It is widely acknowledged that internal current account imbalances in Europe were an important factor behind the financial distress experienced by countries in the Eurozone. What is more controversial, however, is what the main drivers of these imbalances were. Several institutions mention the increase in German competitiveness since the late 1990s as an important determinant of these imbalances driven by German labor market reforms. Particularly, the decline in German real wages, relative to the Euro Area partners, is cited as a key factor.
The decline in real wages can mainly be attributed to a shift from collective bargaining to concession bargaining and the introduction of opening clauses in employment contracts. In order to assess the merits of this explanation, we test the contribution of shocks to the German labor market in the form of a reduction in workers’ wage bargaining power to Eurozone current account imbalances.
We make use of a so-called Global Vector Autoregressive (GVAR) model for 9 Euro Area countries in order to measure the spillover effects of wage bargaining power shocks using a sample ranging from 1992Q1 to 2007Q2. A GVAR is an econometric tool to analyze the dynamic interaction between macroeconomic variables within the context of a multi-country model. It thus allows us to see how shocks to a specific country spillover onto others in the system. We identify the German wage bargaining shocks by imposing minimal robust theory restrictions on the GVAR. The theory restrictions are derived from a small open economy New Keynesian dynamic stochastic general equilibrium (DSGE) model incorporating search and matching frictions in the labor market. The use of a structural GVAR, i.e. a GVAR where we impose theory restrictions to identify shocks, is advantageous because it achieves identification from theory but allows
the responses of variables to specific shocks to be mostly data-driven. This is a more agnostic approach that avoids the reliance on overly restrictive structural models and allows us to assess whether the role of spillovers from German labor market reforms is quantitatively important.
We show that negative shocks to bargaining power in Germany do generally cause an improvement of the domestic (i.e. German) current account, while foreign responses are heterogeneous. However, and most importantly, they account only for a very small fraction of the variation in current account balances. Counter-factual analysis shows that the effect of these shocks on the increasing dispersion of the Eurozone current accounts before the crisis is essentially negligible. Hence, German wage moderation cannot be the lone driver of external imbalances in the Eurozone.
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