Working Paper: CEPR ID: DP6415
Authors: Wendy Carlin; David Soskice
Abstract: The conventional diagnosis of Germany?s poor economic performance focuses on supply-side weaknesses and the need for more vigorous reforms to make low-skill labour markets more flexible. We question this on both theoretical and empirical grounds. In an extended version of a New Keynesian model shifts in aggregate demand can move the economy along a range of constant-inflation medium-run unemployment equilibria. The evolution of the real exchange rate and the external balance help to identify whether aggregate supply or aggregate demand shifts have been dominant in accounting for changes in unemployment. We provide some prima facie evidence for Germany and the UK that aggregate demand factors have played an important role in sustaining growth in the UK and weakening it in Germany over the medium run. We show that Germany has a relatively strong record in implementing OECD recommended reforms but the expected employment effects in low-skill service sectors appear disappointing and poverty has increased. By contrast, it is in high productivity sectors including services that the German economy has performed well, especially in exports. Here labour markets are not flexible in the conventional sense: codetermination, vocational training, and coordinated wage bargaining are important. We pursue the implications of these claims for the design and political economy of reforms in Germany.
Keywords: aggregate demand; German economic performance; labour market reforms; macroeconomic policy
JEL Codes: E65; J59
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| aggregate demand insufficiency (E00) | high unemployment in Germany (J64) |
| shifts in aggregate demand (E00) | unemployment levels (J64) |
| insufficient demand (J23) | persistent unemployment (J64) |
| labor market flexibility (J48) | employment (J68) |
| flexible labor market legislation + depressed demand (J23) | increased income inequality and poverty (D31) |
| failure to facilitate women's reentry into labor market (J68) | issues stemming from insufficient aggregate demand and labor market reforms (E69) |
| successful areas of the German economy (O52) | less flexible labor markets (J46) |