Germany: Selected Issues and Statistical Appendix

This Selected Issues paper and Statistical Appendix analyzes the link between Germany’s economic performance and institutions, taking a long-term perspective and focusing on the labor market. The thesis of the paper is that Germany’s institutional arrangements worked exceptionally well during the Wirtschaftswunder era of rapid catch-up growth, resulting in an economic performance that was envied by much of the world. The paper also examines fiscal consolidation and tax reform proposals, and describes the wage structure in Germany.

Abstract

This Selected Issues paper and Statistical Appendix analyzes the link between Germany’s economic performance and institutions, taking a long-term perspective and focusing on the labor market. The thesis of the paper is that Germany’s institutional arrangements worked exceptionally well during the Wirtschaftswunder era of rapid catch-up growth, resulting in an economic performance that was envied by much of the world. The paper also examines fiscal consolidation and tax reform proposals, and describes the wage structure in Germany.

III. The Wage Structure and Reservation Wages: Accounting for Rising Unemployment Among Low-Skill Workers in Germany43

A. Introduction

84. Continuing a pattern set in the 1980s, the German labor market has continued to perform poorly during the recent recovery. A particularly troubling aspect is the high and rising rate of nonemployment among workers with low skill levels. This paper examines certain important features of the German labor market in an attempt to understand the possible reasons for the disparities in labor market outcomes across different skill groups.

85. First, data from the German Socio-Economic Panel (GSOEP) for west German workers for the years 1984-97 are used to characterize the key features of and changes in the wage structure. Over this period, the wage structure in Germany has remained remarkably stable, with little change in inequality within or between groups. Returns to observed skill attributes such as education and experience have remained essentially unchanged and, if anything, declined marginally during the 1980s.

86. In the second part of the paper, a number of factors that could explain the stability of the wage structure are examined. These include shifts in the relative supplies of skilled and unskilled workers and changes in the sectoral composition of employment. Certain unique features of the GSOEP dataset are also exploited to control for the effects of nonwage compensation, as well as selection and cohort effects. None of these “market factors” appears capable of explaining developments in the wage structure.

87. That leaves “institutional factors” as the residual claimant. Indeed, for Germany, anecdotal and more formal evidence abounds that the wage bargaining system is the proximate cause for the rigidity of relative wages. Unions have traditionally set effective wage floors (there is no legislated minimum wage in Germany) and have negotiated uniform relative wage increases for workers of all skill levels, thereby constraining the flexibility of the wage structure. While these “solidaristic” policies may have served Germany well in previous decades, they have had a deleterious effect on labor market performance over the last 15 years, a period during which the economy has been buffeted by a number of shocks.44

88. As has been well documented for many other industrial economies, it is plausible and likely that there has been a substantial shift in the relative demand for skilled workers in Germany. Factors that have accentuated this demand shift in other countries include skill-biased technological change, increased openness to international trade and de-industrialization, all of which are forces that appear to operate in Germany as well. For instance, Machin and Reenen (1998), using an industry-level database that is comparable across countries, provide persuasive evidence that skill-biased technological change has resulted in relative demand shifts favoring skilled workers in a number of OECD industrial countries including Germany.

89. The interaction of the rigid wage structure, relative demand shifts favoring skilled workers, and a series of adverse macroeconomic shocks has resulted in marked increases in unemployment rates and a deterioration of employment prospects for unskilled workers.45 In other words, given the inflexibility of the relative prices of skills in response to market forces, employers are forced to adjust the relative quantities of skilled and unskilled labor that they employ, to the detriment of unskilled workers. Indeed, employment and retention rates for unskilled workers have continued to fall during the recent recovery, in sharp contrast to the rising employment rate for skilled workers.

90. The penultimate section of the paper provides some interesting evidence that labor supply rigidities might also have contributed to the observed labor market outcomes for unskilled workers. Using data on stated reservation wages among the unemployed, certain aspects of labor supply disincentives at the low end of the skill distribution are highlighted.

91. Thus, the main conclusion of this paper is that comprehensive reforms that influence both the demand for and supply of labor are crucial for improving labor market performance at the low end of the skill/wage distribution. This could involve changes in the wage bargaining structure to allow wages to be more differentiated by skill level. Further, the disincentive effects of the tax and transfer system on labor supply need to be addressed. A discussion of these policy implications constitutes the concluding section of the paper.

B. The Wage Structure

The dataset

92. The data used in this paper are drawn from the public use version of the German Socio-Economic Panel (GSOEP) for the years 1984-97. This is a representative sample of German households and individuals, including immigrants without German citizenship. The sample was expanded to cover unified Germany in the 1990s. The dataset includes details on individual workers’ net and gross wages; hours of work; educational and demographic characteristics; sector and category of occupation; and numerous other individual-specific variables.

93. One of the features of the dataset is that it has a large and relatively stable panel. Nevertheless, the non-response rate for repeat interviews is large enough that attrition bias is a serious concern. To correct for sample attrition, new individuals are added to the survey in a manner that attempts to maintain the representativeness of the sample. To ensure that the results in this paper are representative of the population, the dataset is treated here as a set of repeated cross-sections rather than as a longitudinal survey. This also has the virtues of yielding a larger sample size and keeping the sample size relatively stable over time.

94. To maintain a uniform sample and to minimize distortions from sample selection, much of the analysis below, except where explicitly noted otherwise, is limited to full-time male workers from the west German sample. This also facilitates comparisons with studies for industrial countries that have focused on samples based on similar selection criteria.46 Some summary statistics for the final sample used to analyze the wage structure are shown in Table III-1.

Table III-1.

Summary Statistics

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Notes: The summary statistics reported here are for west German workers with full-time employment and for whom data on all of the variables listed above are available. The total number of observations over the period 1984-1997 is 36,603 (average of 2,600 per year).

95. The wage variable used in this paper is the real gross hourly wage, constructed using reported gross monthly earnings and “usual number of weekly hours” worked, and using the consumer price index for west Germany (1991=100) as the price deflator. The GSOEP also provides data on the number of contracted weekly hours and overtime hours for the month of the survey. There were some discrepancies between the sums of these two variables and the usual weekly hours variable. This latter variable is interpretable as actual hours worked per week in the survey month and is the variable used in this paper. Sensitivity tests indicated that none of the results reported below were much affected by the choice of the hours variable.47 The sample was restricted to persons between the ages of 17 and 65 and excluded workers who report less than 30 or more than 55 hours of work,

96. The education variable also deserves some attention. The GSOEP contains a generated variable on years of education for individuals in the west German sample. This variable is constructed based on information about educational attainment and is the one used in this paper since it greatly facilitates the presentation and discussion of the results. Using dummy variables for highest degree obtained would constitute an alternative and, in some respects, cleaner approach to estimating education premia. Since the focus of this paper is on changes over time in skill premia rather than their levels, this choice turned out not to matter for any of the results reported below. In particular, the time profiles of the skill premia were virtually identical when the education dummies were used. Nevertheless, this discussion should be kept in mind should the results from this paper be used for cross-country comparisons of the levels of skill premia.48 Labor market experience, which is to be interpreted as potential rather than actual labor market experience, is defined as age minus years of education minus 6.

97. Finally, it should be noted that non-citizens are over-represented in the GSOEP sample relative to their share of the west German population. Where appropriate, this feature of the sample is controlled for; for instance, by including controls for citizenship in the wage regressions. In general, using the GSOEP cross-sectional weights that are intended to correct for the non-representativeness of the sample had little effect on the results reported below.

The overall wage structure

98. Figure III-1 displays some summary statistics for real wages for all full-time workers, including women. The top panels show that the median wage has increased by a total of about 20 percent over the period 1984-97. Although a significant gender gap remains, the relative female-male wage differential has narrowed significantly during this period. The bottom panels show that the dispersion of wages, which has historically been smaller than in the United States, declined even further during the latter half of the 1980s. The declines in wage inequality during the 1980s appear to be similar for men and women.

Figure III-1.
Figure III-1.

Germany: Median and Dispersion Measures for Log Hourly Wage

Citation: IMF Staff Country Reports 1999, 130; 10.5089/9781451810417.002.A003

99. Which part of the wage distribution has accounted for the apparent mild compression of the overall distribution? Figure III-2 shows cumulative changes in real wages over the period 1984-97 at different percentile points of the wage distribution, Interestingly, it appears that absolute wage growth has been quite similar at different percentiles of the wage distribution, resulting in the slight narrowing of wage differentials.

Figure III-2.
Figure III-2.

Germany: Wage Growth at Different Points of Wage Distribution

Citation: IMF Staff Country Reports 1999, 130; 10.5089/9781451810417.002.A003

100. Another way to approach this issue, following Juhn, Murphy and Pierce (1993; henceforth referred to as JMP), is to examine the cumulative change in real wages across the entire distribution. The first (top left) panel of Figure III-3 shows the change in real wages from 1984-97 at each percentile point of the aggregate wage distribution for all full-time workers (men and women). A striking result is that wage growth in fact appears to have been higher at the lower end of the wage distribution than at the upper end. This is in stark contrast to recent patterns of wage growth across the distribution in other industrialized countries that are viewed as having more “flexible” labor markets, such as the United Kingdom and the United States. In the United States, for example, a similar plot for the 1980s would have a steep positive slope, with cumulative negative real wage increases over this period at the low end of the distribution.

Figure III-3.
Figure III-3.

Germany: Changes in Log Wages Across Distribution, All Workers

Citation: IMF Staff Country Reports 1999, 130; 10.5089/9781451810417.002.A003

101. The remaining panels of this chart break down the total change over the period 1984-97 into three sub-periods. The mild compression appears to have occurred largely during the late 1980s, continued until about 1992, but then appears to have been reversed during the 1992-97 period, resulting in little net change in inequality over the full sample period.

102. Figures III-4 and III-5 show that, for men, there is some evidence that the wage distribution did grow slightly more unequal over the 1984-97 period while it grew less unequal for women. For both groups, there is clear evidence of compression at the top part of the wage distribution over the full sample and a slight increase in the dispersion of wages since 1992.

Figure III-4.
Figure III-4.

Germany: Changes in Log Wages Across Distribution, Men

Citation: IMF Staff Country Reports 1999, 130; 10.5089/9781451810417.002.A003

Figure III-5.
Figure III-5.

Germany: Changes in Log Wages Across Distribution, Women

Citation: IMF Staff Country Reports 1999, 130; 10.5089/9781451810417.002.A003

103. Panel A of Table III-2 shows a number of percentile differentials for full-time male workers in the sample. The 90-10 percentile differential appears to have declined marginally during the 1980s, before returning to its earlier levels by the mid-1990s. This pattern occurs at both the lower and upper parts of the distribution, as evidenced by the 90-50 and 50-10 percentile differentials. The 75-25 percentile differentials are essentially flat, indicating the stability of the middle part of the wage distribution.

Table III-2.

Measures of Wage Inequality

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Notes: The reported differentials are three-year averages centered on the years shown above. Standard errors are in parentheses. The sample includes west German males with full-time jobs. Panel B reports differentials based on residuals from annual regressions of log hourly wages on a constant, education, experience and with education, experience and squared experience.

104. Overall, these figures yield a picture of relative stability in the aggregate German wage structure over the last 15 years. There is no evidence of increases in wage inequality, let alone increases in inequality of the magnitude seen in the United Kingdom and the United States. Since the evolution of wage inequality appears to have been broadly similar for men and women, and in order to maintain a consistent sample as noted earlier, the remainder of the analysis in this paper is limited to full-time male workers.49

Within-group inequality

105. It is interesting to examine the evolution of wage inequality within skill groups in order to understand the effects of within- and between-group wage dynamics on overall inequality. In the United States, for instance, JMP have documented that the rise in wage inequality in recent decades has been as dramatic within narrowly-defined skill groups as it has been in terms of increases in inequality between these groups.

106. One way to control for between-group effects is to regress wages on observed skill attributes and to examine the dispersion of the wage residuals. Inequality measures based on wage residuals from simple human capital wage equations are reported in Panel B of Table III-2.50 The percentile differentials based on wage residuals are smaller than those based on actual wages but are still quite large, indicating that unobserved attributes constitute an important determinant of the wage distribution. The time profiles of the percentile differentials in this panel are, however, very similar to those in the top panel, indicating that within-group inequality has also been quite stable over the last 15 years. Figure III-6, which shows cumulative wage changes at different percentiles of the residual wage distribution, confirms that inequality within narrowly defined skill groups has evolved in a manner very similar to that of overall wage inequality.

Figure III-6.
Figure III-6.

Germany: Within-Group Wage Changes at Different Ventile Points

Citation: IMF Staff Country Reports 1999, 130; 10.5089/9781451810417.002.A003

107. Figure III-7, which plots cumulative wage changes at different ventiles for specific skill groups, confirms this pattern. It is interesting to note that, while inequality stays rather flat across the distribution within most skill groups, there appears to be a distinct compression of wages among college-educated workers.

Figure III-7.
Figure III-7.

Germany: Changes in Log Wage Residuals Across Distribution

Citation: IMF Staff Country Reports 1999, 130; 10.5089/9781451810417.002.A003

108. A different perspective on the wage distribution is provided in Figure III-8, which shows the evolution of median real wages across different occupational groups. The top left panel shows that, except for trainees, the median wage across different occupational categories is clustered around the overall median and, further, that this clustering has become relatively tighter over the last decade and a half. The remaining panels of this chart show that, within these broadly-defined occupational categories, there is a fairly substantial dispersion of incomes across finer job classifications. This suggests that occupational categories could be inappropriate for understanding changes in the distribution of skill prices.

Figure III-8.
Figure III-8.

Germany: Median Hourly Wages Between and Within Occupational Groups

Citation: IMF Staff Country Reports 1999, 130; 10.5089/9781451810417.002.A003

Relative prices of skills

109. This sub-section turns to an examination of changes in between-group inequality, based on changes in prices for observed skill attributes. The evolution of skill prices has important implications for labor market and, more generally, for macroeconomic outcomes. The incentives for acquisition of human capital are determined by the returns to that capital. The general equilibrium effects of inadequate wage differentiation, which typically implies smaller returns to skill attributes, could be quite large. Furthermore, from the perspective of labor demand, a wage structure that is compressed due to institutional factors could affect the demand for different types of labor.

110. Given the potential problems in using indicators such as job categories as measures of skill, the evolution of skill prices is now analyzed based on estimates of standard human capital wage regressions. The results reported below are based on annual ordinary least squares (OLS) regressions of log hourly wages on education (in years), labor market experience, the square of labor market experience, a dummy variable for German citizenship and interactions of this dummy with education, experience and squared experience.51

111. The first panel of Figure III-9 shows the evolution of the estimated (conditional) return to a year of education, along with the 95% confidence intervals. Coefficient estimates are reported in the first column of Table III-3. The estimated coefficients suggest, for instance, that a college-educated worker (with a four-year college degree), would expect to earn an hourly wage that is about 25 percent higher (4 years * approx. 6 percent) than the wage for a worker with similar labor market experience but only a high school education.

Figure III-9.
Figure III-9.

Germany: Estimated Returns to Education and Experience

Citation: IMF Staff Country Reports 1999, 130; 10.5089/9781451810417.002.A003

Table III-3.

Skill Premia: OLS Results

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Notes: The results reported in this table are from OLS regressions of log hourly wages on a constant, years of education, experience and its square, a dummy for German citizenship, and interactions of this dummy with education, experience and squared experience. Since experience enters the specification as a quadratic, the returns to experience are evaluated at specific experience levels. All coefficients were multiplied by 100. Robust standard errors are reported in parentheses.

112. Two points are worthy of note here. The first is that the estimated wage premia for education are substantially lower than those found in the United Kingdom and the United States. More importantly, the estimated education premium has actually declined marginally in the late 1990s relative to the mid-1980s, exactly the reverse of the trend in the countries mentioned above. In the United States, for instance, the college-high school differential has risen from about 25 percent in 1980 to over 50 percent by 1995.52

113. The second panel of Figure III-9 (and columns 2-4 of Table III-3) shows the returns to labor market experience. Since experience enters the wage regressions as a quadratic, the marginal return to an additional year of experience needs to be evaluated at particular levels of experience. The returns to experience are shown here at 5, 15 and 25 years of experience. As in other industrial countries, the marginal returns to experience tend to be lower at higher levels of experience. The interesting finding again is that, compared to other industrial countries for which good estimates from micro data are available, experience premia are lower in Germany at all experience levels. For the United States, for instance, Buchinsky (1994) reports average returns to experience of about 5 percent and 3 percent when evaluated at 5 and 15 years of experience, respectively. Returns to experience appear to have been lower but also relatively more stable in Germany over the last 15 years.

114. How have skill prices changed at different parts of the wage distribution? The OLS regressions provided estimates of the marginal returns to human capital attributes at the conditional mean of the data. One would also like to know how these premia have evolved at other parts of the distribution. The answer to this question could have important analytical as well as policy implications.

115. Quantile regressions can be used to provide a parsimonious characterization of the entire conditional wage distribution. This technique can be used to estimate the marginal return to a human capital variable at any specific quantile point of the aggregate distribution. A set of quantile wage regressions were estimated, keeping the independent variable and the dependent variables the same as in the OLS regressions discussed above.

116. Figure III-10 plots the estimated returns to education and experience at the 10th, 25th, 75th and 90th percentile points of the distribution. As in other industrial countries, the returns to education are higher at the upper quantiles of the distribution. Interestingly, the differences in returns to education between the lower and upper quantile points are quite small and appear to have decreased slightly over the sample. Thus, inequality both within and between educational groups appears to have fallen over time in Germany. The returns to experience at different quantile points are also clustered fairly close together for each set of experience levels examined here and appear quite stable over time.

Figure III-10.
Figure III-10.

Germany: Returns to Education and Experience at Different Quantile Points

Citation: IMF Staff Country Reports 1999, 130; 10.5089/9781451810417.002.A003

117. Tables III-4 and III-5 provide more detailed results on the returns to education and experience at different points of the wage distribution. As in other countries, the returns to education are higher at the upper quantiles of the distribution but the differences are not very large. For instance, in 1997, the marginal return to an additional year of education was 5.3 percent at the 0.10 quantile and 5.9 percent at the 0.90 quantile. More interestingly, the returns to education have remained relatively stable at the lower quantiles (4.7 percent at the 0.10 quantile in 1984) but have in fact declined markedly at the higher quantiles (from 7.9 percent at the 0.90 quantile in 1984).

Table III-4.

Returns to Education: Results from Quantile Regressions

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Notes: The results in this table are from quantile regressions of log hourly wages on a constant, years of education, experience and its square, a dummy for German citizenship, and interactions of this dummy with education, experience and squared experience. All coefficients were multiplied by 100. Robust standard errors, based on bootstrap sampling techniques, are reported in parentheses.

118. As one would expect, the returns to experience (Table III-5) are higher for recent labor market entrants (5 years of experience) compared to older workers at all quantile points. For younger workers, the marginal return to an additional year of experience is higher at the lower quantile points than at the upper quantiles of the wage distribution. For instance, for workers with 5 years of experience in 1997, the return to experience is 4.2 percent at the 0.10 quantile and 3 percent at the 0.90 quantile. There appears to be an increase across the board in returns to experience in 1985-86, which dissipates fairly quickly. Consistent with the aggregate results discussed earlier, returns to experience at all quantile points and at all levels of experience are slightly higher by 1997 than in 1990.

Table III-5.

Returns to Experience: Results from Quantile Regressions

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Notes: The results reported in this table are from quantile regressions of log hourly wages on a constant, years of education, experience and its square, a dummy for German citizenship, and interactions of this dummy with education, experience and squared experience. Since experience enters the specification as a quadratic, the returns to experience are evaluated at specific experience levels. All coefficients were the returns to experience are evaluated at specific experience levels. All coefficients were multiplied by 100, Robust standard errors, based on bootstrap sampling techniques, are reported in parentheses.

119. Although these results indicate some differences in the evolution of skill prices at different parts of the distribution, the overall picture is one of a relatively stable wage structure over the last 15 years, especially compared to the changes in wage structures that have been documented for other countries. For instance, Buchinsky (1994) estimates average returns to a year of education of about 7 percent in the early 1980s in the United States, rising to about 10 percent by the mid-1980s. He finds a much larger return to education at upper quantiles of the wage distribution than at the lower quantiles and also finds that this disparity has widened significantly during the 1970s and 1980s. This echoes JMP’s findings that both between- and within-group wage inequality have risen in the United States in recent decades.

Effects of changes in observed and unobserved prices and quantities

120. For a more complete description of the effects of changes in skill quantities and prices, a technique developed by JMP is employed in this section of the paper. The technique permits a decomposition of changes in inequality into the components attributable to changes in observed skill quantities, observed skill prices, and unobserved quantities and prices of skills. The main advantage of this framework, compared to a variance decomposition, is that it facilitates an analysis of how composition and price changes have affected the entire wage distribution rather than just a summary measure such as the variance.

Consider a wage regression of the form:

wit=Xitβt+uit(1)

where wit is the log wage, Xit is a vector of observed individual-specific characteristics, uit is the regression residual, and i and t are individual and time subscripts, respectively. The residual can be viewed as being comprised of two components: an individual’s percentile in the wage distribution, Θit, and the distribution function of the wage residuals, Ft(.). It follows that

uit=Ft1(θit|Xit)

where Ft1(.|Xit) is the inverse cumulative residual distribution for workers with characteristics Xit in year t. Defining β¯ to be the set of average prices for observed skill attributes and F¯(.|Xit) to be the average cumulative distribution, equation (2) can be rewritten as follows:

wit=Xitβ¯+Xit(βtβ¯)+F¯1(θit|Xit)+[Ft1(θit|Xit)F¯1(θit|Xit)](3)

Using this formulation, it is straightforward to construct conditional wage distributions that allow one component to vary while keeping the other components fixed. For instance, with fixed observable prices and a fixed residual distribution, equation (3) collapses to:

wit=Xitβ¯+F¯1(θit|Xit)(4)

It is then possible to construct wage distributions where the changes over time are attributable solely to changes in observable quantities. Similarly, holding the other components fixed in turn, one can construct wage distributions where the changes in the distributions over time are attributable to changes in observed prices and to changes in unobserved prices and quantities (i.e., the residual), respectively.

121. Table III-6 reports results from this decomposition to examine the changes in wage inequality, based on various percentile differentials, that can be attributed to these three components. The main story here is that most of the changes in inequality appear to be attributable to changes in the residual, reflecting changes in unobserved prices and quantities, rather than to changes in observed quantities or prices. In other words, changes in within-group inequality appear to dominate the changes in overall inequality, with changes in the distribution of skills and in the relative prices of skill attributes playing only a small role.

Table III-6.

Decomposition of Inequality Changes into Components Attributable to Observed and Unobserved Quantity and Price Changes

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Notes: The numbers reported above are 3-year averages centered on the years shown.

122. Interestingly, the relative importance of changes in the residual distribution for changes in overall inequality is similar above and below the median in the 1985-89 and 1992-96 periods, respectively. By contrast, during 1989-92, changes in unobserved quantities and prices result in a continued compression (relative to the 1980s) above the median but not below. This probably reflect the effects of German unification. Even though the influx of workers into west Germany included workers with relatively high formal educational attainment, the qualifications of these workers may have been valued relatively less in the west German labor market compared to equivalent qualifications obtained in west Germany. Further, it is likely that these workers were viewed as having less favorable work habits (and other unobserved attributes).

123. During 1992-96, the wage compression that occurred over the previous decade was largely reversed, with changes in within-group inequality accounting for much of the increase in overall inequality. This increase was spread in a relatively equal manner above and below the median. In none of the sub-periods examined here do changes in the prices of observed skill attributes affect overall inequality significantly, confirming the earlier results about the stability of skill prices.

The sectoral wage structure

124. Having examined the wage structure based on skill attributes, it is also useful to examine the sectoral wage structure for hints about the determinants of overall labor market outcomes. The top two panels of Figure III-1 1 plot median real wages in eight broadly defined sectors of the economy (workers in the primary sectors—agriculture, forestry, fishing and mining—are excluded).

125. The figures show a tight clustering of median hourly real wages in six of the eight sectors. However, wages in the trade and miscellaneous services sectors are much lower than in the other sectors.53 Note that these are the two sectors where job growth has been relatively strong during the recent cyclical recovery that began in 1993.

126. The lower panels of Figure III-11 plot sectoral real wage developments relative to 1993, the year of the most recent cyclical trough. Manufacturing and construction, two sectors where the union density is relatively high, show relatively robust wage growth. Interestingly, the strongest wage growth during this recovery has been in miscellaneous services where, as noted earlier, job growth has also been strong. This indicates an outward shift in this sector’s demand for labor and suggests that the secular shift in the employment share of this sector has strengthened since 1993.

Figure III-11.
Figure III-11.

Germany: The Sectoral Wage Structure

Citation: IMF Staff Country Reports 1999, 130; 10.5089/9781451810417.002.A003

127. An interesting question arises at this juncture: how much of the change in relative wages across sectors is attributable to composition effects? In other words, how much of the changes in the sectoral wage structure can be attributed to differences in the average level of human capital of workers in each sector, which could of course change over time. One informal way to address this question is to ask how much a worker with a particular set of observed characteristics would earn in different industries. To get a handle on this, annual wage equations were estimated including workers’ human capital attributes and also including industry dummies and dummies for firm size. Based on these estimates, predicted real wages in each industry were then generated using annual sample means of each of the worker characteristics.

128. The results, shown in Figure III-12, indicate that predicted real wages tend to be quite similar across sectors and have evolved in a similar pattern over the sample. What this implies, for instance, is that workers in the miscellaneous services sector tend to be relatively poorly paid largely because they have much lower relative skill levels.54 Thus, this sector appears to have been an important source of employment for unskilled workers; job growth in this sector may have been important in moderating the increases in unemployment among unskilled workers during the 1990s.

Figure III-12.
Figure III-12.

Germany: Predicted Mean Hourly Wage by Sector

Citation: IMF Staff Country Reports 1999, 130; 10.5089/9781451810417.002.A003

The structure of earnings

129. The discussion thus far has focused on the distribution of hourly wages. The cross-sectional dispersion of hourly wages could differ from monthly (or annual) earnings, depending on the covariance between monthly hours and the hourly wage. For instance, it is possible that high-wage workers tend to work (and get paid for) more hours per month than low-wage workers. This would imply that wage inequality is a downward-biased measure of earnings inequality.55 Further, measurement error in the hours variable is a potential problem, especially for salaried workers. Thus, although the hourly wage is indeed the appropriate variable for measuring skill prices, it is nevertheless useful to examine the evolution of earnings inequality as well.

130. Figure III-13 shows cumulative changes in earnings at different percentiles of the wage distribution. Unlike the marginal decline in wage inequality, there appears to have been a slight increase in earnings inequality over the period 1984-97, with much of this increase occurring after 1992. However, the basic picture of stability in the wage structure is reinforced by the stability of the earnings structure.56 This result also indicates that measurement error in the weekly hours variable used to construct the hourly wage measure is unlikely to have affected the earlier results significantly.

Figure III-13.
Figure III-13.

Germany: Changes in Log Monthly Earnings Across Distribution

Citation: IMF Staff Country Reports 1999, 130; 10.5089/9781451810417.002.A003

131. A variance decomposition of earnings inequality indicated that the variances of hourly wages and monthly earnings look quite similar, while the variance of hours worked is roughly offset by the covariance component. The data reveal a slightly negative cross-sectional covariance between hourly wages and hours worked in the 1980s, although the covariance component drifts towards zero by the end of the sample.

C. The Role of Market Forces in the Stability of the German Wage Structure

132. The empirical results in the previous section have clearly demonstrated the stability of the German wage structure over the last 15 years. This section explores a number of possible explanations for this remarkable stability of the German wage structure during a period when all major industrial economies appear to have been going through massive shifts in the relative demand for skills resulting from skill-biased technological change, increased openness to external trade, and shifts in employment and output shares from manufacturing towards services (de-industrialization). In what follows, particular attention is given to the roles of market factors, including the effects of shifts in relative supplies of skilled and unskilled workers and in the sectoral composition of employment. Certain unique features of the GSOEP dataset are also exploited to examine the possibility that measurement issues could affect the patterns of wage variation described in this paper.

Relative supply shifts

133. Changes in wage inequality that are attributable to changes in skill prices can be analyzed in terms of a supply and demand framework for different skill attributes. For instance, Katz and Murphy (1992) note that, despite an increase in the relative demand for skilled workers, wage inequality did not increase substantially in the United States in the 1970s since the relative supply of workers with high education levels rose substantially and offset much of the shift in demand. Despite continuing increases in the relative supply of highly educated workers, however, enormous shifts in the relative demand for skilled labor in the 1980s swamped the changes in supply and resulted in sharp increases in observed skill premia.

134. Is there evidence that shifts in relative skill supplies may have resulted in the stable wage structure observed in Germany? Again, note the maintained hypothesis here that, as in other industrial countries, Germany has experienced shifts in the relative demand for skilled labor in recent decades.

135. Average education levels in Germany have indeed been rising over the last two decades and the relative supply of college graduates, in particular, has increased significantly. In the GSOEP sample used here, for instance, the cross-sectional average of the education variable increases from 11.0 years in 1984 to 11.8 years by 1997 and the proportion of college-educated graduates (>= 16 years of education) rises from about 8 percent in the mid-1980s to about 11 percent by the mid-1990s. Could this supply effect explain the slight decline in the returns to education in the 1980s and the stable returns in the 1990s? A cross-country perspective suggests an answer in the negative. The relative supply of more educated and, especially, college-educated workers has been rising at roughly similar rates in most other major industrial countries as well.

136. Although cross-country comparisons of educational levels are notoriously difficult, ostensibly comparable data from the OECD Education Statistics are used to obtain some suggestive evidence.57 The tabulation below shows the ratio of (a) graduates of higher education (university and non-university) to the total of (a) plus (b) graduates of upper secondary education (general and vocational/technical) in the population. Although the increase in this ratio over the period 1985-97 was 5.4 percentage points in Germany compared to 3.8 percentage points in the United States, this difference seems hardly sufficient to explain the huge disparities in the evolutions of premia for higher education in these two countries. Examinations of other such ratios revealed a very similar picture.

Ratio of Workers with High Relative to Medium Levels of Education

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137. A more direct approach, following Gottschalk and Joyce (1998) is to examine labor market quantities, i.e. unemployment and employment of workers of different skill levels. If there were indeed relative shifts in the supplies of workers with different skill levels, this would be reflected in quantities rather than just prices. The first panel of Figure III-14 plots unemployment rates for workers with different skill levels.58 Clearly, unemployment rates for workers of different skill levels in west Germany have diverged markedly during the 1980s and 1990s. More strikingly, unemployment rates for unskilled workers have risen sharply during the 1990s while the increases in unemployment rates have been much smaller for medium-skilled workers and have in fact fallen for highly skilled workers during the recent cyclical recovery that began around 1993.

Figure III-14.
Figure III-14.

Germany: Unemployment Rates and Employment by Skill Level

Citation: IMF Staff Country Reports 1999, 130; 10.5089/9781451810417.002.A003

138. One cautionary note about interpreting these unemployment rates is that they could reflect the effects of German unification. From the west German perspective, unification was essentially a labor supply shock that was accentuated in the lower portions of the skill distribution and that may have resulted in the observed increases in unemployment rates for low-skill workers. However, in conjunction with the earlier results on the stability of skill premia, this outcome is precisely what one would expect if a rigid wage structure prevented labor market adjustment through the adjustment of relative prices.

139. Even stronger evidence for this interpretation comes an examination of employment levels. As shown in the second panel of Figure III-14, employment levels for workers of different skill levels in west Germany have diverged steadily since the mid-1970s During the 1990s, employment levels of high skill workers have risen sharply even as employment for unskilled workers has actually declined.59 This evidence is difficult to reconcile with a story that relies on changes in the supplies of different skill categories to explain the stability of the wage structure as an equilibrium outcome.

140. In short, there is little evidence that shifts in relative supplies of workers with different skill levels can explain observed relative wage developments. Furthermore, the evolutions of relative unemployment rates and employment levels is strongly suggestive of the notion that, in the presence of institutional constraints that inhibit relative price adjustment, relative shifts in the demand for skills have resulted in quantity adjustments.

Shifts in sectoral employment

141. As in other industrial economies, in recent decades there has been a secular decline in the employment share of manufacturing and a corresponding increase in the employment share of the service sector in Germany. This and other cyclical shifts in sectoral employment could influence the overall wage structure since average wages and the dispersion of wages are likely to be quite different across sectors. These two channels through which changes in the structure of sectoral employment could affect the wage structure are also likely to be influenced by the effects of changing skill compositions of the workforce in these sectors.

142. One way to analyze the effects of sectoral shifts on the wage structure is to use a simple variance decomposition. The total variance of wages in a year can be decomposed into within- and between-industry components as follows:

σt2=Σtsjtσjt2+Σjsjt(wjtw¯t)2(5)

where σt2 is the cross-sectional variance of log hourly wages, sjt is the employment share of sector j, σjt2 is the within-industry variance of wages, w jt is the mean sectoral wage, w¯t is the mean wage in the sample and the subscript t is a time index. Using this formula, the change in variance over time can be decomposed into changes attributable to within- and between-industry variance as well as composition effects within and between industries. The results of this decomposition are shown in Table III-7. 60

Table III-7.

Effects of Sectoral Shifts on Changes in Wage Inequality

(Variance Decomposition)

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Notes: Workers are classified into ten broadly defined sectors (agriculture, forestry and fishing; manufacturing; construction; trade; transport and communications; finance and insurance; business and personal services; other basic services; public administration). See text for details of the decomposition technique.

143. The total decline of 0.086 in overall wage variance from 1984 to 1997 is largely attributable to the decline in variance over the period 1989 to 1992, partly offset by a slight increase in the variance from 1992 through 1997. The key result from this table is that virtually all of the developments in overall wage variance are attributable to changes in wage variation within industries, rather than between-industry wage variation. Composition effects, both within and between industries, account for only a small fraction of the changes in wage variation after 1989.

144. Thus, recent shifts in sectoral employment do not seem to have played much of a role in influencing patterns of overall wage dispersion. Within-industry wage variation appears to dominate overall wage variation and both appear to have evolved in a smaller pattern.

Cohort effects

145. The cross-sectional measures of inequality analyzed in this paper could be affected by changes over time in the observed and unobserved attributes of cohorts that enter the labor market at different periods. For instance, changes in inequality could be dampened by the increasing equalization of educational opportunities for workers in cohorts that have recently entered the labor force. Further, inequality changes over time within cohorts (as employers gain more information about workers based on job histories) could influence measures of overall inequality, especially if relative cohort sizes change over time.

146. It is difficult to disentangle cohort, experience and time effects. Nevertheless, by examining changes in inequality over time for different cohorts and different experience groups, it is possible to get an indication of whether cohort and age effects are important for understanding the evolution of overall wage inequality.

147. For this part of the analysis, synthetic cohort groups were constructed based on the imputed year of market entry for each worker, Table III-8 shows 3-year averages of the 90-10 and 75-25 percentile differentials for each cohort for the years 1986, 1991 and 1996. These results should be interpreted with caution since the samples are relatively small (typical cell size: 250-400; minimum cell size: 100). Although there are some small changes over time in inequality within cohorts, there is little evidence that these changes, or the differences in inequality across cohorts, are an important factor in explaining the apparent stability of the wage structure.

Table III-8.

Wage Inequality Across Cohorts and Experience Groups

article image
Notes: The percentile differentials reported above are 3-year averages centered on years shown.

148. Note that the evolution of inequality within specific (synthetic) experience groups can be tracked by reading diagonally across this table. For instance, the experience group corresponding to the 1972-76 entry cohort has a 90-10 differential of 0.83 in 1986, 0.78 in 1991 and 0.83 in 1996. Within experience groups, there is a pattern of a small dip in the 90-10 differential in 1991, followed by an uptick in 1996. This is consistent with the pattern detected earlier of marginal wage compression in the 1980s, followed by a slight widening of wage dispersion after 1992.

149. The main conclusion from Table III-8 is that changes in inequality within age and cohort groups largely reflect the patterns of overall wage variation. In other words, time effects appear to be more important than age or cohort effects per se in explaining changes in the wage structure.

Supplementary earnings

150. Various forms of monetary compensation other than basic wages and salaries constitute an important element of compensation packages in Germany. These include 13th and 14th month salaries; Christmas and vacation bonuses; and profit-sharing and gratuities. These are usually provided as lump-sum payments once a year. Such payments could play an important role in differentiating total compensation across workers of different skill levels but would not be picked up in data on monthly wages and salaries.

151. The GSOEP does not provide data on these elements of compensation for the year of the survey. Starting in 1990, however, individuals were asked about the gross amounts of different categories of nonstandard compensation that they received in the previous year. Using these data, for each individual a wage adjustment factor was constructed based on supplementary earnings using the following formula:

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152. The adjustment factor turns out to be quantitatively quite important. Its distribution over the period 1990-97, shown in the tabulation below, indicates that the median supplementary income amounted to about 8.3 percent of the basic wage. There was no discernible trend over time in this adjustment factor. However, regressions of this factor on skill attributes did indicate a statistically significant positive relationship between the size of this factor and skill level, suggesting that total compensation could be more differentiated than basic wages.

Distribution of Adjustment Factor for Supplementary Income, 1990-97

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153. For each worker for whom the relevant data were available, a new wage variable was constructed, where the current year wage was multiplied by (one plus) this adjustment factor. OLS estimates of the returns to experience and education are indeed higher using (logarithms of) this wage measure compared to the estimates based on the basic wage but, as shown in Figure III-15, the differences are quite small in economic terms. More important, the time profiles of the returns to skill attributes are not altered when the adjusted wage variable is used. Plots of wage changes at different percentiles over the period 1990-97 (not shown here) were also essentially unaffected by the use of this alternative wage measure.61

Figure III-15.
Figure III-15.

Germany: Returns to Education and Experience, Supplementary Earnings

Citation: IMF Staff Country Reports 1999, 130; 10.5089/9781451810417.002.A003

154. Thus, although there is some evidence that total compensation is more differentiated by skill level than basic wages, the differences are not quantitatively very large. Moreover, over the period 1990-97, the structure of total compensation appears to be essentially as stable as the structure of basic wages.

Selection effects

155. Finally, the sensitivity of the results to sample selection bias is examined. The basic idea here is that, since wages are observed only for those workers who are actually employed, there could be systematic differences in unobserved characteristics of employed versus nonemployed workers (unobserved by the econometrician, that is). In other words, the observed wage distribution may be a biased measure of the offer wage distribution. Further, the magnitude of selection bias could vary systematically across skill levels, thereby biasing estimated wage differentials across skill levels.62

156. Although sample selection effects are likely to be less important for men than for women, selection-corrected wage equations were estimated for the sample of males.63 To conserve space, the results are only summarized briefly here; detailed results are available from the author. The selection-corrected coefficient estimates for the education and experience variables were virtually identical to those from the basic OLS regressions. The only interesting difference was that, during the 1990s, the estimated education premia declined marginally more than in the OLS regressions. This might reflect the fact that older workers were more likely than younger workers to be laid off during the 1990s (as revealed by relative increases in unemployment rates among older workers). Older workers typically tend to have lower education levels and, therefore, estimates that account for negative selection effects for such workers indicate a smaller education premium. The basic story of stable skill premia is thus confirmed by these results.

Interpretation

157. The results presented in this section provide fairly strong evidence that the stability of the German wage structure is attributable to constraints imposed by institutional forces rather than to market factors. As discussed earlier, the wage bargaining system and the role of unions have resulted in an inflexible wage structure that does not allow prices for skills to respond to shifts in the demand for and supply of different skills.

158. Some authors have argued that the relatively narrow dispersion of wages is attributable to the tighter distribution of skills in Germany compared to countries like the United Kingdom or the United States. The German wage structure is also sometimes viewed as providing the right incentives for firms to provide optimal levels of training to their low-skill workers (see, e.g., Acemoglu and Pischke, 1999). Nevertheless, the rigidity of the wage structure during a period of massive shifts in demand towards the upper end of the skill distribution has had obvious deleterious consequences, as evident from the rising nonemployment rates and declining employment levels for unskilled workers. It should also be borne in mind that the central argument in this paper is based not so much on the levels of wage differentials as it is on the inability of the wage structure to adjust to demand shifts over time.

159. The observed price and quantity outcomes are also consistent with explanations put forward by authors such as Blanchard (1998) who have argued that institutional rigidities in continental European countries have resulted in the substitution of capital for labor following adverse macroeconomic shocks and, consequently, rising unemployment rates. In Germany, overall labor costs appear to be less of a problem than that of rigid wage differentials. Given the evidence of capital-skill complementarity (see Keane and Prasad, 1996, and references therein), stylized facts for Germany such as the falling aggregate wage share, rising employment levels for skilled workers and declining employment prospects for unskilled workers in the 1990s are all perfectly consistent with the substitution of capital for unskilled labor.

160. It is worth emphasizing at this juncture that this paper should not be construed as making the argument that rising wage inequality is a sign of or prerequisite for labor market flexibility. Wage inequality is viewed here more as an outcome of shifts in the demand for and supply of different skill attributes.64 The point is simply that, if skill prices are not allowed to adjust to these shifts, quantities will have to adjust instead. It should also be noted that this paper has little to say about broader concepts of income inequality or about the overall welfare effects of changes in wage inequality.

D. Reservation Wages and Labor Supply

161. This section of the paper turns to a brief examination of issues related to labor supply. Although a careful analysis of the determinants of labor supply for workers of different skill levels is beyond the scope of this paper, the GSOEP provides some interesting data related to this issue. In the years 1994 and 1996-97, survey respondents who reported being unemployed and who reported having looked for a job in the three months before the survey were asked what net monthly earnings they would have to be offered in order to accept a job. In other words, what was their reservation wage? The answers to this question have potentially important implications for policies designed to influence labor supply.

162. A careful analysis of the determinants of reservation wages would require examining a large set of covariates that could influence the reservation wage, including manner of job separation (quit or layoff), length of unemployment spell, alternative sources of income, presence of other employed persons in the household, industry of last job etc.

163. Nevertheless, a simple but illuminating experiment can be used to cast some light on issues related to labor supply disincentives. Using estimates from annual OLS wage equations for net monthly earnings, for each unemployed worker reporting a reservation wage, a predicted “offer wage” was generated conditional on his (or her) level of education and labor market experience.65 A scatter plot is then constructed showing each worker’s predicted real offer wage and the difference between the real reservation wage and this predicted real offer wage for the years 1994 and 1996-97 (using the west German CPI as the price deflator, 1997=100).

164. The scatter plot (Figure III-16, top left panel) is striking. There appears to be a clear negative relationship between offer wages, which could be interpreted as a market-based measure of skill levels, and the differential between reservation and offer wages. The vertical line in the figure shows the median net monthly earnings among all employed workers, averaged over the years 1994 and 1996-97. Unemployed workers with low levels of human capital appear to be willing to work only for a wage higher than the wage that the market is prepared to pay them. Unemployed workers with higher skill levels, on the other hand, appear to desire employment strongly enough that they are willing to accept a lower wage than that typically paid to workers with similar skill attributes. The pattern is similar when the sample is restricted to unemployed workers actively engaged in job search (Figure III-16, top right panel)66

Figure III-16.
Figure III-16.

Germany: Reservation and Offer Wages, 1994, 1996-97

Citation: IMF Staff Country Reports 1999, 130; 10.5089/9781451810417.002.A003

165. Why do unskilled workers have such high reservation wages relative to their earnings potential? One possibility is that social transfers to the unemployed—including unemployment benefits, unemployment assistance, and social benefits—are sufficiently generous that, at the margin, low-skill workers have less of an incentive to accept low-paying jobs. To shed further light on this issue, a similar plot as that described above was constructed using the data for 1997 but breaking the sample into those reporting that they were receiving unemployment benefits or unemployment assistance at the time of the survey and those that were not (Figure III-16, lower panels). Interestingly, the result noted above comes through clearly even among workers who report receiving no unemployment benefits or unemployment assistance. This suggests that, for workers with low levels of skill attributes, high reservation wages could result not just from the generosity of unemployment benefits but from other factors including the generosity of other components of social transfers and the high effective marginal tax rates they face when moving from social support to low-wage employment.

E. Policy Implications

166. This paper has produced two main empirical results. One is that the German wage structure has been quite stable over the last 15 years; this stability may in large part be attributable to institutional factors, including the wage bargaining system, rather than market forces. The second result, a more tentative one, is that the social transfer system appears to reduce the incentives for low-skilled workers to seek and accept employment. How are these results to be interpreted and, by extension, what are their policy implications?

167. As evidenced by patterns of employment growth and evolutions of unemployment rates during the recent cyclical recovery, unskilled workers essentially appear to have been priced out of their jobs because of the inflexible wage structure that has not accommodated shifts in demand at different parts of the skill distribution. Further, skill price rigidities appear to have encouraged capital-labor substitution, with detrimental effects on the employment probabilities of unskilled workers. Thus, the corporatist approach to wage bargaining, that served Germany well in earlier decades, appears not to be as benign under current circumstances. Further, pursuing distributional objectives through the labor market, rather than through the tax and transfer system, appears to result in overall efficiency losses via lower aggregate employment levels and consequent increases in the burden on social safety nets and the pension system.

168. But can the problem of high unemployment among unskilled and low-skill workers be solved by measures to influence labor demand alone? The second set of results in this paper suggests otherwise. Unemployed workers with low skill attributes appear reluctant to accept jobs even at the existing offer wage levels. Their high reservation wages could be linked to the generosity of social transfers as well as the disincentive effects of high effective marginal tax rates at low income levels, both of which are problems that have been noted by observers of German labor markets. Hence, to spur employment growth for these workers, it would appear necessary to make changes to the social benefit and tax systems in order to induce a positive labor supply response.

169. In the transition to such durable reforms, short-term measures such as employment subsidies might have a role to play, although their effectiveness is likely to be limited (see Chapter IV of this paper). Active labor market policies could also play a useful role. In this respect, Germany does quite well. For instance, apprenticeship schemes and other policies for facilitating school-to-work transitions for younger workers have resulted in youth unemployment rates that are far lower than in most other European countries. Good training and re-training programs also abound in Germany. There might, however, be some scope for improving employment intermediation mechanisms.

170. In summary, a mutually reinforcing set of institutional reforms that influence both labor demand and labor supply appear essential to cure the problem of nonemployment among low-skilled workers.

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43

Prepared by Eswar Prasad, Research Department. A substantially revised and extended version of this chapter will be published as an IMF Working Paper.

44

See van der Willigen (1995) for a description of the wage bargaining structure and Chapter I of this paper for a discussion of how it may have been well suited to the Wirtschaftswunder era of the 1960s and 1970s.

45

See Chapter I for a description of the possible mechanics of this interaction.

46

Part-time workers and apprentices account for a relatively small fraction of the sample and including them did not have much affect on any of the results discussed below. Results for the sample including part-time workers and apprentices are available from the author. An analysis of wage growth in east Germany following unification constitutes an interesting topic in its own right (see Hunt, 1999b).

47

As noted by Hunt (1999a), using the sum of the contracted weekly hours and overtime hours variables is problematic. This sum would not capture “under-time” since only positive overtime hours are reported in the survey.

48

DeNew (1996, pp. 110-111) has an extensive discussion of the mapping between educational attainment and years of schooling for this dataset and notes that, regardless of the mapping used, when estimating wage equations “…the differences are typically minor, and the results for education and experience remain very robust.”

49

Restricting the sample to German citizens made no difference to these results.

50

Log hourly real wages were regressed separately for each year on a constant, education, experience and its squared, a dummy for German citizenship and interactions of this dummy with education, experience and squared experience.

51

The inclusion of higher order polynomials of experience did not change any of the results.

52

As noted earlier, the levels of these premia must be interpreted with caution since the education variable might have different connotations in different countries.

53

Trade includes retail and wholesale trade. Miscellaneous services comprise what are typically thought of as low-end services, including restaurants and hotels, trash removal and other basic services.

54

A cautionary note is in order here. Even in the United States, as shown by Krueger and Summers (1988), inter-industry wage differentials tend to be significant despite controlling for observed (and even some unobserved) worker attributes. This could account for some but probably not much of the differential between median wages in the miscellaneous services sector and most other sectors.

55

Further, the dispersion of annual earnings could differ from that of monthly earnings. However, the GSOEP data set does not contain a variable indicating the number of months that a worker is employed during the survey year.

56

Steiner and Wagner (1998) also find little change in earnings inequality during the 1980s.

57

Source: OECD Education Statistics, 1985-92, Table IV-3.

58

These data, which are limited to west Germany, are taken from Reinberg and Rauch (1999) and are based on the Mikrozensus, a comprehensive survey of the German labor force. The raw data from this survey are not publicly available.

59

Using the GSOEP data, annual probit employment equations were estimated for men (extending the sample to include men without a job). The estimated coefficients confirm the sharp increase in the employment probabilities of workers with higher levels of education during the 1990s.

60

These results are based on a classification that corresponds roughly to the 1-digit SITC sectoral classification; this coarse classification is intended to capture the effects of shifts in employment from manufacturing to services. Using the full set of GSOEP industry codes, which would be similar to using a 2-digit classification, revealed quite similar results.

61

The results reported in this paragraph, including the comparisons of skill premia with and without supplementary earnings, are limited to those observations for which the data needed for constructing the adjustment factor are available. This amounts to about 90 percent of the sample for the years 1990-97.

62

For an explanation of the selection bias problem, see Heckman’s (1979) classic paper. Keane and Prasad (1996) provide an example of the importance of accounting for selection bias in estimating skill differentials.

63

The selection model involves two equations: (i) the basic OLS wage equation and (ii) a probit employment choice equation. The employment choice equation includes the right hand side variables in equation (i) and a set of additional variables that could influence self-selection into employment but would not be expected to affect the wage. This set of additional variables included dummies for marital status, presence of kids, status as head of household and geographic regions. The parameters of equations (i) and (ii) were jointly estimated by full information maximum likelihood techniques.

64

The Netherlands, for instance, appears to have attained much better labor market outcomes, with little increase in wage inequality. This appears to be attributable to recent labor market reforms that have greatly increased the relative supply of skilled workers, particularly by fostering higher labor force participation rates among educated women.

65

The sample in this part of the analysis includes both men and women, A gender dummy and its interactions with other independent variables was included in the wage regressions used to generate the predicted offer wage. The coefficient estimate on this dummy variable was then used to adjust the offer wage for gender effects.

66

The estimated wage equations explain only about 35 percent of the variation in wages across workers. Thus, unobserved attributes (not observed by the econometrician) clearly play a significant role in wage determination. However, since unobserved attributes would be expected to be lower among the unemployed than among the employed, this bias would probably actually strengthen the result described here. That is, unemployed workers, particularly the less-skilled ones, would be likely to have inferior unobserved attributes compared to employed workers and should therefore expect to earn even less than would be indicated by the wage equation estimates.

Germany: Selected Issues and Statistical Appendix
Author: International Monetary Fund