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

3.2 The functioning of the labour market
3.2.1 Overview
An analysis of labour market inertia is an essential part of any attempt to explain Germany’s
slow growth in the 1990s. The growth scenarios presented in previous sub-sections suggest that
a lack of labour market dynamics - in particular in terms of employment growth - is the single
most important factor behind Germany’s anaemic output growth. However, the look at
aggregate data alone does not provide satisfactory insight into the mechanisms that underlie the
disappointing labour market performance. The purpose of the present section is to analyse the
underlying structural weaknesses of the labour market in order to close that gap. The discussion
of micro-evidence confirming shortcomings in specific labour market segments thus
complements the macro-oriented earlier sections.
The macroeconomic role of employment is dual by nature. As a production factor it affects the
supply side, as a source of private households’ income it affects demand. This section focuses
mostly on labour as a production factor and is organised as follows: The first sub-section
provides an overview of the employment situation and its development during the 1990s. As the
corollaries of employment, unemployment and labour market participation are also briefly
discussed. The second sub-section deals with wage formation. Given that in the aggregate,
wages do not seem to be overly rigid, the analysis concentrates on the compression of the wage
structure and on the issue of wage differentiation across skills levels and regions. In sub-section
3, the broad costs of job creation are assessed, introducing both non-wage labour costs and the
cost-related issue of labour market flexibility. Sub-section 4 reviews labour supply under the
aspects of work incentives in the tax-benefit system, impediments for female labour market
participation and mismatch problems. Sub-section 5 concludes on what seem to be the main
structural problems for employment growth.
Employment dynamics
The number of people in employment declined in Germany during most of the past decade
(Figure 3.11). Only from 1998 onwards have part of the losses in employment been
compensated, and total employment in 2000 was roughly at the same level as in 1991. Even if
one excludes the period of very strong employment destruction in the former GDR until 1993,
the overall picture of low employment dynamics remains. What is more, the pick-up of
employment growth from 1998 onwards was limited to the West Germany. In the East,
employment started to decline again after a short period of employment gains in 1994-95.
Labour in Germany is a much underused resource, not only due to close to 4 million
unemployed people, but also due to a large hidden labour force. With an employment rate of
65%, Germany lies two percentage points above the EU average, but still significantly below
the target, set by the European Council at Lisbon, of 70% for the EU as a whole by 2010. The
employment rate is also well below that of some northern European countries and the UK
(Table 3.10 includes Norway which, as can be seen, is a European benchmark in this respect). It
is interesting to see that employment rates for prime age male workers do not differ much
between “high employment” and “low employment” countries. The employment rate of men
aged 30 to 49 is even higher in Germany and Italy than e.g. in Sweden. The main disparities in
the overall employment rate stem from the marked differences in employment of women and
older workers.
The picture of low employment dynamics is even more worrying if one looks at employment
volume, i.e. the number of hours worked. Whereas the 1994-1997 decline in national
employment was rather soft, hours worked declined by 4½ % in the same period. The
subsequent increase was substantially weaker in hours worked than in employment, also
reflecting a tendency towards more part-time work. Furthermore, the East-West differential

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becomes even more evident in the development of hours worked in recent years. The downward
trend of labour volume continues in the East; it even accelerated in 2000.