Labour Economics
German unification

German unification created a single labour market from two disparate regions with vastly different productivity levels. Although East German real wages might have been expected to converge to West German levels eventually, their rapid rise to some 60% above the previous year's level by the summer of 1991 was quite remarkable. It is hard to reconcile with the rapid increases in open and hidden unemployment in the region (which might have been expected to restrain such a wage surge), the decline in Eastern German measured output per worker and the continued steady growth of real wages in the West.
In Discussion Paper No. 573, Research Fellow Michael Burda and Michael Funke extend models of union behaviour and collective bargaining to allow for the fact that most wage contracts in the East were in fact negotiated by Western labour unions. Their simplest monopoly union model, in which the union can discriminate perfectly between East and West, generates wage differentials that reflect differing demand and supply conditions and the elasticities of labour demand in the two regions. Their results suggest that unions' mark-ups over the competitive wage should be higher in the West than in the East, which is inconsistent with those actually observed.
Burda and Funke therefore extend their model to test whether migration affects the fall-back wage that would clear the market in the union's absence and they find that migration unambiguously compresses East-West wage differentials. If labour is perfectly mobile, the wage differential merely reflects any difference in the two regions' elasticities of labour demand. To the extent that labour mobility is imperfect, the monopoly union can `segment' the market. A union that considers migration in setting its demands is likely to price labour more expensively in the East according to the weight it places on rents earned there.
Burda and Funke find that bargaining models that allow for Pareto-superior contracts and/or the power of management yield some additional insights in the determination of wages. They conclude that government subsidization of firms will reduce the firms' fall-back positions and increase the bargained wage. The Treuhand's policy of extending subsidies to those firms in the East that have yet to be privatized therefore entails a danger of higher Eastern wage outcomes, which suggests that a form of `soft budget constraint' may apply to the transformation of the East European economies.

German Trade Unions after Unification: Third Degree Wage Discriminating Monopolists?
Michael Burda and Michael Funke

Discussion Paper No. 573, August 1991 (AM)