The impact of the current financial crisis on the German labour market

Bachelor Thesis, 2009

35 Pages, Grade: First Class


Table of Contents

List of Abbreviations

List of Figures and Tables

1 Introduction
1.1 Problem Definition and Objectives

2 Theoretical Foundations
2.1 Unemployment
2.2 Efficient Market Hypothesis and Behavioural Finance

3 Theoretical Discussion
3.1 The German labour market
3.2 Origins and anatomy of financial crises

4 Practical Examination on the Impact of the current Financial Crisis on the German Labour Market
4.1 Quantitative Examination
4.1.1 Impact on the real economy
4.1.2 Unemployment and Short-Time Work Development
4.2 Qualitative Examination
4.2.1 General Forecasts in the Media
4.2.2 Interpretation of Results of Interviews

5 Conclusion

List of Literature

List of Abbreviations

Abbildung in dieser Leseprobe nicht enthalten

List of Figures and Tables

Figure 1: Efficient versus Inefficient Market

Figure 2: Hysteresis Development

Figure 3: Historical Unemployment Development in Germany

Figure 4: Economic Model of Financial Crises

Figure 5: DAX Index Performance

Figure 6: MSCI BARRA World Commodity Index Performance

Figure 7: Dow Jones Euro Stoxx Automobiles & Parts Index Performance

Figure 8: Unemployment and Short-Time Work Development from 2007

Figure 9: Unemployment and Short-Time Work Merged

Figure 10: Economic Indicators

Table 1: Unemployment Development from 2007

Table 2: Short-Time Work Development from 2007

Table 3: Sample Questionnaire for Interviews

1 Introduction

1.1 Problem Definition and Objectives

The years since the early 1970s are unprecedented in terms of the volatility in the prices of commodities, currencies, real estate and stocks, and the frequency and severity of financial crises (Kindleberger, C. P. and Aliber, R. Z., 2005).

Many authors have already studied about reasons of the origin of financial crises and their impact on the economy concerned, since financial crises, in particular global ones and especially the current one affect all economic factors significantly. The economic growth slows down or even turns into a recession due to decreasing investments, affected by a significantly lower liquidity of companies and investors. All these factors also affect the GDP and the labour market of the economy concerned, in this case Germany, which economy has turned into a recession in February 2009 (, 2009a).

The subject of this paper has been chosen due to the present global relevance of the impact of a financial crisis on the labour market. The topic in particular has been chosen due to the fact that it is of worldwide relevance since the outbreak of the crisis analysed occurred on an unexpected scale, more precisely the worst of its kind since the Great Depression in the 1930s.

The focus of this paper lies on the analysis of the current crisis in terms of the impact on the German labour market.

2 Theoretical Foundations

2.1 Unemployment

Initially, the conception unemployment has to be defined as well as how unemployment rates are calculated. Theoretically, full employment is reached when nobody is voluntarily unemployed. Due to the fact that it is very hard to determine who is voluntarily unemployed, this quantity cannot be used for unemployment statistics (Franz, 2005, p.349). The German unemployment statistics are created by the Bundesagentur für Arbeit (Federal Employment Office) in accordance with the regulations of §119 SGB, III (SGB, 2005). Thus, the definition of an unemployed person is when the person is not employed, when the person tries to get employed, and when this person is willing to accept job offers of the Bundesagentur für Arbeit for the occupational integration (§119 SGB III). People who are affected by short-time work or who are in further training measures are not included in the pool of unemployed (Edling, 2006, p.225) and build the amount of hidden unemployment.

There is a second measure concept for international comparability of unemployment, which follows the agreed upon standards of the International Labor Organisation (ILO): Unemployed persons are defined as those who report that they are without work, that they are available for work and that they have taken active steps to find work in the last four weeks (ILO, 1982).

To calculate the unemployment rate, this paper uses the concept of dividing the number of unemployed by the total labour force, in accordance with §119 SGB, III.

2.2 Efficient Market Hypothesis and Behavioural Finance

According to Selwyn-Brown (1910), “crises are essentially psychological phenomena” (p.154), therefore the theories about the EMH and behavioural finance, which are contrary to each other, will be introduced.

The prevalent theory regarding capital markets has been the EMH, firstly addressed by Bachelier (1900, 1964), cited by Courtault et al. (2000). This hypothesis is included in this paper in order to highlight the paradox between this theory and the existence of anomalies. The underlying assumption of the EMH is that security prices, such as of stocks or commodities, are only influenced by information. According to Malkiel (1992), a capital market is perfectly efficient if it fully and correctly reflects all relevant information in determining security prices. This hypothesis is extended by Louhichi (2008): “empirical studies show that this extreme version of market efficiency hypothesis is not valid”. In his point of view, a perfectly efficient market immediately adjusts prices to market news; an inefficient market adjusts prices slowly (figure 1). Jones and Litzenberger (1970, p.147) furthermore prove empirically that the market is not as perfect as random walk theorists claim and that the market does not always adjust immediately and correctly.

Figure 1: Efficient versus Inefficient Market

Abbildung in dieser Leseprobe nicht enthalten

From Goriaev, 2008, slide 5.

Since anomalies challenge the validity of the EMH, a new capital markets theory arose, the behavioural finance theory.

In contrast to the EMH, the behavioural finance theory assumes a market that is not fully rational. Security prices are influenced by the actions of market participants. Some central issues in behavioural finance are why investors and managers make systematic errors and how those errors create market inefficiencies. Among such inefficiencies, underreactions or overreactions to information are often cited. Barberis, Shleifer and Vishny (1998) and Daniel, Hirshleifer and Subrahmanyam (1998) present behavioural models that accommodate such overreaction and underreaction.

The model of Barberis, Shleifer and Vishny (1998, p.315) is motivated by evidence from cognitive psychology of two judgement biases, the conservatism bias, firstly identified by Edwards (1968), and the representativeness heuristic, documented by Kahnemann and Tversky (1982, p.33). In a more recent study, Griffin and Tversky (1992) use strength and weight as characteristics in their framework. DeBondt (1993, p.368) proofed that people extrapolate past trends. Barberis, Shleifer and Vishny (1998) argue that their findings challenge the EMH (p.308).

The model of Daniel, Hirshleifer and Subramanyam (1998, p.1845) is related to the one of Barberis et al., but uses different foundations. It assumes the existence of informed and uninformed market participants.

Another approach of behavioural finance comes from Gaunt (2004, p.28), arguing that the market overreacts to both good and bad news, leading to the assumption that people overweight the value of recent information.

Furthermore, the aspect of abnormal performance is given by Sun (2005, p.3). He differs between quantitative and qualitative news, whereby market participants tend to overweight qualitative news. Psychological evidence to this thesis is provided by Einhorn and Hogarth (1981, p.77).

3 Theoretical Discussion

3.1 The German labour market

The German labour market is characterized by a high level of underemployment, which is steadily and gradually increasing since the 1970’s (Sachverständigenrat, 2005, p.132). One of the main reasons for this persistent unemployment is the high rate of low-skilled unemployed, which has been rising significantly in Germany since 1991 (Sachverständigenrat, 2005, pp.133-134). Germany’s structural change led to more capital intensive production, which further strengthened the position of skilled labour force despite a widening wage gap (Hollandars & ter Weel, 2002, p.580). In comparison to the former EU-15 states, Germany has the third highest unemployment rate of low-skilled people (Sachverständigenrat, 2007, p.149) due to the inflexibility of the German labour market. Compared to more flexible labour markets, which faster adjust real and relative wages, the reaction to macroeconomic shocks is significantly different. The German labour market is more rigid, characterized by greater institutional control over wage setting and greater labour costs associated with employment protection regulations (DiPrete et al., 2006, p.313).

Another issue is high long-term unemployment. Bjornstad (2006, pp.469-470) empirically proofs that many workers tend to give up themselves after a duration of nine months of being unemployed.

Because of the oil crisis and the fall of Bretton-Woods in 1973, the demand for labour considerably declined. Due to the fact that two employee-focussed parties governed in the 1970’s, namely the social democratic party of Germany (SPD) and the liberal party (FDP), many labour laws were introduced. The power of trade unions increased during this time as well, which lead to better working conditions and higher wages (Stein, 2001). One of the main reasons of the German labour market being such rigid is the rigidity of wages, since companies in Germany cannot adjust wages to economic conditions as companies can do in more flexible economies like the UK or the USA (Nickell, 1997).

In 1983, the German unemployment rate rocketed to about 9.5% due to a high national debt and inflation and especially due to the second oil price shock in 1979 and the accordingly worldwide recession (Franz, 2005, p.358).

There has been a negative trend in the German labour market from 1991 (Sachverständigenrat, 1993, p.44), leading to an inability of the economy to keep a proportional growth of labour demand to labour supply. This trend was strengthened by the recession of 1993 and the collapse of the new economy bubble in 2001. Meyer (2001) provides strong evidence of the existence of hysteresis, meaning that future development depends on past events, by showing that there are consistencies in the German labour market, namely that labour demand does not recover the same way after recessions as it declines during weak economic times (figure 2).

Figure 2: Hysteresis Development

Abbildung in dieser Leseprobe nicht enthalten

Source: Meyer, 2001

Even though the fluctuation of the unemployment rate can partly be explained by the concept of business cycles, it has been constantly growing for decades (cf. figure 3).

Figure 3: Historical Unemployment Development in Germany

Abbildung in dieser Leseprobe nicht enthalten

Source: Statistisches Bundesamt (2007)

The reasons for the increasing unemployment rate, besides cyclical movements, are especially relatively high unit labour costs, the German social security system, and disparities between labour supply and demand. The economic upturn until the start of the financial crisis has reduced the unemployment rate. This effect was strengthened by the stronger international competitive position and the labour market reforms (Loerwald et al., 2008, p.312).

3.2 Origins and anatomy of financial crises

According to Bordo et al. (2001), cited by Allen and Gale (2007), a typical crisis can be summarized as an economic downturn that lasts about 2 to 3 years and costs 5-10 percent GDP, on average. Furthermore, recessions are more severe as soon as they coincide with crises.

Kindleberger and Aliber (2005, p.24) distinguish between a historical and an economical view of crises, since historians argue every event is unique, whereby economists analyse patterns. Thereby the standard pattern is called business cycle.

Figure 4 shows a standardized economic model illustrating the basic sequence of financial crises. Generally, there are two possibilities, either the government intervenes by bailout or not. If the government decides not to help, the financial crisis takes place, leading to a decrease in investments, consumption and therefore output, which furthermore leads to a decrease in demand for labour and therefore to higher unemployment. As soon as the government intervenes, this effect will revert, leading to the same economic numbers in terms of output, unemployment etc. as before in the long-run.


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The impact of the current financial crisis on the German labour market
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Benjamin Schmitt (Author), 2009, The impact of the current financial crisis on the German labour market, Munich, GRIN Verlag,


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