1, the value of inputs over the value of output is nearly twice as high in manufacturing as in the other two sectors (66.1 percent in 1995 versus 37.8 percent in the tradable service sector) and this share increased by about 7 percentage points to 72.9 percent in 2007. The share of domestic inputs remained constant over the same period at about 51 percent. Thus, the increase in the share of inputs used by Germany’s manufacturing sector, relative to the output value in that sector, is driven by increased

4 See Table 1 and Table A1 in Appendix C available online with this paper at http://e-jep.org for details and data sources. 5 Pilat, Cimper, Olsen, and Webb (2006) point out that the relatively fast productivity growth in manufacturing is associated with relative declines of the prices for manufacturing products (this is Baumol’s cost disease). Thus, shares in value added at current prices understate the share of value added at constant prices in manufacturing to total value added at constant prices, which makes it remarkable that manufacturing in Germany has retained its share in value added at current prices. 174 Journal of Economic Perspectives

Table 1 Evolution of the Share of Value of Total Inputs and Domestic Inputs over the Value of Output, Overall and by Sector, 1995–2007

Overall Nontradable sectors Tradable manufacturing Tradable services

Panel A: Value of Total Inputs/Output Value 1995 48.2% 39.9% 66.1% 37.9% 2000 51.0% 37.9% 70.1% 41.4% 2007 53.2% 38.2% 72.9% 41.6%

Panel B: Value of Domestic Inputs/Output Value 1995 39.8% 35.3% 51.7% 32.4% 2000 40.3% 32.2% 51.7% 34.8% 2007 40.5% 32.1% 51.2% 34.2%

Panel C: Value of Domestic Inputs/Value of Total Inputs 1995 82.6% 88.3% 78.1% 85.6% 2000 79.0% 84.9% 73.7% 84.0% 2007 76.1% 83.9% 70.3% 82.2%

Notes: Calculations based on input-output statistics from the German Statistical Offi ce (Fachserie 18, Reihe 2, Years: 1995 –2007). We classify sectors with export volumes below the 25th percentile of the distribution of export volumes in 1995 as “nontradable sectors” and those with export volumes above this threshold and that belong to the manufacturing sector as “tradable manufacturing.” The sectors above this threshold that do not belong to the manufacturing sector are classifi ed as “tradable services.” uusese ooff iinputsnputs fromfrom aabroadbroad relativerelative toto inputsinputs fromfrom domesticdomestic industries.industries. However,However, eevenven inin 2007,2007, 70 percent70 percent ofof overalloverall inputsinputs inin Germany’sGermany’s manufacturingmanufacturing sectorsector werewere ddomesticallyomestically produced.produced. Thus,Thus, thethe argumentargument thatthat Germany’sGermany’s mmanufacturinganufacturing ssectorector hhasas bbecomeecome nnothingothing mmoreore tthanhan aann aassemblyssembly pplacelace fforor fforeignoreign pproducedroduced iinputsnputs ((forfor eexample,xample, SinnSinn 22006)006) isis uunjustifinjustifi ed.ed. InIn fact,fact, whilewhile GermanGerman manufacturingmanufacturing hashas mademade iincreasingncreasing useuse ofof importedimported inputs,inputs, thethe shareshare ofof domesticdomestic inputsinputs inin manufacturingmanufacturing fi nnalal ooutpututput vvaluealue hhadad remainedremained hhighigh aandnd rrelativelyelatively sstabletable bbetweenetween 11995995 aandnd 22007.007. TToo whatwhat eextentxtent hhaveave GGermany’sermany’s ddomesticomestic iinputsnputs ccontributedontributed ttoo ccompetitivenessompetitiveness iinn iitsts eexport-orientedxport-oriented mmanufacturinganufacturing ssectorector aandnd tthehe ttwowo ootherther ssectors?ectors? IInn FFigure 4,igure 4, wwee pplotlot tthehe eevolutionvolution ooff uunitnit llaborabor ccostsosts iinn tthehe tthree sectors,hree sectors, wwherehere iindustriesndustries aarere wweightedeighted wwithith rrespectespect ttoo ttheirheir eexportsxports fforor tthehe ttwo tradablewo tradable ssectors.ectors.6 WWhenhen ccomputingomputing uunitnit llaborabor ccosts,osts, wwee fi rstrst considerconsider onlyonly thethe valuevalue addedadded iinn thethe sector,sector, aass denoteddenoted bbyy ssolidolid llinesines iinn FFigure 4.igure 4. WWee tthenhen cconsideronsider fi nnalal ooutpututput vvaluealue iinn tthehe ssector,ector, wwhichhich iiss tthehe ssumum ooff vvaluealue aaddeddded iinn tthehe ssectorector aandnd aallll inputsinputs iintonto tthehe ssectorector ddenotedenoted bbyy ddottedotted llinesines iinn Figure Figure 4.4. ThisThis iindexndex ((UnitUnit LLaborabor CCosts:osts: ““EndEnd PProducts”)roducts”) iincorporatesncorporates ggainsains iinn ccompetitivenessompetitiveness iinn a ssectorector ddueue ttoo tthehe uusagesage ooff inputsinputs ffromrom ootherther ddomesticomestic ssectors.ectors. WWee aalsolso pplotlot mmedianedian rrealeal wwages,ages, aadjusteddjusted uusingsing GGermany’sermany’s CConsumeronsumer PPricerice IIndex,ndex, fforor tthehe tthree sectors.hree sectors. WWhilehile rrealeal wwageage growthgrowth inin thethe manufacturingmanufacturing sectorsector isis relativelyrelatively modest,modest,

6 Details on how unit labor costs are calculated can be found in Appendix A and in Appendix C, which are available online with this article at http://e-jep.org. From Sick Man of Europe to Economic Superstar: Germany’s Resurgent Economy 175

Figure 4 Evolution of Real Daily Wages and Unit Labor Costs by Sector, 1995–2007

A: Nontradable Sectors B: Tradable Manufacturing

110 110 Real daily wages 105 105 Real daily wages 100 100 95 95 Unit labor costs: Unit labor costs: 90 “Value added” 90 “Value added” 85 85 80 Unit labor costs: 80 75 “End product” 75 Unit labor costs: “End product” Indexeded wage growth 70 Indexeded wage growth 70 1995 1997 1999 2001 2003 2005 2007 1995 1997 1999 2001 2003 2005 2007

C: Tradable Services 110 Unit labor costs: “Value added” 105 Real daily wages 100 95 90 Unit labor costs: 85 “End product” 80 75 70 1995 1997 1999 2001 2003 2005 2007

Notes: The fi gures show indexed real mean daily wages by sector (base year 1995 = 100). Nominal wages are defl ated using the consumer price index (1995 = 100) provided by the German Federal Statistical Offi ce. The data underlying these indices are in columns (1), (4), and (7) of Table A2. The fi gure also shows indexed unit labor costs both “Value added” and “End product” by sector. The data underlying these indices are in columns (2), (3), (5), (6), (8), and (9) of Table A2 of the online Appendix. Table A2 includes a detailed description of data and methods of calculations. aatt aaboutbout 88.2 percent.2 percent ooverver tthehe 111-year1-year pperiod,eriod, iinn tthehe ootherther ttwo sectorswo sectors aaverageverage wwagesages ffellell iinn rrealeal ttermserms bbyy 11.2.2 aandnd 44.1 percent,.1 percent, rrespectively,espectively, ooverver tthishis ttimeime pperiod.eriod. AAss vvisibleisible inin thethe fi gure,gure, domesticdomestic unitunit laborlabor costcost forfor totaltotal productionproduction inin manu-manu- ffacturing,acturing, takingtaking accountaccount ofof iinputsnputs pproducedroduced inin otherother ssectorsectors ((”end”end pproducts”),roducts”), ddeclinedeclined ffarar mmoreore rrapidlyapidly tthanhan uunitnit llaborabor ccostsosts iinn vvaluealue aadded—added—a ddeclineecline tthathat ccannotannot bbee eexplainedxplained byby thethe increaseincrease inin thethe shareshare ofof importedimported inputsinputs inin totaltotal outputoutput value.value. MMoreover,oreover, uunitnit llaborabor ccostsosts iinn endend productsproducts startstart toto declinedecline atat thethe startstart ofof thethe observa-observa- ttionion periodperiod inin 1995,1995, wwhilehile uunitnit llaborabor ccostsosts iinn vvaluealue aaddeddded ddecreaseecrease rrapidlyapidly oonlynly ffromrom 22003003 oonwardsnwards wwhenhen mmeanean wwages,ages, aandnd iinn pparticulararticular wwagesages aatt tthehe 115th percentile5th percentile ooff tthehe wwageage ddistributionistribution startstart ttoo ddecreaseecrease iinn realreal termsterms ((asas sshownhown eearlierarlier iinn FFigure 3).igure 3). TThus,hus, GGermany’sermany’s mmanufacturinganufacturing ssectorector iimprovedmproved ccompetitivenessompetitiveness iinn sseveraleveral wways.ays. First,First, manufacturingmanufacturing ddrewrew oonn iinputsnputs ffromrom ddomesticallyomestically pprovidedrovided nnontradableontradable aandnd eespeciallyspecially ttradableradable sservices,ervices, wwherehere rrealeal wwagesages ffellell bbetweenetween 11995995 aandnd 22007.007. SSecond,econd, tthehe ddeclineecline iinn unitunit laborlabor costs,costs, coupledcoupled withwith thethe increaseincrease inin meanmean realreal wageswages inin mmanufacturing,anufacturing, iimpliesmplies tthathat pproductivityroductivity iincreasesncreases iinn tthehe mmanufacturinganufacturing ssectorector hhaveave 176 Journal of Economic Perspectives

ooutpacedutpaced wwageage iincreasesncreases iinn tthathat ssector.ector. IInn ccomparison,omparison, ttotalotal uunitnit llaborabor ccostsosts ffellell llessess iinn tthehe nnontradableontradable ssectorsectors ((minusminus 222.2 percent)2.2 percent) aandnd mmuchuch llessess iinn tthehe ttradableradable sserviceservices ((minusminus 99.7 percent),.7 percent), eevenven tthoughhough nnominalominal wwagesages ggrewrew mmuchuch llessess iinn tthesehese ttwo sectorswo sectors ccomparedompared ttoo ttradableradable mmanufacturing.anufacturing. NNoteote aalsolso tthathat pproductivityroductivity iincreasesncreases iinn tthehe mmanufacturinganufacturing ssectorector hhaveave eexceededxceeded tthehe iincreasesncreases iinn tthehe ttwowo ootherther ssectors.ectors. FFinally,inally, ttoo iincreasencrease tthehe competitivenesscompetitiveness ooff iitsts oownwn fi nalnal products,products, thethe manufacturingmanufacturing ssectorector hhasas mmadeade increasedincreased uusese ooff tradetrade integrationintegration withwith EasternEastern EuropeanEuropean countriescountries throughthrough iinputsnputs iimportedmported ffromrom aabroad,broad, aandnd ffarar mmoreore ssoo tthanhan ootherther EEuropeanuropean ccountries.ountries. TThese inputshese inputs mmadeade uupp 114.5 percent4.5 percent ooff ttotalotal ooutpututput iinn tthehe mmanufacturinganufacturing ssectorector iinn 11995995 aandnd 221.5 percent1.5 percent iinn 22007.007. CCalculatingalculating tthehe ooutsourcingutsourcing iindicatorndicator ssuggesteduggested bbyy EEggergger aandnd EEggergger ((2003,2003, pp. . 6 642)42) fforor GGermany,ermany, FFrance,rance, aandnd IItalytaly rregardingegarding iimportedmported iinputsnputs ffromrom PPoland,oland, HHungary,ungary, aandnd tthehe CCzechzech aandnd tthehe SlovakSlovak Republics,Republics, uusingsing ddataata ffromrom tthehe OECDOECD IInput-Output-Tablesnput-Output-Tables ((atat hhttp://www.oecd.org/trade/input-outputtablesttp://www.oecd.org/trade/input-outputtables ..htm)htm) aandnd OOECDECD IInternationalnternational TTraderade aandnd BBalancealance ooff PPaymentsayments SStatisticstatistics ((atat hhttp://ttp:// wwww.oecd.org/std/its/),ww.oecd.org/std/its/), sshowshows tthathat iinn tthehe yyearear 22000,000, iimportedmported iinputsnputs ffromrom tthesehese ffour countriesour countries aamountedmounted ttoo aaboutbout 88.5 percent.5 percent ooff iinputsnputs iinn GGermany,ermany, ccomparedompared ttoo 22.5 percent.5 percent iinn IItalytaly aandnd 11.9 percent.9 percent iinn FFrancerance ((relativerelative tto GDP).o GDP).

The Increase in Competitiveness and Germany’s Labor Market Institutions

TThehe mmovementsovements iinn GGermanerman wwages,ages, wwithinithin aandnd aacrosscross ssectors,ectors, bbelieelie tthehe ccommonommon bbeliefelief thatthat Germany’sGermany’s llaborabor mmarketarket iinstitutionsnstitutions areare overlyoverly rigid.rigid. Instead,Instead, wewe argueargue thatthat tthehe specifispecifi c governancegovernance structurestructure ofof thethe GermanGerman systemsystem ofof industrialindustrial relationsrelations offersoffers vvariousarious mmarginsargins ooff fl exibility.exibility. InIn thethe earlyearly toto midmid 1990s,1990s, thesethese institutionsinstitutions allowedallowed forfor aann uunprecedentednprecedented iincreasencrease iinn tthehe ddecentralizationecentralization ((localization)localization) ooff tthehe pprocessrocess tthathat ssetsets wwages,ages, hhours,ours, andand otherother aspectsaspects ofof workingworking conditions,conditions, fromfrom thethe industry-industry- andand rregion-wideegion-wide levellevel toto thethe levellevel ofof thethe singlesingle fi rmrm oror eveneven thethe singlesingle worker,worker, whichwhich inin pparticulararticular helpedhelped toto bringbring downdown wageswages atat thethe lowerlower endend ofof thethe wagewage distribution.distribution. TThishis decentralizationdecentralization tooktook placeplace eveneven thoughthough thethe institutionalinstitutional setupsetup ofof thethe domi-domi- nnatingating ssystemystem ooff iindustry-widendustry-wide wwageage bbargainingargaining bbasicallyasically rremained unchanged.emained unchanged. TThehe sspecifipecifi c featurefeature whichwhich wewe stressstress herehere isis thatthat thethe governancegovernance structurestructure ofof tthehe GGermanerman ssystemystem ooff iindustrialndustrial relationsrelations isis notnot rootedrooted inin legislationlegislation andand isis notnot ggovernedoverned byby thethe politicalpolitical process,process, butbut insteadinstead isis laidlaid outout inin contractscontracts andand mutualmutual aagreementsgreements betweenbetween thethe threethree mainmain laborlabor marketmarket parties:parties: tradetrade unions,unions, employeremployer aassociations,ssociations, andand worksworks councilscouncils (the(the workerworker representativesrepresentatives whowho areare typicallytypically ppresentresent inin medium-sizedmedium-sized andand largelarge fi rms).rms).7 ForFor thisthis reason,reason, GermanyGermany waswas inin thethe ppositionosition ttoo rreacteact iinn aann uunprecedentednprecedented wwayay ttoo tthehe challengeschallenges ofof thethe earlyearly 1990s.1990s.

7 Works councils have to be set up in establishments with more than fi ve employees when demanded so by the employees. About 92 percent of employees in establishments that have more than 50 employees work in establishments with a works council, but only 18 percent of employees in establishments that are smaller (Addison. Schnabel, and Wagner 1997; Beckmann, Föhr, and Kräkel 2010). Christian Dustmann, Bernd Fitzenberger, Uta Schönberg, and Alexandra Spitz-Oener 177

TThehe pprinciplerinciple ooff aautonomyutonomy ooff wwageage bbargainingargaining isis llaidaid ddownown iinn tthehe GGermanerman cconstitutiononstitution andand impliesimplies thatthat negotiationsnegotiations taketake placeplace withoutwithout thethe governmentgovernment ddirectlyirectly exertingexerting inflinfl uence.uence. AsAs such,such, GermanyGermany hashas hadhad nono statutorystatutory minimumminimum wagewage iimposedmposed bbyy tthehe ppoliticalolitical pprocessrocess overover thethe periodperiod wewe study.study. Rather,Rather, anan elaborateelaborate ssystemystem ooff wwageage fl oorsoors isis negotiatednegotiated periodicallyperiodically betweenbetween tradetrade unionsunions andand employeremployer aassociations,ssociations, ttypicallyypically aatt tthehe iindustryndustry aandnd rregionalegional level.level. TThishis modelmodel ofof industrialindustrial relationsrelations hashas beenbeen veryvery successfulsuccessful inin Germany,Germany, wherewhere nnegotiationegotiation withwith unionsunions andand participationparticipation ofof workwork councilscouncils inin decision-makingdecision-making pprocessesrocesses areare widelywidely regardedregarded asas anan importantimportant cornerstonecornerstone inin furtheringfurthering ccommonommon interestsinterests andand eveneven improvingimproving productivity.productivity. AsAs a consequence,consequence, negotia-negotia- ttionsions areare usuallyusually farfar moremore consensus-basedconsensus-based andand lessless confrontationalconfrontational thanthan inin otherother ccountries.ountries. ForFor example,example, GermanyGermany lostlost onon averageaverage 11 days11 days ofof workwork eacheach yearyear perper 11,000 employees,000 employees byby strikesstrikes andand lock-outslock-outs betweenbetween 19911991 andand 1999,1999, butbut onlyonly fi ve daysve days pperer 11,000 employees,000 employees betweenbetween 20002000 aandnd 22007.007. TThesehese fi gguresures forfor the earlierthe earlier andand laterlater ttimeime periodperiod comparecompare toto 4040 andand 32 days32 days perper 1,000 employees1,000 employees inin thethe UnitedUnited States,States, 3300 andand 30 days30 days inin thethe UnitedUnited Kingdom,Kingdom, 7373 andand 103 days103 days inin France,France, 158158 andand 93 days93 days iinn Italy,Italy, andand 222020 aandnd 1164 days64 days iinn CCanadaanada ((LeschLesch 22009).009). GGermany’sermany’s ccultureulture ooff ccommonommon iinterestnterest iiss ddissimilarissimilar ttoo tthehe vviewiew aaboutbout wworkerorker rrepresentationsepresentations ccommonlyommonly hheldeld iinn tthehe UUnitednited SStates.tates. A rrecentecent UUSS eexamplexample iiss tthehe aattemptttempt ooff tthehe mmanagementanagement ooff tthehe GermanGerman companycompany VVolkswagenolkswagen ttoo introduceintroduce a worksworks ccouncilouncil aatt iitsts CChattanoogahattanooga pplantlant iinn TTennessee.ennessee. WWhilehile tthehe pparticipationarticipation ooff wworksorks ccouncilsouncils iinn mmanagementanagement ddecisionsecisions iiss cconsideredonsidered bbyy VVolkswagenolkswagen aass a ccorner-orner- sstonetone ooff successfulsuccessful fi rrmm ppolicyolicy thatthat helpshelps furtheringfurthering commoncommon interests,interests, TTennesseeennessee GGovernorovernor BillBill HaslamHaslam hhasas bbeeneen ooutspokenutspoken iinn oopposingpposing aanyny uunionnion fformationormation aatt tthehe pplant,lant, fearingfearing thatthat itit endangersendangers tthehe state’sstate’s eeffortffort ttoo aattractttract iinvestmentnvestment ((GreenhouseGreenhouse 22013).013). A kkeyey ddifferenceifference bbetweenetween UUSS aandnd GGermanerman llaborabor mmarketarket iinstitutionsnstitutions lliesies iinn tthehe ffactact tthathat a wworksorks ccouncilouncil iinn GGermanyermany eelectedlected bbyy tthehe eemployeesmployees ddoesoes nnotot hhaveave ttoo bbee a uunionnion rrepresentativeepresentative ((althoughalthough iinn ppracticeractice tthehe mmajorityajority ooff wworksorks ccouncilsouncils aarere uunionnion rrepresentatives),epresentatives), wwhilehile tthehe iinstallationnstallation ooff a wworksorks ccouncilouncil iinn a UUSS fi rrmm automaticallyautomatically iinvolvesnvolves tthehe fi rmrm bbecomingecoming uunionized.nionized. TThus,hus, wworksorks ccouncilsouncils iinn GGermanyermany mmayay aactct iinn ggreaterreater iindependencendependence ffromrom a uunionnion iiff tthehe ssurvivalurvival ooff ttheirheir fi rrmm iiss aatt sstake.take.

Unions and Employer Associations IInn GGermany,ermany, ccontractualontractual aagreementsgreements bbetweenetween unionsunions andand employeremployer associationsassociations aarere nnegotiatedegotiated eithereither onon thethe region-industryregion-industry llevelevel oorr oonn tthehe fi rmrm level.level. InIn additionaddition toto wwages,ages, wworkingorking ttimeime rregulationsegulations aarere aann iimportantmportant ccomponentomponent ooff tthehe nnegotiations.egotiations. A distinguishingdistinguishing featurefeature fromfrom USUS laborlabor marketmarket institutionsinstitutions isis thatthat thethe recogni-recogni- ttionion ooff ttraderade uunionsnions iinn GGermanyermany iiss aatt tthehe ddiscretioniscretion ooff tthehe fi rm,rm, andand unionunion contractscontracts ccoverover oonlynly tthehe wworkersorkers iinn fi rmsrms thatthat recognizerecognize thethe relevantrelevant sectoralsectoral wagewage bargainingbargaining ((union)union) ccontract—regardlessontract—regardless ofof wwhetherhether tthehe wworkerorker iiss a uunionnion mmemberember ((forfor ddiscus-iscus- ssion,ion, sseeee OOECDECD 2004;2004; DustmannDustmann andand SchoenbergSchoenberg 2009;2009; Fitzenberger,Fitzenberger, Kohn,Kohn, andand LLembckeembcke 2013).2013). Also,Also, GermanGerman fi rmsrms thatthat onceonce recognizedrecognized thethe unionunion contractscontracts cancan llaterater ooptpt ooutut aatt ttheirheir oownwn ddiscretion.iscretion. EEvenven wwithinithin unionunion wagewage contractscontracts negotiatednegotiated aatt tthehe industryindustry level,level, therethere isis scopescope forfor wagewage fl exibilityexibility atat thethe fi rmrm levellevel throughthrough 178 Journal of Economic Perspectives

sso-calledo-called ““opening”opening” oror “hardship”“hardship” clauses,clauses, providedprovided thatthat workers’workers’ representativesrepresentatives aagreegree ((forfor eexample,xample, HHasselassel 11999;999; HHasselassel aandnd RRehderehder 22001;001; CCarlinarlin aandnd SSoskiceoskice 22009;009; BBrändle,rändle, HHeinbach,einbach, aandnd MMeiereier 22011;011; BBispinck,ispinck, DDribbusch,ribbusch, aandnd SSchultenchulten 22010).010). AAfterfter optingopting outout ofof a collectivecollective agreement,agreement, fi rmsrms stillstill havehave toto paypay wageswages forfor thethe iincumbentncumbent employeesemployees accordingaccording toto thethe ccollectiveollective aagreementgreement uuntilntil a nnewew aagreementgreement aatt tthehe fi rmrm llevelevel hashas beenbeen reached,reached, butbut theythey dodo notnot havehave toto honorhonor newnew negotiatednegotiated wwageage iincreasesncreases andand tthehe fi rmrm needneed notnot followfollow thethe oldold collectivecollective agreementsagreements forfor newnew hhires.ires. Thus,Thus, overover timetime a fi rmrm maymay bebe ableable toto lowerlower wagewage costscosts considerablyconsiderably byby optingopting ooutut ooff tthehe uunionnion ccontract—providedontract—provided iitsts eemployeesmployees aacceptedccepted tthis.his. AAfterfter 1995,1995, therethere waswas indeedindeed a dramaticdramatic declinedecline inin unionunion coveragecoverage inin Germany.Germany. TThishis ddeclineecline isis almostalmost entirelyentirely drivendriven byby a declinedecline inin industry-wideindustry-wide agreements.agreements.8 FFromrom 11995995 ttoo 22008,008, tthehe ssharehare ooff eemployeesmployees ccoveredovered bbyy iindustry-widendustry-wide aagreementsgreements ffellell fromfrom 7755 ttoo 556 percent,6 percent, whilewhile thethe shareshare coveredcovered byby fi rm-levelrm-level agreementsagreements fellfell ffromrom 10.510.5 toto 9 percent.9 percent. TheThe percentagepercentage ofof GermanGerman workersworkers thatthat werewere notnot coveredcovered bbyy aann aagreementgreement iinn 11995995 ––19971997 wwasas hhighestighest iinn tthehe ttradableradable sserviceservices ((2222 ppercent),ercent), aass ccomparedompared ttoo ttradableradable mmanufacturinganufacturing ((9.8 percent)9.8 percent) aandnd nnontradablesontradables ((12 percent).12 percent). BByy 22006006 ––2007,2007, nnoncoverageoncoverage hadhad sharplysharply increasedincreased inin allall three sectorsthree sectors toto 440,0, 227,7, aandnd 332 percent2 percent inin thethe tradabletradable services,services, mmanufacturing,anufacturing, aandnd nnontradablesontradables respectively,respectively, aandnd thisthis shareshare continuedcontinued toto rise.rise. ByBy 2010,2010, accordingaccording toto thethe GermanGerman StructureStructure ofof EEarningsarnings Survey,Survey, 41 percent41 percent ofof allall employeesemployees inin fi rmsrms withwith atat leastleast 10 employees10 employees inin tthehe sectorssectors Manufacturing,Manufacturing, Mining,Mining, andand ServicesServices areare notnot coveredcovered byby anyany collectivecollective wwageage aagreementgreement ((StaBuStaBu 22013).013). HHasas tthishis ddecreaseecrease inin unionunion coveragecoverage ratesrates contributedcontributed toto a reductionreduction inin wagewage ggrowthrowth andand toto anan increaseincrease inin inequality?inequality? WeWe investigateinvestigate thisthis questionquestion inin Figure 5,Figure 5, wwherehere wwee pplotlot tthehe oobservedbserved cchangeshanges iinn llogog rrealeal wwagesages bbetweenetween 11995995 aandnd 22008008 aalonglong tthehe wagewage distribution.distribution. WeWe alsoalso plotplot thethe counterfactualcounterfactual changeschanges thatthat wouldwould havehave ooccurredccurred ifif unionizationunionization ratesrates hadhad remainedremained atat thethe samesame levellevel asas inin 1995,1995, usingusing thethe rreweightingeweighting approachapproach developeddeveloped inin DiNardo,DiNardo, Fortin,Fortin, andand LemieuxLemieux (1996),(1996), whichwhich eessentiallyssentially reweighsreweighs wageswages observedobserved inin 20082008 withwith thethe odds-ratioodds-ratio thatthat a workerworker withwith sspecifipecifi c observedobserved characteristicscharacteristics hashas beenbeen observedobserved inin thethe 2008-coverage-status2008-coverage-status inin 11995995 versusversus beingbeing observedobserved inin thethe 2008-coverage-status2008-coverage-status inin 2008.2008. NoticeNotice thatthat thisthis cconstructedonstructed counterfactualcounterfactual exerciseexercise isis byby nono meansmeans “causal,”“causal,” amongamong otherother reasonsreasons bbecauseecause iitt iignoresgnores ggeneraleneral eequilibriumquilibrium eeffectsffects ooff dde-unionization.e-unionization. TThehe fi guregure ssuggestsuggests thatthat Germany’sGermany’s wageswages inin 20082008 wouldwould havehave beenbeen higherhigher ifif unionunion coveragecoverage hhadad rremainedemained tthehe ssameame aass iinn 11995995 tthroughouthroughout tthehe eentirentire wwageage ddistribution,istribution, bbutut tthehe ddifferenceifference iiss pparticularlyarticularly largelarge atat thethe lowerlower endend ofof thethe wagewage distribution.distribution.

Works Councils and Opening Clauses WWageage inequalityinequality hashas alsoalso increasedincreased stronglystrongly amongamong employeesemployees coveredcovered byby unionunion ccontracts,ontracts, tthushus ssuggestinguggesting tthathat tthehe GGermanerman ssystemystem ooff iindustrialndustrial rrelationselations hhasas aallowedllowed fforor wwageage aadjustmentsdjustments eveneven withinwithin thethe unionizedunionized sector.sector. ThisThis patternpattern isis illustratedillustrated inin

8 See Data Appendix A and Table A3 in Appendix C, available online with the paper at http://e-jep.org. From Sick Man of Europe to Economic Superstar: Germany’s Resurgent Economy 179

Figure 5 Observed versus Counterfactual Wage Growth between 1995 and 2008 along the Wage Distribution: The Role of De-unionization

Unionization at 1995 level

0 Observed change

–.1 Change in log real wage

–.2 5152535 45 55 65 75 85 Percentile

Notes: The fi gure shows the observed wage growth by percentile between 1995 and 2008, as well as the counterfactual wage growth which would have prevailed if the share of workers covered either by industry-wide or fi rm-wide agreements had remained at its 1995 level. The counterfactual wage distribution is computed using the reweighting approach developed by DiNardo, Fortin, and Lemieux (1996). Calculations are based in the LIAB.

FFigure 6,igure 6, wwherehere wwee sshowhow tthehe eevolutionvolution ofof thethe 15th,15th, 50th,50th, andand 85th percentile85th percentile ofof thethe wwageage ddistributions,istributions, indexedindexed atat 0 iinn 11995,995, fforor tthosehose ccoveredovered bbyy a uunionnion ((panel A)panel A) aandnd uuncoveredncovered byby a unionunion (panel B)(panel B) sectors.sectors. TheThe fi guregure showsshows thatthat wagewage inequalityinequality roserose sstronglytrongly inin thethe coveredcovered sectorsector bothboth atat thethe bottombottom andand thethe toptop ofof thethe wagewage distribu-distribu- ttion,ion, whilewhile inin thethe uncovereduncovered sectorsector itit remainedremained basicallybasically constantconstant atat thethe bottombottom ooff tthehe wwageage ddistributionistribution andand onlyonly increasedincreased atat thethe toptop ofof thethe wagewage distribution.distribution. HHowever,owever, nnoticeotice thatthat duedue toto thethe indexationindexation thethe fi guresgures hidehide thethe largerlarger differentialsdifferentials iinn wagewage levelslevels atat specifispecifi c percentilespercentiles inin thethe uncovereduncovered sectorsector relativerelative toto thethe coveredcovered ssector:ector: WhileWhile thethe 85–50th85–50th andand 50–15th differentials50–15th differentials werewere onon averageaverage 0.40.4 andand 0.340.34 iinn tthehe ccoveredovered ssectorector bbetweenetween 19951995 andand 22008,008, ttheyhey wwereere aaboutbout 00.5.5 iinn tthehe uuncoveredncovered ssector.ector. Thus,Thus, three factorsthree factors contributedcontributed toto thethe riserise inin overalloverall inequalityinequality duringduring thethe ttimeime periodperiod underunder consideration,consideration, namely,namely, thethe shiftshift ofof workersworkers fromfrom thethe coveredcovered toto tthehe uncovereduncovered sectorsector (which(which led,led, duedue toto thethe largerlarger differencesdifferences inin wagewage levelslevels inin thethe uuncoveredncovered sector,sector, toto anan increaseincrease inin lowerlower tailtail inequality),inequality), thethe increaseincrease inin inequalityinequality iinn tthehe ccoveredovered sector,sector, aandnd thethe increaseincrease inin inequalityinequality atat thethe toptop ofof thethe wagewage distribu-distribu- ttionion iinn tthehe uuncoveredncovered ssector.ector. 180 Journal of Economic Perspectives

Figure 6 Indexed Wage Growth of the 15th, 50th, 85th Percentiles, West Germany, by Union Coverage Status, 1995–2008

A: Covered Sector

.15

.1 85th percentile

.05

50th percentile Wage growth Wage 15th percentile –.05

–.1 1995 1998 2001 2004 2007 Year

B: Uncovered Sector

.15

85th percentile .05

0 Wage growth Wage

–.05 50th percentile 15th percentile

–.1 1995 1998 2001 2004 2007 Year

Notes: Calculations based on LIAB Sample for West German Full-Time Workers between 20 and 60 years of age. The fi gure shows the indexed (log) real wage growth of the 15th, 50th, and 85th percentiles of the wage distribution, with 1995 as the base year. Nominal wages are defl ated using the consumer price index (1995 = 100) provided by the German Federal Statistical Offi ce. Christian Dustmann, Bernd Fitzenberger, Uta Schönberg, and Alexandra Spitz-Oener 181

WWee thinkthink thatthat thethe changechange inin wagewage inequalityinequality inin thethe coveredcovered sectorsector isis duedue ttoo tthehe ddecentralizationecentralization ofof wagewage settingsetting sincesince thethe beginningbeginning ofof thethe 1990s,1990s, whenwhen iindustry-levelndustry-level collectivecollective bargainingbargaining camecame uundernder iincreasingncreasing ppressureressure ffromrom eemployersmployers wwhoho demandeddemanded moremore fi rm-specifirm-specifi c andand differentiateddifferentiated regulations.regulations. WorksWorks councilscouncils aaccommodatedccommodated thisthis ddecentralizationecentralization toto securesecure jobsjobs iinn GGermany,ermany, wwhichhich aalsolso sstrength-trength- eenedned theirtheir rolerole inin thethe industrialindustrial relations.relations. AsAs anotheranother response,response, thethe tradetrade unionsunions aandnd eemployers’mployers’ aassociationsssociations aagreedgreed oonn aann iincreasingncreasing nnumberumber ooff ““openingopening cclauses”lauses” iinn iindustry-levelndustry-level ccollectiveollective aagreements.greements. OOpeningpening cclauseslauses aallowllow fi rmsrms toto deviatedeviate fromfrom ccollectivelyollectively agreedagreed industry-wideindustry-wide standards.standards. AtAt fi rst,rst, thesethese openingopening clausesclauses focusedfocused oonn hourshours ofof work,work, butbut laterlater theythey alsoalso affectedaffected wages.wages. Also,Also, thethe openingopening clausesclauses werewere iinitiallynitially onlyonly temporarytemporary toto avoidavoid bankruptcy,bankruptcy, butbut laterlater theythey werewere alsoalso implementedimplemented ttoo ensureensure competitivenesscompetitiveness inin moremore generalgeneral terms.terms. FirmsFirms thatthat useuse openingopening clausesclauses nnegotiateegotiate thethe detailsdetails concerningconcerning paypay andand workingworking timetime agreementsagreements withwith thethe worksworks ccouncil.ouncil. UnderUnder GermanGerman law,law, fi rmsrms withoutwithout a worksworks councilcouncil cannotcannot useuse openingopening cclauses,lauses, bbutut ssuchuch fi rmsrms maymay insteadinstead decidedecide toto stopstop recognizingrecognizing a unionunion contract.contract. FFirmsirms wwithith a wworksorks ccouncilouncil nnotot ccoveredovered bbyy a uunionnion ccontractontract maymay rreacheach aann aagreementgreement oonn wwagesages wwithith tthehe wworksorks ccouncil.ouncil. BBrändle,rändle, HHeinbach,einbach, aandnd MMeiereier ((2011,2011, FFigure 1)igure 1) rreporteport tthathat oopeningpening cclauseslauses fforor wwagesages oonlynly sstartedtarted ttoo ggainain iimportancemportance iinn 11995995 ((openingopening cclauseslauses rregardingegarding hhoursours ooff wworkork hhadad existedexisted beforebefore 1995).1995). AmongAmong industry-wideindustry-wide collectivecollective contractscontracts inin manu-manu- ffacturing,acturing, lessless thanthan 5 percent5 percent involvedinvolved openingopening clausesclauses forfor wageswages inin 1995,1995, butbut thisthis hhadad risenrisen toto aboutabout 60 percent60 percent inin 2004.2004. AccordingAccording toto a surveysurvey ofof worksworks councilscouncils inin 22005,005, aaboutbout 75 percent75 percent ofof allall fi rmsrms withwith collectivecollective agreementsagreements useuse openingopening clausesclauses ((BispinckBispinck 22007;007; BBispinck,ispinck, DDribbusch,ribbusch, aandnd SSchultenchulten 2010).2010). TToo summarize,summarize, thethe specifispecifi c governancegovernance structurestructure ofof thethe GermanGerman systemsystem ofof iindustrialndustrial rrelationselations aallowedllowed fforor aann uunprecedentednprecedented iincreasencrease iinn tthehe ddecentralizationecentralization ooff thethe wagewage ssettingetting pprocess,rocess, lleadingeading ttoo a ddecreaseecrease iinn rrealeal wwages,ages, iinn pparticulararticular aatt tthehe llowerower endend ofof thethe wwageage ddistribution.istribution. TThishis wwasas ddrivenriven bbyy ttwowo mmainain ddevelopments:evelopments: 11) ) a sharpsharp ddeclineecline iinn tthehe ssharehare ooff wworkersorkers ccoveredovered bbyy uunionnion aagreements;greements; aandnd 22) an) an increaseincrease iinn oopeningpening cclauseslauses tthathat sstrengthenedtrengthened tthehe rroleole ooff fi rm-basedrm-based wworksorks ccouncilsouncils inin wagewage determinationdetermination relativerelative toto tradetrade unions.unions. ThisThis argumentargument isis consis-consis- ttentent withwith thethe fi ndingnding thatthat thethe riserise iinn fi rm-levelrm-level differencesdifferences iinn wwagesages ccontributesontributes sstronglytrongly ttoo tthehe rriseise iinn wwageage iinequalitynequality iinn GGermanyermany ((Antonczyk,Antonczyk, FFitzenberger,itzenberger, aandnd SSommerfeldommerfeld 22010;010; CCard,ard, HHeining,eining, aandnd KKlineline 22013).013).

What Led to Greater Flexibility in the German Labor Market?

WWhyhy wwereere wwageage rrestraintsestraints andand decreasingdecreasing realreal wageswages atat thethe lowerlower endend ofof thethe wwageage distributiondistribution inin GermanyGermany possiblepossible afterafter thethe midmid 11990s990s butbut notnot before?before? AfterAfter aall,ll, GGermanerman fi rmsrms hhaveave aalwayslways hhadad tthehe ooptionption nnotot ttoo rrecognizeecognize a uunionnion ccontractontract aandnd ttoo ppayay wwagesages belowbelow thethe unionunion wage,wage, providedprovided theirtheir employeesemployees acceptedaccepted this.this. OOpeningpening clausesclauses hadhad beenbeen possiblepossible beforebefore thethe midmid 1990s.1990s. OurOur answeranswer tracestraces ttoo thethe majormajor changeschanges inin Germany’sGermany’s economyeconomy inin thethe earlyearly 1990s1990s relatedrelated toto thethe 182 Journal of Economic Perspectives

rreunifieunifi cationcation ofof GermanyGermany andand thethe openingopening upup ofof thethe nearbynearby centralcentral andand easterneastern EEuropean economies.uropean economies. OOnn oneone hand,hand, thethe extraordinaryextraordinary costcost ofof GermanGerman unifiunifi ccationation bburdenedurdened tthehe GGermanerman eeconomyconomy iinn aann uunprecedentednprecedented wway,ay, wwhichhich iiss ppartlyartly rresponsibleesponsible fforor GGermany’sermany’s ddismalismal pperformanceerformance tthroughouthroughout tthehe 11990s990s aandnd eearlyarly 22000s.000s. TThehe GGermanerman CCouncilouncil ooff EEconomicconomic EExpertsxperts ((SVRSVR 22004,004, ttable able 1 100,00, pp. . 6 644)44) eestimatesstimates nnetet ttransfersransfers ooff aaboutbout 9900 billion00 billion eeurosuros ffromrom fformerormer WWestest GGermanyermany ttoo EEastast GGermanyermany dduringuring tthehe ttimeime pperioderiod 11991991 ttoo 22003.003. TThehe ttotalotal ssumum ooff nnetet ttransfersransfers ccorrespondsorresponds ttoo aaboutbout hhalfalf ooff oone year’sne year’s GGDPDP iinn GGermanyermany dduringuring tthathat ttimeime pperiod.eriod. OOnn tthehe ootherther hhand,and, tthehe oopeningpening ooff ccentralentral aandnd eeasternastern EEuropeanuropean ccountriesountries cconstitutedonstituted a uuniquenique oopportunitypportunity fforor GGermanerman iindustryndustry ttoo mmoveove pproductionroduction aabroad.broad. TTheyhey oofferedffered a sstabletable iinvestmentnvestment cclimate,limate, aass wwellell aass ((despitedespite bbeingeing llockedocked aawayway fforor sseveraleveral ddecadesecades bbehindehind tthehe IIronron CCurtain)urtain) a llongong hhistoryistory ooff ttraderade aandnd iinteractionnteraction wwithith GGermany.ermany. TThehe sstructuretructure ooff iindustryndustry aandnd eeducationducation ssystems,ystems, fforor iinstance,nstance, ssharedhared mmanyany ssimilarities,imilarities, wwhichhich ssurvivedurvived tthehe SSovietoviet eera.ra. VVocationalocational ttrainingraining pplayslays a kkeyey rroleole iinn tthehe eeducationducation ssystem,ystem, iinn a wwayay ssimilarimilar ttoo GGermany,ermany, iinn ccountriesountries llikeike HHungaryungary oorr PPoland.oland. GGermanerman wwasas aalsolso wwidelyidely sspokenpoken iinn ppartsarts ooff CCentralentral aandnd EEasternastern EEurope.urope. AAtt tthehe ssameame ttime,ime, wwagesages iinn tthesehese ccountriesountries wwereere ffarar llowerower tthanhan iinn GGermany,ermany, aandnd wworkingorking rregulationsegulations mmoreore fl exibleexible ((forfor eexample,xample, GGeisheckereishecker 22006;006; MMarinarin 22006).006). MMovingoving pproductionroduction aabroadbroad ttoo tthesehese ccountriesountries ttookook pplacelace aatt a mmoderateoderate ppace:ace: fforor eexample,xample, tthehe sstocktock ooff GGermanerman fforeignoreign ddirectirect iinvest-nvest- mmentent ttoo PPoland,oland, HHungary,ungary, aass wwellell aass tthehe CCzechzech aandnd tthehe SSlovaklovak RRepublicsepublics aamountedmounted ttoo aaboutbout 11 percent percent ooff GGermanerman GGDPDP iinn 22000000 aandnd aaboutbout 22.3 percent.3 percent iinn 22010010 ((accordingaccording ttoo oourur ccalculationsalculations aandnd ddataata ffromrom hhttp://stats.oecd.org/Index.aspx?DatasetCode=FDIttp://stats.oecd.org/Index.aspx?DatasetCode=FDI __POSITION_PARTNER).POSITION_PARTNER). HHowever,owever, tthehe ppossibilityossibility tthathat GGermanerman fi rmsrms mmightight rrelocateelocate pproductionroduction ttoo tthesehese llow-wageow-wage ccountriesountries wwasas vveryery ccredible,redible, aandnd wwidelyidely ddiscussediscussed iinn ppublicublic ((amongamong GGermanerman mmediaedia ooutlets,utlets, sseeee tthehe aarticlesrticles iinn DIHK 2003;2003; MMihmihm aandnd KKnopnop 22004;004; HHawranek,awranek, HHornig,ornig, aandnd JJung 2004).ung 2004). TThehe fi sscalcal bburdenurden ooff GGermanerman rreunifieunifi ccation,ation, ccoupledoupled wwithith aann iimmediatelymmediately mmoreore ccompetitiveompetitive ggloballobal eenvironment,nvironment, mmadeade iitt iincreasinglyncreasingly ccostlyostly fforor GGermanerman fi rrmsms toto paypay highhigh unionunion wages.wages. TheThe newnew opportunitiesopportunities toto movemove productionproduction abroad,abroad, wwhilehile remainingremaining stillstill nearby,nearby, changedchanged thethe powerpower equilibriumequilibrium betweenbetween tradetrade unionsunions aandnd employeremployer federations,federations, andand forcedforced unionsunions and/orand/or worksworks councilscouncils toto acceptaccept ddeviationseviations fromfrom industry-wideindustry-wide agreementsagreements whichwhich oftenoften resultedresulted inin lowerlower wageswages fforor workers.workers. InIn a similarsimilar vein,vein, BurdaBurda (2000)(2000) predictedpredicted thatthat thethe EU-accessionEU-accession ofof EEasternastern EuropeanEuropean countriescountries wouldwould fosterfoster a reductionreduction ofof laborlabor marketmarket rigiditiesrigidities inin tthehe oldold EU memberEU member countriescountries (including(including Germany).Germany). Germany’sGermany’s unionsunions andand worksworks ccouncilsouncils realizedrealized thatthat theythey hadhad toto makemake concessionsconcessions inin orderorder notnot toto bebe furtherfurther mmarginalized,arginalized, andand thethe specifispecifi c characteristicscharacteristics ofof thethe GermanGerman systemsystem ofof industrialindustrial iinstitutionsnstitutions allowedallowed thethe tradetrade unionsunions toto adaptadapt toto thethe newnew economiceconomic realitiesrealities andand toto mmakeake thesethese concessions.concessions. AsAs a result,result, thethe GermanGerman laborlabor marketmarket appearedappeared toto bebe farfar mmoreore fl exibleexible thanthan manymany wouldwould everever havehave expected.expected. WWhyhy ddidid otherother continentalcontinental EuropeanEuropean countriescountries notnot reactreact inin thethe samesame wayway asas GGermany?ermany? OneOne importantimportant reasonreason isis thatthat thethe particularlyparticularly diffidiffi cultcult economiceconomic situa-situa- ttionion inin whichwhich GermanyGermany foundfound itselfitself inin thethe earlyearly 1990s1990s waswas toto a largelarge partpart specifispecifi c toto From Sick Man of Europe to Economic Superstar: Germany’s Resurgent Economy 183

GGermany,ermany, ddueue ttoo tthehe reunifireunifi cationcation ofof Germany,Germany, whichwhich waswas notnot feltfelt inin otherother EuropeanEuropean ccountries.ountries. ThisThis waswas reinforcedreinforced byby Germany’sGermany’s geographicgeographic vicinityvicinity toto thethe countriescountries ofof ccentralentral andand easterneastern Europe,Europe, whichwhich gavegave GermanyGermany anan earlyearly tastetaste ofof thethe challengeschallenges ooff gglobalization.lobalization. TThishis ddecadeecade ooff eeconomicconomic sstagnationtagnation aandnd hhardship,ardship, wwhenhen GGermanyermany wwasas tthehe ““sicksick mmanan ooff EEurope,”urope,” ppreparedrepared tthehe ppopulationopulation fforor aacceptingccepting agreementsagreements fforor thethe sakesake ofof economiceconomic growth,growth, whichwhich sawsaw inequalityinequality riserise dramaticallydramatically forfor thethe fi rstrst ttimeime iinn tthehe aafter-warfter-war pperiod.eriod. IInn addition,addition, thethe systemsystem ofof industrialindustrial relationsrelations inin otherother continentalcontinental EuropeanEuropean ccountriesountries doesdoes nnotot aallowllow fforor tthehe ssameame iinherentnherent oopportunitiespportunities ooff fl exibleexible adaptationadaptation aass tthehe GGermanerman ssystem.ystem. FForor eexample,xample, iinn ccountriesountries llikeike FFrancerance aandnd IItaly,taly, uunionnion wwagesages aarere oftenoften bargainedbargained atat thethe nationalnational levellevel andand applyapply toto allall fi rmsrms inin thethe economy,economy, rregardlessegardless ofof whetherwhether thethe fi rmrm explicitlyexplicitly recognizesrecognizes thethe unionunion contract.contract. CoverageCoverage bbyy uunionnion wwageage ccontractsontracts hhasas rremainedemained remarkablyremarkably stablestable atat veryvery hhighigh llevelsevels aatt aaboutbout 990 percent0 percent iinn FFrancerance aandnd 880 percent0 percent iinn IItalytaly dduringuring tthehe 11990s990s aandnd tthehe 22000s000s ((OECDOECD 22004,004, 22012;012; VVisserisser 22013).013). FFurthermore,urthermore, iinn ccontrastontrast ttoo GGermany,ermany, uunionnion wwageage ccontractsontracts aarere typicallytypically extendedextended toto allall workersworkers inin anan industryindustry (OECD(OECD 2004,2004, table 3.4,table 3.4, p. 148;p. 148; VVisserisser 2013,2013, table 4,table 4, ppp. 96p. 96 ––98).98). IInn tthesehese aandnd ootherther ccontinentalontinental EEuropeanuropean ccountries,ountries, aaddingdding fl exibilityexibility intointo collectivecollective agreementsagreements wouldwould requirerequire politicalpolitical reformsreforms atat thethe nnationalational level.level. MoreMore generally,generally, manymany ofof thethe regulationsregulations whichwhich areare determineddetermined byby llaborabor ccontractsontracts iinn GGermanyermany aarere eeitherither llegallyegally eenforcednforced inin otherother ccountriesountries (such(such aass tthehe mminimuminimum wwageage iinn FFrance)rance) oror nationallynationally implementedimplemented (for(for example,example, unionunion aagreementsgreements eextendxtend toto allall fi rmsrms inin thethe economy),economy), andand thereforetherefore requirerequire consentconsent oonn a muchmuch higherhigher levellevel (nationally,(nationally, oror eveneven onon thethe politicalpolitical level)level) toto bebe modifimodifi eded aandnd cchanged.hanged. ThereThere isis muchmuch lessless scopescope inin thesethese countriescountries forfor a decentralizationdecentralization ooff wwageage ssettingetting ((andand ootherther aaspectsspects ooff wworkingorking conditions)conditions) withinwithin theirtheir systemsystem ofof iindustrial relations.ndustrial relations. IInn ggeneral,eneral, tthehe ddecentralizationecentralization ofof unionunion agreementsagreements isis certainlycertainly beingbeing ddiscussediscussed mmoreore wwidelyidely aacrosscross Europe,Europe, butbut whetherwhether oror whenwhen suchsuch changeschanges mightmight ooccurccur mmoreore wwidelyidely rremainsemains uuncertain.ncertain.

DDiscussioniscussion aandnd OOutlookutlook

WWee havehave arguedargued thatthat thethe remarkableremarkable transformationtransformation ofof thethe GermanGerman economyeconomy ffromrom thethe “sick“sick manman ofof Europe”Europe” toto a leanlean andand highlyhighly competitivecompetitive economyeconomy withinwithin llittleittle moremore thanthan a decadedecade isis rootedrooted inin thethe inherentinherent fl exibilityexibility ofof thethe GermanGerman systemsystem ooff iindustrialndustrial relations.relations. ThisThis systemsystem allowedallowed GermanGerman industryindustry toto reactreact appropriatelyappropriately aandnd fl exiblyexibly overover timetime toto thethe demandsdemands ofof GermanGerman unifiunifi cation,cation, andand thethe globalglobal chal-chal- llengesenges ofof a newnew worldworld economy.economy. However,However, thisthis intrinsicintrinsic fl exibilityexibility becamebecame onlyonly eevidentvident underunder thethe extraordinaryextraordinary ddiffiiffi cultcult economiceconomic circumstancescircumstances andand thethe extremeextreme dduressuress inin whichwhich GermanyGermany foundfound itselfitself inin thethe decadedecade afterafter reunifireunifi cation.cation. HowHow doesdoes oourur thesisthesis fi t withwith twotwo otherother possiblepossible explanationsexplanations forfor Germany’sGermany’s increasedincreased competi-competi- ttiveness:iveness: Germany’sGermany’s HHartzartz laborlabor marketmarket reformsreforms ofof 2003,2003, oror thethe changeschanges broughtbrought aaboutbout bbyy tthehe aadoptiondoption ooff tthehe eeuro?uro? 184 Journal of Economic Perspectives

GGermany’sermany’s ggovernmentovernment uundernder GGerharderhard SSchröderchröder iimplementedmplemented tthehe sso-calledo-called ““HartzHartz RReforms”eforms” ttoo tthehe llaborabor marketsmarkets inin 2003,2003, whichwhich areare oftenoften creditedcredited forfor spur-spur- rringing Germany’sGermany’s economyeconomy (for(for example,example, RinneRinne andand ZimmermannZimmermann 2012,2012, 2013;2013; seesee FFitzenbergeritzenberger 20092009 forfor a criticalcritical assessmentassessment ofof thethe HartzHartz Reforms).Reforms). TheseThese reformsreforms wwereere eextremelyxtremely ccontroversialontroversial aatt tthehe ttime.ime. TTheyhey rreducededuced aandnd llimitedimited tthehe bbenefienefi ttss wwhilehile uunemployed,nemployed, lliberalizediberalized aagencygency wwork,ork, rreformedeformed ““active”active” llaborabor mmarketarket ppolicies,olicies, aandnd rreorganizedeorganized tthehe FFederalederal LLaborabor AAgency,gency, bbutut ddidid nnotot mmakeake aanyny iinstitutionalnstitutional cchangeshanges iinn tthehe wwageage ssetting process.etting process. TThehe HartzHartz rreformseforms wwereere iimplementedmplemented sstartingtarting iinn 22003,003, hhenceence nnearlyearly a ddecadeecade aafterfter thethe processprocess ofof wagewage decentralizationdecentralization andand thethe improvementimprovement inin competitive-competitive- nnessess hadhad begunbegun inin Germany.Germany. ItIt seemsseems plausibleplausible thatthat thethe changeschanges alreadyalready underwayunderway iinn GGermany’sermany’s laborlabor marketsmarkets helpedhelped inin preparingpreparing thethe politicalpolitical groundground forfor thethe HartzHartz rreforms.eforms. IInn aaddition,ddition, aass tthehe eenumerationnumeration ooff tthehe mmainain ccomponentsomponents ooff tthehe rreformseforms mmakesakes clear,clear, thethe sscalecale ooff tthehe rreformseforms iiss mmodestodest eenoughnough tthathat ttheyhey sseemeem uunlikelynlikely ttoo hhaveave triggeredtriggered thethe dramaticdramatic increaseincrease inin competitivenesscompetitiveness oror thethe enormousenormous dropdrop inin GGermanerman uunemploymentnemployment oorr ttoo hhaveave lleded GGermany’sermany’s llaborabor mmarketarket tthroughhrough tthehe ddeepeep rrecessionecession inin 2008–2009.2008–2009. Further,Further, whilewhile thethe focusfocus ofof thethe reformsreforms waswas onon creatingcreating iincentivesncentives forfor seekingseeking employment,employment, ttheyhey ddidid llittleittle ttoo supportsupport tthehe rremarkableemarkable wwageage rrestraintestraint wwitnesseditnessed ssinceince tthehe mmidid 11990s,990s, wwhichhich iiss tthehe kkeyey ffactoractor iinn eexplainingxplaining tthehe ggainain inin competitiveness.competitiveness. WWee thereforetherefore believebelieve thatthat whilewhile thethe HartzHartz reformsreforms havehave contributedcontributed toto thethe rrecentecent declinedecline inin long-termlong-term uunemploymentnemployment aandnd ttoo tthehe ccontinuedontinued iincreasencrease iinn wwageage iinequalitynequality atat tthehe llowerower eendnd ooff tthehe wwageage ddistribution,istribution, ttheyhey wwereere nnotot ccentralentral oorr eessentialssential inin thethe processprocess ofof improvingimproving thethe competitivenesscompetitiveness ofof GermanGerman industry.industry. MMoreover,oreover, aalthoughlthough oonene ssometimesometimes hhearsears tthehe aargumentrgument tthathat ootherther ccontinentalontinental EEuropeanuropean ccountriesountries sshouldhould mmusteruster tthehe ppoliticalolitical wwillill ttoo aadoptdopt ttheirheir oownwn vversionersion ooff thethe HartzHartz rreforms,eforms, wwee bbelieveelieve tthathat ssuchuch a rrecommendationecommendation mmayay bbee mmisleading.isleading. IInn oourur vview,iew, tthehe sspecifipecifi c ggovernanceovernance sstructuretructure ooff tthehe GGermanerman ssystemystem ooff iindus-ndus- ttrialrial relations—activatedrelations—activated underunder extremeextreme duress—isduress—is wwhathat ppavedaved tthehe wayway forfor thethe rremarkableemarkable decentralizationdecentralization ooff wwageage ddeterminationetermination ffromrom tthehe iindustryndustry llevelevel ttoo tthe levelhe level ooff tthehe ssingleingle fi rmrm oorr ssingleingle wworker,orker, aandnd wwhichhich ttogetherogether wwithith a ssignifiignifi cantcant iincreasencrease inin pproductivityroductivity ultimatelyultimately improvedimproved GGermany’sermany’s ccompetitiveness.ompetitiveness. WWhetherhether tthehe politicalpolitical processprocess wwouldould hhaveave bbeeneen aableble ttoo aachievechieve a ssimilarimilar ddegreeegree ooff wwageage ddecentralization,ecentralization, hadhad thethe autonomyautonomy ofof wagewage bargainingbargaining notnot existedexisted inin Germany,Germany, iiss doubtful.doubtful. InIn oourur vview,iew, tthehe ppolicyolicy rrecommendationecommendation ffromrom GGermanyermany fforor tthehe rrestest ooff continentalcontinental EuropeEurope shouldshould notnot bebe thethe HartzHartz reformsreforms (the(the adviceadvice givengiven oftenoften byby ppolicymakers,olicymakers, aass iinn a FFebruaryebruary 22013013 sspeechpeech bbyy GGermanerman CChancellorhancellor AAngelangela MMerkelerkel rreportedeported inin dede WeckWeck 2013),2013), butbut reformsreforms thatthat wouldwould targettarget thethe systemsystem ofof industrialindustrial rrelationselations byby decentralizingdecentralizing bargainingbargaining toto thethe fi rmrm levellevel whilewhile keepingkeeping workers’workers’ rrepresentativesepresentatives iinvolvednvolved ttoo ssecureecure tthathat eemployeesmployees bbenefienefi t aagaingain wwhenhen eeconomicconomic cconditionsonditions iimprove.mprove. SSomeome aarguergue tthathat tthehe aadoptiondoption ooff tthehe ccommonommon EEuropeanuropean ccurrencyurrency iiss a mmainain ffactoractor tthathat hhasas hhelpedelped GGermanyermany ttoo iimprovemprove ccompetitiveness.ompetitiveness. AAgain,gain, wwee bbelieveelieve tthathat tthehe arrivalarrival ofof thethe euroeuro maymay havehave beenbeen a contributingcontributing factor,factor, butbut notnot thethe mainmain one.one. Christian Dustmann, Bernd Fitzenberger, Uta Schönberg, and Alexandra Spitz-Oener 185

FFirst,irst, rrecallecall tthathat GGermanyermany wwasas sshiftinghifting iitsts llaborabor mmarketarket iinstitutionsnstitutions aandnd iimprovingmproving iitsts competitivenesscompetitiveness dduringuring tthehe mmidid 11990s,990s, aandnd tthehe eeurouro ddidid nnotot sstarttart uuntilntil 11999.999. SSecond,econd, wwithinithin tthehe ccommonommon ccurrencyurrency aarea,rea, aandnd afterafter 2001,2001, GermanyGermany continuedcontinued ttoo gaingain ccompetitivenessompetitiveness wwithith rrespectespect ttoo iitsts mmainain ttradingrading ppartnersartners ssuchuch aass IItalytaly aandnd SSpain.pain. TThird,hird, tthehe eeurouro hhasas ppersistentlyersistently aappreciatedppreciated aagainstgainst tthehe UUSS ddollar,ollar, lleadingeading toto thethe increaseincrease inin competitivenesscompetitiveness ofof thethe UnitedUnited StatesStates asas wewe illustratedillustrated iinn Figure 1.Figure 1. IItt sseemseems uunlikelynlikely tthathat GGermany’sermany’s ddeutschemarkeutschemark ((ifif tthehe eeurouro hhadad nnotot bbeeneen introduced)introduced) wwouldould hhaveave aappreciatedppreciated mmuchuch mmoreore aagainstgainst tthehe ddollarollar tthanhan tthehe eeurouro has,has, aatt lleasteast nnotot bbeforeefore tthehe sstarttart ooff tthehe ggloballobal fi nnancialancial crisiscrisis aaroundround 22008008 aandnd tthehe ongoingongoing EuropeanEuropean debtdebt crisis.crisis. Finally,Finally, itit isis notnot clearclear whetherwhether anan appreciationappreciation ooff a GGermanerman ccurrencyurrency ((whichwhich pprobablyrobably wwouldould nnotot hhaveave ttakenaken pplacelace bbeforeefore 22008)008) wwouldould hhaveave hhadad a ddramaticramatic iimpactmpact oonn GGermany’sermany’s ooverallverall ccompetitivenessompetitiveness aatt lleasteast iinn thethe medium-term,medium-term, bbecauseecause iitt wwouldould aalsolso hhaveave mmadeade iimportedmported iinputsnputs llessess ccostlyostly aandnd itit wouldwould possiblypossibly hhaveave ffosteredostered eevenven sstrongertronger llaborabor mmarketarket aadjustmentsdjustments ooff tthehe ttypeype wwee hhaveave describeddescribed above.above. ForFor example,example, thethe depreciationdepreciation ofof thethe BritishBritish ppoundound bbyy nnearlyearly 330 percent0 percent iinn 22008008 ––20092009 hhasas ddoneone llittleittle ttoo hhelpelp UUKK mmanufac-anufac- tturinguring eexports.xports. OOff course,course, tthehe eexistencexistence ooff tthehe ccommonommon eeurouro ccurrencyurrency aarearea rraisesaises a nnumberumber ooff iissuesssues fforor ccountriesountries wwithinithin tthehe eeurozone.urozone. WWithoutithout tthehe ppossibilityossibility ttoo ddepreciateepreciate nnationalational currencies,currencies, tthehe oonlynly wwayay fforor ccountriesountries llikeike FFrance,rance, IItaly,taly, aandnd SSpainpain ttoo ggainain competitivenesscompetitiveness rrelativeelative ttoo ootherther ccountriesountries ooff tthehe eeurozoneurozone iiss ttoo rreduceeduce uunitnit llaborabor ccosts—thatosts—that is,is, bbyy iincreasingncreasing pproductivityroductivity rrelativeelative toto rrealeal wwages.ages. WWhetherhether tthesehese countriescountries willwill succeedsucceed inin thisthis endeavorendeavor remainsremains aann oopenpen question.question. TThehe mmoreore centralizedcentralized andand legallylegally anchoredanchored naturenature ofof theirtheir laborlabor marketmarket institutions,institutions, iinn ccomparisonomparison ttoo GGermany,ermany, ddoesoes pputut tthemhem aatt a ddisadvantageisadvantage iinn mmakingaking ssuchuch aann aadaptation.daptation. BoeriBoeri (2011)(2011) pprovidesrovides aann aassessmentssessment ooff tthehe ppoliticalolitical eeconomyconomy ooff llaborabor mmarketarket rreformseforms wwithith a pparticulararticular ffocusocus oonn ccountriesountries ooff ssouthernouthern EEurope.urope. HHee aarguesrgues thatthat thethe politicalpolitical processprocess oftenoften allowsallows onlyonly forfor two-tiertwo-tier reformsreforms (affecting(affecting oonlynly a subsetsubset ofof allall employees)employees) insteadinstead ofof completecomplete reforms,reforms, whichwhich maymay notnot resultresult iinn anan increaseincrease oof competitivenessf competitiveness TThehe rriseise iinn iinequalitynequality iinn GGermanyermany hhasas lleded ttoo aann iintensiventensive ddebateebate aaboutbout iitsts ssocialocial cconsequences,onsequences, andand itsits effecteffect onon ppovertyoverty aandnd ssocialocial jjustice.ustice. FForor eexample,xample, rrecentecent nnego-ego- ttiationsiations betweenbetween employersemployers andand employeeemployee associationsassociations inin GermanyGermany suggestsuggest thatthat ffutureuture wagewage settlementssettlements willwill trytry toto makemake upup forfor thethe lossloss inin realreal wageswages manymany workersworkers eexperiencedxperienced inin recentrecent ddecades.ecades. IItt iiss aalsolso llikelyikely tthathat ccertainertain aaspectsspects ooff llaborabor aandnd wwageage rregulationsegulations willwill inin thethe futurefuture bebe “put“put inin legislativelegislative stone.”stone.” AsAs oneone example,example, thethe newnew ccoalitionoalition governmentgovernment inin GermanyGermany willwill introduceintroduce a nationallynationally legislatedlegislated minimumminimum wwage.age. Thus,Thus, tthehe ppossibilityossibility fforor GGermanyermany ttoo rrelyely oonn iitsts ssystemystem ooff iindustrialndustrial rrelationselations ttoo iimprovemprove iitsts ccompetitiveompetitive ppositionosition bbyy hhavingaving a ddecentralizedecentralized ddecisionecision mmakingaking pprocessrocess mmayay bbee ccutut bback,ack, aandnd tthishis mmayay rrestrictestrict Germany’sGermany’s aabilitybility toto reactreact inin similarsimilar waysways toto ffutureuture economiceconomic challenges.challenges. IfIf thatthat occurs,occurs, thenthen futurefuture gainsgains inin GermanGerman competi-competi- ttivenessiveness willwill needneed toto bebe accomplishedaccomplished ratherrather throughthrough increasesincreases inin productivityproductivity thatthat ooutstriputstrip wwageage iincreases.ncreases. TThishis ppatternattern mmayay hhelpelp ttoo bbringring cconvergenceonvergence iinn tthehe ccompeti-ompeti- ttivenessiveness ooff tthehe ccountriesountries iinn tthehe eeurozone.urozone. 186 Journal of Economic Perspectives

■ Christian Dustmann is grateful for insightful and stimulating discussions with Wendy Carlin. We thank Wendy for comments on earlier drafts. We also benefi ted from excellent research assistance by Marina Furdas, Stefanie Licklederer, Olga Orlanski, and Florian Weiss. Bernd Fitzenberger dedicates his contribution for this paper to John Pencavel, his fabulous teacher in labor economics.

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