The German labor market

A paper by an MIT economist explains its unique features…

Germany has less low-wage work and less inequality than the US, but more flexibility and lower unemployment than France.

Germany—the world’s fourth largest economy—has remained partially insulated from the growing labor market challenges faced by the United States and other high-income countries. In many advanced economies, the past few decades have seen sustained increases in earnings
inequality, a fall in the labor share, the disappearance of “good jobs” in manufacturing, the rise of precarious work, and a deterioration in the power of organized labor and individual workers. These developments threaten to prevent economic growth from translating into shared prosperity. Figure 1 shows that compared to the United States, German organized labor has remained strong. Half of German workers are covered by a collective bargaining agreement, compared to 6.1 percent of private-sector Americans (BLS, 2022). Trust in unions is almost twice as high in Germany compared to the US. Employees in Germany work fewer hours, the country’s
low-wage sector is 25 percent smaller, and labor’s share of national income is higher. The German manufacturing sector still makes up almost a quarter of GDP (compared to 12 percent in the US). Germany has one of the highest robot penetration rates in the world (IFR, 2017)—yet in contrast to the US (Acemoglu and Restrepo, 2020), robotization has not led to net employment declines in Germany, especially in areas with high union strength
(Dauth, Findeisen, Suedekum, and Woessner, 2021). At the same time, relative to other OECD countries—many of which, like France or Italy, have maintained even higher collective bargaining coverage through more rigid bargaining systems—the German labor market features low unemployment and high labor force participation (though also a larger low-wage sector).

Bargaining is mostly (but not entirely) at the sectoral level rather than the firm level.

The first pillar is the sectoral bargaining system. In Germany, unions and employer associations engage in bargaining at the industry-region level, leading to broader coverage than in the US. Meanwhile, partial decentralization of bargaining to the firm level—through flexibility provisions in sectoral agreements, or direct negotiations between individual firms and sectoral unions—gives firms space to adapt to changing circumstances. However, this flexibility has also resulted in a gradual erosion of bargaining coverage.

Workers have multiple channels to share their perspectives in firms’ decision making.

The second pillar of the German model is firm-level codetermination. Workers are integrated into corporate decision-making through membership on company boards and the formation of “works councils,” leading to ongoing cooperative dialogue between shareholders,
managers, and workers. Overall, the German model combines centralized “social partnership” between unions and employer associations at the industry-region level with decentralized mechanisms for local wage-setting, dialogue, and customization of employment conditions.

There’s a tradeoff between flexibility and collective bargaining. Germany’s balance between them has evolved over time.

A recurrent theme in our discussion of the German model will be a tension at the heart of the model: between firms’ flexibility and workers’ collective bargaining strength. Since the 1990s, the model has become more decentralized and flexible. This evolution has arguably contributed to reductions in unemployment and increases in economic growth, but has
entailed a substantial erosion of collective bargaining and works council coverage (as Figure 2 illustrates) and a weakening of bargaining agreements. This erosion may explain Germany’s slowly increasing—and perhaps underappreciated—exposure to the afflictions suffered by
other developed-world labor markets: rising wage inequality and the spread of low-wage, precarious jobs.