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Abstract: It is commonplace in the debate on Germany's labor market problems to argue that high unemployment and low wage dispersion are related. This paper analyses the relationship between unemployment and residual wage dispersion for individuals with comparable attributes. In the conventional neoclassical point of view, wages are determined by the marginal product of the workers. Accordingly, increases in union minimum wages result in a decline of residual wage dispersion and higher unemployment. A competing view regards wage dispersion as the outcome of search frictions and the associated monopsony power of the firms. Accordingly, an increase in search frictions causes both higher unemployment and higher wage dispersion. The empirical analysis attempts to discriminate between the two hypotheses for West Germany analyzing the relationship between wage dispersion and both the level of unemployment as well as the transition rates between different labor market states. The findings are not completely consistent with either theory. However, as predicted by search theory, one robust result is that unemployment by cells is not negatively correlated with the within cell wage dispersion.
This dissertation contains five independent chapters dealing with wage dispersion and unemployment. The first chapter deals with the explanation of international changes in wage inequality and unemployment in the 80s and 90s. Both theoretically and empirically, social benefits and its link to average income are blamed for the different experiences across countries. The second chapter discusses the search framework, to explain residual wage inequality and finds that institutional wage compression has ambiguous effects on employment. In the third chapter, we apply the theory to German data. We show that job-to-job transitions are important in explaining both frictions and career advances. In the fourth chapter, we empirically assess the relationship between wage dispersion and unemployment for homogeneous workers. We find that neither a frictional nor a neo-classical view in explaining this relationship are convincing. Unemployment within cells is not negatively correlated with wage dispersion. Finally, the last chapter builds a theoretical model which treats heterogeneous individuals in a production function framework and a frictional labor market. The model generates both wage dispersion within and between skill groups and both frictional and structural unemployment. In sum, the dissertation stresses the importance of modelling frictions to understand different types of wage inequality and unemployment.