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Reevaluating the German labor market miracle

  • Michael C. Burda ORCID logo EMAIL logo and Stefanie Seele
From the journal German Economic Review


From 2003 to 2018, employment in Germany increased by 7.3 million, or by 19.3 % – growth not observed since unification. This “labor market miracle” was marked by a persistent and significant expansion of both part-time and low-wage jobs and a deterioration in pay for these jobs, while total hours hardly increased; overall wage growth returned only after 2011. These developments followed in the wake of the landmark Hartz reforms (2003–2005). A modified framework of Katz and Murphy (1992) predicts negative correlation of wages with both relative employment and participation across cells in the period following these reforms. In contrast, wage moderation alone should generate positive association of wages and participation. Our findings are most consistent with a persistent, positive labor supply shock at given working-age population in a cleared labor market. An alternative perspective of labor markets, the search and matching model, also points to the Hartz IV reforms as the central driver of the German labor market miracle.

JEL Classification: E24; J21

Article note

This paper updates and extends Burda and Seele (2016).

Funding statement: This research was supported by Collaborative Research Center (SFB) 649 and the Forschungsschwerpunkt 1764 of the German Science Foundation (DFG). Disclaimer: neither author has received financial or other compensation for this research, nor does it necessarily represent the position of the VDMA or the INSM.


We are grateful to Michael Böhm, Bernd Fitzenberger, Albrecht Glitz, Maarten Goos, Amanda Gosling, Juan Jimeno, Tom Krebs, Andrey Launov, Christian Merkl, Thomas Steger and anonymous referees for helpful comments and to Tobias Bergmann, Thomas Dengler, Niklas Flamang, and Tobias König for capable research assistance.

Appendix A Decomposition of total hours into full-time and part-time hours: A shift-share approach

Hours worked H are decomposed into full-time F and part-time P hours as follows:

where the LF and LP are workers employed at full and part-time, respectively. Take first differences of H and rewrite:
So we have


The change in total hours over the interval is decomposed into 1) the change in full-time workers weighted by the average hours worked by a full-time worker in period t; 2) the change in the hours per full-time worker, weighted by the number of full-time workers in t1; 3) the change in part-time workers weighted by the average hours worked by a part-time worker in period t; 4) the change in hours per part-time worker, weighted by the number of part-time workers in t1.

Appendix B Data description

B.1 German wages: Imputed hourly wages from SIAB and GSOEP

Previous studies analyzed hourly wages for Germany by using the earnings surveys, the micro census (both provided by the Federal Statistical Office), or, more commonly, the German Socio-Economic Panel (GSOEP). Unfortunately, at the individual-level, neither the quarterly earnings survey, nor the micro census are freely available for research. Social security records, namely the Sample of Integrated Labour Market Biographies (SIAB), contains an imputed daily wage at the individual level, but lacks information about working hours. The GSOEP is used frequently because it is freely accessible for research and it contains information about monthly wages and hours worked per week.

In both micro data sets, all socially insured employees in full-time or part-time work are grouped by the following categories: age groups, gender, place of residence, and qualification. In addition to the previously described differences in the two surveys, variables such as employment status, qualification or wage have different definitions. To aggregate both micro data sets in groups is meaningful only, if these aggregates are conditional on corresponding characteristics in both data sources.

The conceptual discrepancy, i. e. definitions of variables and respondents of the two data sources, lead to differences in the wage measures in levels and its growth rates.[21] However the two wage measures are highly correlated in levels as well as growth rates. An hourly wage measure is imputed in a synthetic panel based in group means of working hours from the GSOEP and median gross daily wages from the SIAB. The synthetic panel fills a lack in limited availability of hourly wage information for socially insured employees of all firm sizes.

B.2 Construction of relative wages and relative employment

The relative wage is defined as:


which is weighted by the relative employment γit=Lit/i=1NLit. The relative, weighted employment is defined as:


with average relative weighted wage of group i: ω¯i=t=1Tωit/T. For the description of relative participation, see Section 4.3 footnote 14.

Appendix C Generalization of Katz-Murphy (1992) to endogenous labor supply, market clearing and rigid wage cases

C.1 Marshall: Market clearing

The model can be extended in a straightforward way to include endogenous labor supply with an analogue of Equation (5). Let labor supply be LS=S(W,Z) and assume that it is “everywhere upward-sloping” in the sense that Z contains the marginal utility of wealth (the Lagrange multiplier from the canonical labor supply problem), and that SW contains only substitution effects. Market clearing dLS=dLD=dL implies

It follows that


and for the case of stable demand (dX=0)


which is a quadratic form in the k×1 vector DWSW1SZdZ. The fact that DW is negative definite plus dX=0 imply that dWdL<0.

C.2 Pigou: Introducing wage rigidity

The wage is a linear combination of market clearing and exogenous rigid wage dW:


where ϕ is a constant 0<ϕ<1 that controls the extent of wage rigidity in the economy. The change in the market-clearing wage W is the change in the Marshallian outcome, so after substitution


Because labor force participation equals labor supply, we have



The inner product dWdP is given by


This will form the basis of predictions regarding the correlation of wages and participation.

C.2.1 Case of wage rigidity shocks only dW0(dX=dZ=0)

If dW0 and dX=dZ=0 then


which is a quadratic form in the positive definite matrix SW; as wage rigidity disappears (ϕ0), dWdP approaches zero (since no other shocks are active by assumption). In the rigid wage case with wage shocks operative, relative wages and relative participation should covary positively. Note that this effect exists only as long as wage rigidity is relevant (ϕ>0).

C.2.2 Case of labor supply shocks only dZ0(dX=dW=0)

Suppose instead that shocks to wage rigidity are absent (dW=0) and labor demand is stable dX=0, but labor supply shocks are operative (dZ0). Then dP=SW(1ϕ)DWSW1+ISZdZ and dW=(1ϕ)DWSW1SZdZ, so

which is a quadratic form in DWϕSW, a negative definite matrix. Thus dWdP<0 unambiguously. If only labor supply shocks are operative, the correlation between wages and participation in the partially rigid wage case remains negative regardless of the degree of wage rigidity. As wage flexibility goes to zero ϕ1, dZ has no effect on the wage and the effect vanishes.

Appendix D Mortensen-Pissarides (1994; 1999) with a labor force participation margin

D.1 Basic structure and continuation values for labor force participants

The exposition follows Mortensen and Pissarides (1999) and Pissarides (2000) and omits well-established proofs. The mass of total working population is fixed at 1, and can be in one of three labor market states: unemployment (u), nonparticipation () and employment (e=1u). When out of the labor force, the worker receives monetary equivalent flow bε at each point in continuous time. Each worker in the labor force [0,1] has a valuation of nonparticipation described by a continuous cdf G(). b is the unemployment benefit paid to those searching for work (Arbeitslosengeld I), and ε measures the flow value of being outside of the labor force – leisure, value of education, social welfare (Arbeitslosengeld II), plus cost of active job search, all measured as a fraction of the unemployment benefit.

First, we study the sub-system conditional on labor force participation. In the steady state, the continuation valuations of the two possibilities for workers participating in the labor market (ILO definition) U and W are defined by functional equation

for employed workers, conditional on the current state of idiosyncratic productivity x[0,1], and


for unemployed workers. The prime (′) refers to the state in the next instant (after dt has transpired) conditional on a new draw of x (a shock actually having occurred). Similarly, for firms producing with a worker of productivity x

and for firms posting a vacancy:


The reservation level of productivity R is the level of the idiosyncratic productivity shock x below which mutually agreed dissolution of the match occurs; there are no involuntary separations in this model. Shocks occur in the interval (t,t+dt) with Poisson incidence rate λ and x is distributed according to a time-invariant c. d. f. F(z).

The participation constraint implies


The wage, which serves to divide the match surplus, is determined by Nash bargaining:


with first order condition


The solution for the (state contingent) wage w(x) is


which, given the reservation level of utility can be rewritten as


A free-entry condition for vacancy posting by firms:


Constant unemployment implies du=0:


which completes the model. The unemployment rate is u=s(1)s+θq(θ), where the separation rate s and nonparticipation are yet to be determined.

D.2 Modeling the participation margin

Following Pissarides (2000, Chapter 7), stock equilibrium between states of nonparticipation and unemployment is determined by indifference between participation and unemployment for the marginal worker with identity 0,1, there are no frictions between the two states.[22] While all workers value the state of unemployment at rU and receive identical income in nonparticipation (εb), each worker is heterogenous with respect to nonparticipation, described by a cumulative distribution function G(.), which also gives the worker’s unique identity on 0,1, with =0 having the highest, and =1 having the lowest (periodic) monetary valuation of nonparticipation. Aggregate equilibrium reflects indifference at the margin between participation and unemployment for the marginal worker, satisfying


The mass of nonparticipation is thus given by


Workers with low values of have the highest valuation of non-work time and are least likely to participate. Note that the right hand side is either parametric (b, β, c) or is endogenous and determined by free entry and zero profit condition on vacancies (θ).

We consider comparative-static changes in parameters b, β, and A; b describes the monetary periodic flow value to job searchers relative to ε. Because 0<ε<1, non-participation in equilibrium will be interior: 1>>0.

D.3 Equilibrium

In steady-state, W=W, U=U,J=J and V=V. The firm’s valuation equations for the two states plus the free entry/exit condition for vacancies V=0 imply J=cq(θ)=pwr+s; labor market tightness θ is fully determined by model parameters and the matching function according to

Note that inserting RU into JD leads to the JD curve:


and RU into LP leads to the LP curve.

D.4 Comparative statics

We seek expressions for the following derivatives of equilibrium reservation productivity R, labor market tightness θ, and labor force nonparticipation with respect to the “Hartz-parameters” matching efficiency A and income of searching unemployed b, as well as worker bargaining power β. Total differentiation of JD, JC and LP, eliminating rU using RU and substituting q(θ)=Ax(θ1,1), with dA,db,dβ0 and all other model parameters held constant, yields the following linearized system in dθ, dR, and d:

or in matrix form:


where the functions g and x are evaluated at steady state values. Defining


we can use Cramer’s Rule to derive the following comparative statics results:

confirming the graphical analysis in the main text.

Using the JC curve cq(θ)=(1β)1Rr+λp, the last expression can be rewritten as

Given that 1λ(1F(R))r+λ>0 and Δ<0, a necessary and sufficient condition for ddβ>0 is β>θ1x1x, or that worker bargaining power is strictly greater than the local elasticity of the vacancy posting rate (q) with respect to job tightness (θ) evaluated at the equilibrium.


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Published Online: 2020-03-06
Published in Print: 2020-06-26

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