Blog Post

Inequality in Germany – how it differs from the US

The pay gap between workers and CEOs in Germany is driven by a lack of managers. Income inequality could fall if there were more managers available for companies to hire. Firms should start hiring more CEOs who are women or from abroad.

By: and Date: July 5, 2016 Topic: Macroeconomic policy

The rise in income inequality over the last 20 years is a widely discussed problem in Germany at the moment. But there is little discussion on the drivers of this inequality, and why Germany is more equal in income than the US. There is one reason for this which is widely overlooked.

A major source of inequality in rich countries is the rising pay of the top 1% of income earners. In Germany the top 1% of income earners are CEOs in industrial firms, partners in law firms and in management consultancies, and some medical doctors. Why has the income of this group increased so much?

Where you work is decisive

A worker’s income does not depend so much on their education level, but on the firm they work for, as shown by two new studies on the US and Germany (Song et at 2015, Card et al 2013).  To increase your income you have to work for a firm which is very productive and which pays high wages. If you work for the same firm all your life, you can only marginally increase your income.

Wage inequality between firms, rather than within firms, explains the evolution of inequality. Matching very productive firms with very talented people generates inequality in income, meaning that the ability of workers to move between firms is important in generating inequality.

The competition for talent

But what influences the mobility of workers between firms? If we look at CEOs, it depends on the trade environment that firms face, as I showed in a paper with Thierry Verdier (Marin & Verdier 2012).

In Germany, trade liberalisation has increased the chances of finding a better paying job. New foreign firms enter the market and search for qualified managers, but managers familiar with the German market environment are scarce, and foreign firms compete with incumbent firms for these managers, driving up their pay. This competition for managers contributed to a 3.5 fold increase in CEO pay in Germany between 1977 and 2009 (Fabbri & Marin 2016).

Germany is an economy very open to international trade. The competition for managers from foreign firms is much stronger in Germany than in the US, and therefore CEO compensation should be larger in Germany. But this is not the case. CEO pay in the US is 6 times higher now than it was in the 1970s (Frydman & Saks 2010). This means that there must be other factors at work beyond openness to trade.

Offshoring of managerial tasks

In a new study we find an answer to this puzzle (Marin et al 2015). CEO pay increased by less in Germany than in the US because of the offshoring of managerial tasks to eastern Europe, which started in the mid 1990s after the fall of communism.

Managerial offshoring is widespread. In 57 percent of foreign direct investment projects in eastern Europe a local manager was hired rather than a German manager. On average 2 to 3 managers per investment were offshored to eastern Europe.

Managerial offshoring to eastern Europe reduced the demand for managers in Germany, leading to a decline in managerial pay. According to our estimates, managerial offshoring has led to a decline in CEO pay in Germany by 18 percent compared to what it would without offshoring. The results suggest that managers in Germany operate in a tight labour market. Their scarcity allows them to receive high incomes which do not necessarily correspond to their performance.

Declining skill premium

There is an additional reason why inequality in Germany is less pronounced than in the US: the offshoring of production to eastern Europe by German firms since the beginning of the 1990s.

As German firms could not find skilled workers in Germany (in particular engineers) they relocated production to eastern Europe where there were many skilled workers who were cheaply available.

This led to a decline in the demand for skilled workers in Germany, lowering their wages. Offshoring of skilled workers to eastern Europe reduced the skill premium by 40 percent according to my estimates (Marin 2011).

Workers with university degrees generally enjoy higher incomes in Germany, but the falling skill premium dampened the spread between skilled and unskilled workers during this period.

While US firms offshored production to Mexico in the 1990s, the relocation of US-value chains to Mexico were not skill-intensive but labour-intensive. The relocation of production to Mexico reduced the demand for unskilled workers in the US, lowering their wages. This contributed to a larger income gap between skilled and unskilled workers in the US (Feenstra & Hanson 1996).

Why education is not a panacea

In rich countries, the response to the challenges of globalisation has been education, education, education. The only way to compete with a rising China, so the argument goes, is to expand education in rich countries.

But the declining skill premium in Europe suggests that the supply of people with university degrees exceeds demand. A further expansion of education will lead to a further decline in the skill premium. In Germany a university graduate earns about 60 percent more than a high school graduate, and a sufficient spread in income between skilled and unskilled workers is desirable to maintain the incentives for education.

In Germany, anxiety about the future is leading more young people to enroll in universities. But will a university degree still provide an insurance against unemployment when there is an oversupply of university graduates in the future?

We must find new ways to deal with the differences in income between CEOs and the rest of the population. In Germany a CEO in the manufacturing sector earned 8 times more than a skilled worker in the same sector in 1977, but in 2007 the CEO earned 17 times more (Fabbri and Marin 2016).

The rise in CEO pay in Germany is due to of the scarcity of trained managers. So to reduce the gap between CEO and worker pay, we must find more CEOs. This can be done by diversifying the boardroom with more women and foreign CEOs. In Germany CEOs are mainly German and male. If firms start to hire foreign and female managers, we can reduce both the scarcity of managers and inequality in one fell swoop.

 


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article More on this topic More by this author
 

External Publication

L’Union européenne et les États-Unis, un an après

Après une année troublée par Kaboul et AUKUS, qu'avons-nous retenu de l'an I de la présidence Biden ? Maria Demertzis revient sur les évènements marquants de l'année 2021 pour la relation entre les États-Unis et l'Union européenne.

By: Maria Demertzis Topic: Global economy and trade Date: December 8, 2021
Read article
 

Blog Post

Inclusive growth

The triple constraint on artificial-intelligence advancement in Europe

Skills, data and financing shortcomings constrain artificial-intelligence innovation in Europe.

By: Mia Hoffmann and Laura Nurski Topic: Digital economy and innovation, Inclusive growth Date: December 6, 2021
Read article Download PDF More on this topic
 

Book/Special report

European governance

Instruments of a strategic foreign economic policy

Study for the German Federal Foreign Office produced by Bruegel, the Kiel Institute for the World Economy and DIW Berlin.

By: Katrin Kamin, Kerstin Bernoth, Jacqueline Dombrowski, Gabriel Felbermayr, Marcel Fratzscher, Mia Hoffmann, Sebastian Horn, Karsten Neuhoff, Niclas Poitiers, Malte Rieth, Alexander Sandkamp, Pauline Weil, Guntram B. Wolff and Georg Zachmann Topic: European governance Date: November 12, 2021
Read article More on this topic More by this author
 

Blog Post

What to make of the EU-US deal on steel and aluminium?

While deeply disappointing that the surprise deal maintains aluminium and steel tariffs against the EU beyond a modest quota, it alleviates a major irritant in transatlantic relations and contains interesting and innovative features relating to climate policy and to dispute settlement under WTO rules.

By: Uri Dadush Topic: Global economy and trade Date: November 4, 2021
Read article
 

Blog Post

European governanceInclusive growth

The socioeconomic effects of COVID-19 on women

The pandemic has disproportionately affected women both professionally and at home. Although the gender gap in labour force participation since the onset of the pandemic hasn't worsened, policy still needs to tackle existing gender gaps, which for some EU countries are very substantive.

By: Maria Demertzis and Mia Hoffmann Topic: European governance, Inclusive growth Date: November 3, 2021
Read article More on this topic
 

Blog Post

Strong, balanced, sustainable and inclusive growth? The G20 and the pandemic

The G20 is not doing enough to support strong, balanced, sustainable and inclusive growth in the wake of COVID-19, with the poorest countries left behind by the recovery.

By: Suman Bery and Pauline Weil Topic: Global economy and trade Date: October 29, 2021
Read article Download PDF
 

Parliamentary Testimony

European ParliamentInclusive growth

Understanding the socioeconomic effects of the COVID-19 pandemic on women

Testimony before the European Parliament's Committee on Economic and Monetary Affairs (ECON) on the consequences of the pandemic on women.

By: Maria Demertzis and Mia Hoffmann Topic: European Parliament, Inclusive growth, Macroeconomic policy Date: October 27, 2021
Read article
 

Blog Post

European governance

Germany’s post-pandemic current account surplus

The pandemic has increased the net lending position of the German corporate sector. By incentivising private investment, policymakers could trigger a virtuous cycle of increasing wages, decreasing corporate net lending, which would eventually lead to a reduction of the economy-wide current account surplus.

By: Lionel Guetta-Jeanrenaud and Guntram B. Wolff Topic: European governance, Macroeconomic policy Date: October 21, 2021
Read article
 

External Publication

European Parliament

Tailoring prudential policy to bank size: the application of proportionality in the US and euro area

In-depth analysis prepared for the European Parliament's Committee on Economic and Monetary Affairs (ECON).

By: Alexander Lehmann and Nicolas Véron Topic: Banking and capital markets, European Parliament, Macroeconomic policy Date: October 14, 2021
Read article More by this author
 

Opinion

European governance

The inconsistency in global strategic relations

All of this talk on strategic retrenchment and autonomy is the language of escalation, not of appeasement and collaboration.

By: Maria Demertzis Topic: European governance, Global economy and trade Date: October 13, 2021
Read article More by this author
 

Blog Post

Inclusive growth

Making antitrust work for, not against, gig workers and the self-employed

Policymakers should act to deal with labour-market concentration trends that potentially harm workers, especially gig workers and the self-employed.

By: Georgios Petropoulos Topic: Digital economy and innovation, Inclusive growth Date: October 11, 2021
Read article More by this author
 

Podcast

Podcast

Is tech redefining the workplace for women?

Laura Nurski, Sabine Theresia Köszegi and Giuseppe Porcaro explore the relationship between artificial intelligence and job transformation and ask whether the impact differs by gender.

By: The Sound of Economics Topic: Digital economy and innovation, Inclusive growth Date: October 6, 2021
Load more posts