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

B1.2 Competitiveness and the labour market
One of the main handicaps for growth and employment in East Germany has been the rise of
wages above increases in productivity. Wage convergence in collective agreements had the
consequence of high unit labour costs caused by wages that have been about 13% above
productivity on average since 1996 (Figure B1.3). In 2001, compensation per employee was
at 78% of the West German level, while output per employee was at 71% of that in the West.
This holds in spite of an average weekly working time of 38.9 hours in 1999, compared to
36.8 hours in West Germany. Among the reasons for the low labour productivity in the new
Länder are a low capital intensity due to different relative factor prices, a low utilisation rate

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20
Box 1 (continued)
of production capacities and the need for many East German firms to compete through lower
prices.
8
Figure B1.3: Compensation, productivity and unit labour costs in East Germany,
1991-2001 
(current prices, West Germany = 100)
Source: Arbeitskreis “Volkswirtschaftliche Gesamtrechnung der Länder”; own calculations
Wage developments in East Germany are the outcome of many forces, preventing wages from
developing in line with productivity. The initial situation of the German monetary union and
unification is crucial to understanding the process in the 1990s. While the 1:1 conversion rate
of the GDR Mark to the D-Mark is often said to have been the main problem, this does not
seem to be the case given that wages in the East were only about one third of those in the
West. At the time this corresponded largely to differences in productivity. More important
was the situation of wage bargaining in 1991 when wage convergence within five years was
agreed in many sectors. These negotiations were mainly led by employers’ associations and
trade unions from the West due to the fact that most East German firms were not yet
privatised by the 
Treuhandanstalt
and not sufficiently represented to raise the issue of
competitiveness. Whether this was done with the intention “to bind future East German firms
and to effectively prevent them from threatening their markets”
9
is arguable. However, three
factors have certainly contributed to this situation: first, the federal government’s initial
optimism on the time path of catching-up of East Germany (“flourishing landscapes”);
second, the objective of avoiding major out-migration from East Germany that was presumed
to take place if considerably lower wage prevailed for a longer time; and third, equity
considerations ( “equal pay for equal work”). These factors created an environment in which
rapid wage convergence was the most popular strategy to take. However, the five-year-
agreements on full wage convergence proved to be unfeasible and were basically abandoned
in 1993, but high rates of wage increases continued throughout the 1990s.
While one may conclude that unit labour costs have already fallen considerably towards the
end of the 1990s, it is to be recognised that a major share of the adjustment has taken place
through the reduction of employment and other channels. In manufacturing, which is the
sector that is most exposed to external competition, firms are forced to adjust immediately by
either closing down, increasing their capital-intensity (by higher investment and/or reduction
of employment), or by leaving employers’ associations, which allows them to pay wages
below those of industry-wide agreements between employers’ associations and trade unions.
8
Cf. Sachverständigenrat 2000, p.186f.
9
Sinn/Westermann 
2001, 
p.17.
49
62
69
73
75
76
76
76
77
77
78
35
48
59
64
65
67
68
68
68
69
71
141
128
116
113
116
113
112
113
113
113
110
0
20
40
60
80
100
120
140
160
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
compensation per em ployee
GDP/employment
nominal unit labour costs

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