Macroeconomic Implications of the Hartz IV Labor Market Reform

• Applicant: Professor Dr. Christian Merkl
• Subject Area: Economic Policy, Applied Economics
• Term: from 2019 to 2023
• Project identifier: Deutsche Forschungsgemeinschaft (DFG) - Project number 424639011

More than a decade after the implementation of the Hartz reforms in Germany, there is still substantial disagreement about the quantitative macroeconomic effects in the existing literature. How much did Hartz IV contribute to the decline of unemployment? How much did Hartz IV affect earnings inequality? In addition, the debate on the open-economy effects is still ongoing: Did the Hartz reforms lead to a substantial increase of the current account surplus?Our project proposal aims at obtaining guidance from the rich Nuremberg based microeconomic data and to use the derived insights for macroeconomic modeling. The identified microeconomic patterns will allow us to develop theory and to discipline for our quantitative counterfactual exercises.In the first project, we aim at proposing a novel methodology to evaluate the Hartz IV reform through the lens of a macroeconomic model of the labor market that distinguishes between a partial and an equilibrium effect of the reform. Instead of directly assuming a certain reduction of the benefit replacement rate, we will use the IAB Job Vacancy Survey to empirically measure and then target the partial effect of Hartz IV in our model. Furthermore, we will use the time series behavior of the selection rate and the job-finding rate to determine the relative importance of partial and equilibrium effects over the business cycle. Our macroeconomic model of the labor market will be calibrated to the microeconomic estimates and used to evaluate the macroeconomic employment and earnings effects of Hartz IV. In addition, we will analyze welfare issues and interactions with other reform steps (such as Hartz III).In the second project, we aim at gaining deeper insights on the open-economy effects of the Hartz reforms based on the tradability of establishments’ output. We will document how worker and job flows as well as earnings changed around the time of the Hartz III and Hartz IV reforms depending on the degree of tradability of establishments’ output. We will use the Administrative Wage and Labor Market Flow Panel (AWFP), which contains flows and earnings for all German establishments, and link it with two sources on international exposure. We will contrast these empirical results with the results from a monetary union model with search frictions and a tradable and a non-tradable sector. From a theoretical perspective, we expect that the tradable sector is affected more (immediately) by labor market reforms. We will analyze whether a standard model of this type can generate similar patterns as in the data with reasonable parameter values. If this is not the case, we will modify parameters and important assumptions such as the wage formation mechanisms. In case model and data are sufficiently close, we can perform important counterfactual exercises in an open-economy setting. If model and data are nevertheless far apart, the project may discover an interesting puzzle for future theoretical research.

• DFG Programme: Research Grants