The Effects of Organisational Change on Wage Inequality in Germany

Wage inequality has increased over the last two decades in Germany as well as in most other advanced economies (Dustmann et al., 2009; Giesecke and Verwiebe, 2009; OECD, 2011). This development is usually discussed against the background of technological change, globalisation, institutional changes and economic crises. There has been much debate in the literature whether the rise in wage inequality can be explained best by market based theories, such as the theory of skill biased technological change (Acemoglu, 2003; Autor et al., 2008), or by institutional theories (Sørensen, 2000, Morgan, Cha, 2007; Weeden, Grusky, 2014). This discussion obtains a new perspective by the finding that large parts of the rise in wage inequality are associated to increasing workplace heterogeneity in Germany (Gross, 2012; Card et al., 2013) and in the U.S. (Barth et al. 2014). This finding points to increasingly diverse processes of rent creation and rent sharing at the firm level. However, while it is well-known that structures at the firm level do affect the level of wages, it is less clear how such structures contribute to the dynamics of wage inequality. Therefore this study examines the effects of changing organisational structures on the rise in wage inequality in Germany.

The dominant economic explanations of rising wage inequality state that the demand for highly skilled workers has increased due to technological progress and increased international trade. Thus they predict rising inequality across differently skilled individuals but not for equally skilled individuals in different firms (Machin, 2008). In contrast, the sociological concept of social closure (Sørensen, 1983, 1996, 2000) is well suited to explain inequalities across firms. The core idea of social closure is that members of powerful groups restrict access to the group and thus can achieve wage premiums (rents) from monopoly-like positions. At the firm level this means that workforces benefit from organisation specific institutions that secure advanced bargaining power of firm insiders compared to firm outsiders, such as firm internal labour markets, firms’ coverage by collective bargaining or employee representation and firms’ composition with respect to characteristics that are typically ascribed different levels of power (gender, nationality). The importance of firm level institutions has been potentially enhanced by decreasing institutionalisation at the national level, while it is potentially constrained by competition in product and labour markets. Against this theoretical background, the paper addresses the following research questions: 1) Do changes in firm structures over time affect total wage inequality? and 2) Do institutions of social closure at the firm level contribute to the explanation of the rise in wage inequality?

For the empirical analysis, linked employer-employee panel data from the institute for employment research is used (LIAB). These data allow, in contrast to the essential study by Card et al. (2013), to consider a large set of firm characteristics as determinants for the apparent rise in wage inequality. Applying regression-based decompositions of variance (Fields, 2003) the development of wage inequality between 2000 and 2010 is decomposed into changes associated to firm characteristics, individual characteristics and changes in the remuneration of unobserved characteristics. In order to consider that employees might be sorted into firms based on unobserved individual characteristics, the development of wage inequality is additionally decomposed using panel estimations in two time periods (2000 to 2005 and 2005 to 2010).

Main findings are that besides rising inequality across differently skilled individuals, a large share of the rise in wage inequality can be attributed to changes in observed structures at the firm level. Additionally, part of the rise in wage inequality is due to increased sorting of differently skilled workers amongst firms. Substantial parts of the rise in wage inequality can be attributed to social closure at the firm level in the form of temporary employment and works councils. However, the firm characteristics contributing most to the rise in wage inequality are firm size and the composition of firms’ workforces with respect to human capital.

These results confirm on the one hand that the returns to human capital are rising. This finding supports the hypothesis of skill biased technological change. On the other hand, it is found that the rise of overall inequality is associated to rising inequality across firms, part of which stems from different levels of social closure at the firm level. These results point to increasing importance of employer rents which presumably stem from productivity differences across firms and concentration on product markets (see also Foster et al., 2008; Weeden and Grusky, 2014). Workers’ ability to participate in these rents increasingly relies on different levels of bargaining power drawn from social closure at the firm level.