German unification brought the widespread importation of the Federal Republic's institutions into the former GDR, including its system of collective bargaining. This and the `high wage strategy' have stimulated a lively debate over the suitability of such institutions for an economy undergoing major structural change. Critics argue that they slow down the transition, while trade unions maintain that they may hasten it by encouraging the development of human capital formation.

In Discussion Paper No. 652, Research Fellow Michael Burda and Michael Funke develop a traditional two-sector model in which the industrial sector is dominated by a single union and an employers' association which bargain over wages and employment, while employment and wages in the other sector are determined by a competitive labour market. When the unionized sector (the industrialized, organized sector in the ex-GDR) is hit by a permanent negative shock, it will shrink more slowly than under perfect competition, so structural change is retarded. In a second model, the industrial sector exhibits `learning by doing', skills and productivity may derive from high levels of activity in that sector, and collective bargaining can promote an industry's chances of survival relative to the competitive outcome. Burda and Funke conclude that collective bargaining and high wages may play a positive role in East Germany's transformation; whether they do will depend on whether high-tech industries are really characterized by `learning by doing' and whether they form the unionized sector.

Michael Burda presented this paper at a June joint lunchtime meeting with the European Centre for Advanced Research in Economics, to be reported more fully in the next issue of this Bulletin.

Trade Unions, Wages and Structural Adjustment in the New German States
Michael Burda and Michael Funke

Discussion Paper No. 652, June 1992 (HR)