The monopoly makes organizations not only small but also unproductive: why East Germany did not unite.
Union membership has declined around the world. A large body of literature discusses the direct consequences of this trend on the labor market (Katz and Autor 1999). In this column, we shift the focus to macroeconomic and misallocation outcomes as employers align strategically selected union layoffs. The East and West German labor markets provide a good laboratory for studying these interactions. Both regions share the same legal and cultural institutions. In East Germany, however, for historical reasons, collective bargaining and union membership are represented on small trees. In a communist economy, trade unions did not have a role to play in representing workers’ interests. As a result, after reunification, union membership declined dramatically, and union bargaining disappeared, especially among small trees (see Schnabel 2005). The size-wage curve for plants, therefore, is steeper east than west. This raises concerns in East Germany about choosing a business model that requires a tree to grow As a result, the most productive plants create relatively small customer networks and employ relatively few workers. The overall productivity effect of these disincentives is large, as we see in Bachmann et al. (2022). Thirty years after German reunification, labor productivity and wages in East Germany are about 25% lower (see Figure 1), and discouragement from a steep size-wage curve explains at least ten percent of this gap.
We came to this conclusion using high-quality administrative wage data from two different sources: (1) the German Structure of Earnings Survey (SES), which has been collecting detailed employee contract information, hours and wage data every four years since 2006, From a large number of plants above ten employees; And (2) the Administrative Wages and Labor Market Flow Panel (AWFP), which collects plant-level data from German social security files (see Bachmann et al. 2017 for an analysis of the German labor market flow with these data). The advantage of the latter is that these are quarterly data from 1993, that is, almost immediately after the reunification, but the wage and hourly data are somewhat inferior to the SES. We combine these data with a new different different-firm model. In this model, plants have market potential for the product and face an upward-sloping size-wage curve when deciding on their entry, their customer network and their size. In this model, closing a steep size-wage transaction not only creates a significant negative overall productivity effect but also explains the difference in plant size distribution between East and West Germany.
Figure 1 Output and wages
Comments: The figure shows the annual log output per worker in East and West Germany, the annual log output per hour, and the annual log labor compensation per hour. Output is measured as total value added, which is the GDP concept available at the regional level, because product specific subsidies and taxes (the difference between the two) are only available at the national level. The top panel displays it for the entire economy, the bottom panel for the private, non-primary sector. Calculations are based on National Accounts (VGR) from 1992 to 2017. Data has only been available since 2008 by region and sector, which is why the lower panel started only that year. Similarly, working hours data by region began in 2000. Weinand and von Auer (2020) provide county-level consumer price indices for Germany in 2016 that we compile regionally using population weights. With 2016 as the base year, we then calculate a time series of regional prices using the regional GDP-deflator-based inflation rate from the national account.
According to the data, the overall and industrial differences in labor productivity and wages are systematically related to the absence of large plants in East Germany. The share of employment in large plants with more than 249 employees is almost double that in the West (see Figure 2). Even after reunification, East German plants enter smaller markets and remain smaller than their West German counterparts, as seen in the analysis of AWFP data.
Figure 2 Plant size distribution in East and West Germany
Comments: The figure shows the distribution of employment-weighted plant sizes for East and West Germany. The panels display an approximate density function (by a Gaussian kernel smoothing) in the private, non-primary sector and manufacturing sectors, respectively. We pool in 2006, 2010 and 2014 samples Data source: SES 2006/10/14.
In industry-level data, there is a positive correlation between missing large plants and east-west productivity / wage gaps (see Figure 3). For example, both labor productivity (36%) in vehicle production and employment density in large plants (21 percent points) have a particularly large East-West gap, while construction has a small labor productivity gap (14%) and virtually the same concentration in East and West Germany.
What’s more, the lack of large trees, low productivity and low wages are systematically related to the difference in size-wage curve, which we estimate separately for East and West Germany, as well as by industry, from SES data. On average, plant elasticity in East Germany is one-fifth greater than in West Germany. The industries with the formerly steep shape-wage curve are also industries where many large plants are absent and especially low average wages. Instead, the earlier steep size-wage curves reveal the fact that workers at small plant in the East are more likely to receive bargaining wages individually and collectively than their Western counterparts, an example of non-uniform union layoffs.
Figure 3 Large plants by productivity and wage differences and industry
Comments: The top panels relate the log differences in output per 2014 between West and East Germany in industries with more than 249 employees (left panel) and log plant employment deviation (right panel). Output is measured as total value added, which is the GDP concept available at the regional level, because product-specific subsidies and taxes (the difference between the two) are only available at the national level. Lines shows (VGR) employment-weighted minimum square regression. The following panels relate the log wage difference between West and East German industries to the same plant size measurement. Lines shows (SES) employment-weighted minimum square regression. Data source: SES 2006/10/14 (plant size, wages) and VGR (labor productivity).
To measure the impact of a steep size-wage trade closure on tree size distribution and overall labor productivity, we employ a different-plant model. First, the plant decides to enter the market. After entering the market, they choose how many customers to collect, eliminating additional sales and marketing costs. This customer base choice also takes into account the labor required to provide additional customers and thus, increases wages in line with the upward-sloping size-wage curve present in a larger customer base data. Ultimately, plants, considering the market potential of their products, decide on the price taken from each individual customer and, consequently, the number of workers required to serve this customer.
Trade-off plants face the problems of this decision which leads them to acquire fewer customers as much as the size-wage schedule they face. In fact, according to the data, marketing costs are significantly lower in East German industries that have significantly higher wage curves than their West German counterparts. This has two effects on overall productivity. First, since plants tend to stay small on average and gain a small number of customers, the average customer bundles from fewer trees. That is, the monopoly power in the labor market creates an unfavorable love of diversity in the commodity market, which makes the economy less efficient. Second, compared to less exclusive energy situations, the distribution of employment across plants is narrowed, and labor is redistributed to more or less productive plants. Again, the result is a loss of overall productivity. This second effect is exacerbated by product market power.
We calibrate the model with the average tree size and the share of large trees in West Germany. The imposition of a steep size-wage trade-off from East Germany explains a ten percentage point lower productivity in that region. Also, aimless, the model replicates the size distribution of plants in East Germany. That is, it matches the size of a small average tree and a relatively small number of large trees.
There are many alternative explanations for the lack of integration in overall labor productivity between East and West Germany. First, this phenomenon may be due to low capital intensity, old-fashioned capital or low labor quality in East Germany, in which case, contrary to our interpretation, the root cause of the problem will not be the difference in total factor productivity. Second, the phenomenon may be due to differences in overall gross factor productivity which have different sources than our interpretation, such as the high degree of flexibility of the labor market in West Germany or the difference in industrial formation. Third, differences in total factor productivity and differences in plant size distribution may be the result of cumulative effects in metropolitan areas, and in West Germany they are simply greater. None of these alternative explanations have strong support for the data as far as the persistent lack of convergence is concerned, although some of them may play a role in the immediate aftermath of reunification (e.g. Dauth et al. 2021). We do not address why workers do not redistribute to West Germany despite high wages, a fact for which Hayes and Porzio (2020, 2021) provide an interesting complementary explanation based on regional housing bias and redistribution costs in the labor market. In contrast, we want to explain the low total aggregate factor productivity resulting from a combination of lack of strong dynamics between East and West and market imperfections in East Germany.
Our model highlights two pathologies arising from monopoly power in the labor market that monopoly power typically leads to lower overall employment: productive businesses attract fewer workers and create a much smaller customer base, a form of reduced investment. . Wages (normal policy recommendations in the presence of monopoly power in the labor market) or market subsidies cannot cure these pathologies. In contrast, they can be partially cured by marketing subsidies. They encourage the plant to create a larger customer base than the Liesage-Fire balance and thus increase productivity. Alternatively, more small and medium-sized plants in East Germany may require a collective bargaining agreement through a trade union presence.
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