European Economy. Economic Papers. Germany's growth performance in the 1990's

Figure 3.16: Real unit labour costs (index; 1982=100)
Source : AMECO
However, unit labour costs remain high in absolute terms. As a consequence, firms try to reduce
the labour share in output (basically, by substituting labour by capital). In very general terms,
shifts towards more capital-intensive production are relevant in large parts of the manufacturing
sector. Still, the aggregate growth of labour productivity, which should reflect enhanced capital-
intensity of production, was relatively low in Germany compared to other countries, such as
France or the UK (Table 3.17). This indicates that the phenomenon has not been specific to
Germany.
Table 3.17: Average yearly productivity growth (in %)
1982-1989
1994-2000
1982-2000
D
1.75
1.39
1.74
F
2.40
1.51
1.87
I
1.86
1.64
1.66
UK
2.44
1.73
2.05
Source: National Accounts
In the services sector, the option of substituting labour by capital is not always viable. Here,
labour cost are ultimately reflected in the (relative) price of the service provided. The high costs
have as a consequence that a service is not provided at all, or that households opt for doing the
work themselves. It is those services that are by definition labour-intensive and offer very
limited possibilities of productivity-enhancing investment where the employment gap to the US
as the service society par excellence is particularly wide. Penalising labour costs thus contribute
to the weakness of the low paid services segment. This also fits the anecdotal evidence that a
rather high share of this kind of services is provided through the shadow economy. To catch the
whole picture, however, restrictions stemming from market regulation and the demand side also
need to be taken into account. In fact, “cultural” explanations of low demand are quite popular.
For instance, Freeman/Schettkat (2000b) argue that Germans prefer to work shorter hours and
produce typical personal services for themselves, instead of working longer and paying for the
8 0
8 5
9 0
9 5
1 0 0
1 0 5
1 9 8 2
1 9 8 4
1 9 8 6
1 9 8 8
1 9 9 0
1 9 9 2
1 9 9 4
1 9 9 6
1 9 9 8
2 0 0 0
D _ W
D *
F
I
U K
* in d e x b a s e f o r " D " is 1 9 9 1 v a lu e o f " D _ W "

---

same product. After all, it is hard to disentangle the effects of consumer preference from those
of services’ high prices.
Income taxes and social security contributions add up to a high tax wedge in Germany (Table
3.18). It is the highest among the four largest Member States for single earners and double
income couples and in particular well above the tax wedge in the UK. Whereas the income tax
scheme is progressive, social security contributions (which are high in France, Italy and
Germany alike) are flat-rate and seem to counteract the tax progression (note that income tax is
already zero for low income, single earner couples). In competitive labour markets, in the long
run, additional labour tax burden will affect mainly the structure and less so the level of labour
costs. This is because with rather inelastic labour supply, the tax incidence falls almost
exclusively on employees. However, this might not be the case in the short to medium term, and
it does not hold true, if labour markets are non-competitive as it is the case in Germany. The
employees succeed in shifting part of the additional labour tax burden onto employers, with the
result of rising levels of unemployment (see, e.g. Daveri/Tabellini (1997)). Wage floors, in