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Germany’s economy is so bad even sausage factories are closingIWHThe Economist, January 15, 2026
East German manufacturers’ revenue productivity (value-added per worker) is some 8 (25) percent below West German levels, even three decades after German unification. Using firm-product-level data containing information on product quantities and prices, we analyse the role of product specialisation and reject the prominent ‚extended work bench hypothesis‘, stating a specialisation of Eastern firms in the intermediate input production as explanation for these sustained productivity differences. We decompose the East’s revenue productivity disadvantage into Eastern firms selling at lower prices and producing more physical output for given amounts of inputs within ten-digit product industries. This suggests that Eastern firms specialise vertically in simpler product varieties generating less consumer value but being manufactured with less or cheaper inputs. Vertical specialisation, however, does not explain the productivity gap as Eastern firms are physically less productive for given product prices, implying a genuine physical productivity disadvantage of Eastern compared to Western firms
I study how labour market power affects firm wage differences using German manufacturing sector firm-level data (1995-2016). In past decades, labour market power increasingly moderated rising between-firm wage inequality. This is because high-paying firms possess high and increasing labour market power and pay wages below competitive levels, whereas low-wage firms pay competitive wages. Over time, large, high-wage, high-productivity firms generate increasingly large labour market rents while selling on competitive product markets. This provides novel insights on why such “superstar firms” are profitable and successful. Using micro-aggregated data covering most economic sectors, I validate my results for ten other European countries.
I study how cross-country capital market integration affects the gains from trade in a model with financial frictions and heterogeneous, forward-looking firms. The model predicts that misallocation among exporters increases as trade barriers fall, even as misallocation decreases in the aggregate. The reason is that financially constrained productive exporters increase their production only marginally, while unproductive exporters survive for longer and increase their size. Allowing capital inflows magnifies misallocation, because unproductive firms expand even more, leading to a decline in aggregate productivity. Nevertheless, under integrated capital markets, access to cheaper capital dominates the adverse effect on productivity, leading to higher output, consumption and welfare than under closed capital markets. Applied to the period of European integration between 1992 and 2008, I find that underdeveloped sectors experiencing higher export exposure had more misallocation of capital and a higher share of unproductive firms, thus the data is consistent with the model’s predictions. A key implication of the model is that TFP is a poor proxy for consumption growth after trade liberalisation.
Does finance facilitate efficient allocation of resources? Our aim in this paper is to find out whether increases in private and public indebtedness affect capital misallocation, which is measured as the dispersion in the return to capital across firms in different industries. For this, we use a novel dataset containing industrylevel data for 18 European countries and control for different macroeconomic indicators as potential determinants of capital misallocation. We exploit the within-country variation across industries in such indicators as external finance dependence, technological intensity, credit constraints and competitive structure, and find that private debt accumulation disproportionately increases capital misallocation in industries with higher financial dependence, higher R&D intensity, a larger share of credit-constrained firms and a lower level of competition. On the other hand, we fail to find any significant and robust effect of public debt on capital misallocation within our country-sector pairs. We believe the distortionary effects of private debt found in our analysis needs a deeper theoretical investigation.
In this paper we analyse how the terms of trade (TOT) – the ratio of export prices to import prices – affect total factor productivity (TFP). We provide empirical macroeconomic evidence for the European Union countries based on the times series SVAR analysis and microeconomic evidence based on industry level data from the Competitiveness Research Network (CompNet) database which shows that the terms of trade improvements are associated with a slowdown in the total factor productivity growth. Next, we build a theoretical model which combines open economy framework with the endogenous growth theory. In the model the terms of trade improvements increase demand for labour employed in exportable goods production at the expense of technology production (research and development – R&D) which leads to a shift of resources from knowledge development towards physical exportable goods. This reallocation has a negative impact on the TFP growth. Under a plausible calibration the model is able to replicate the observed empirical pattern.
This paper finds that employment protection legislation (EPL) had a significant impact on employment adjustment in Europe over 2001-2013, once we account for firm-size related exemptions to EPL. We construct a novel coverage-adjusted EPL indicator and find that EPL hinders employment growth at the firm level and increases the share of firms that remain in the same size class. This suggests that stricter EPL restrains job creation because firms fear the costs of shedding jobs during downturns. We do not find evidence that EPL has positive effects on employment by limiting job losses after adverse shocks. In addition to standard controls for the share of credit-constrained firms and the position in the business cycle, we also control for sizerelated corporate tax exemptions and find that these also significantly constrain job creation among incumbent firms.
Using firm-level data between 2004 and 2012 for eleven countries of the European Union (EU), we document the size of product and labour market imperfections within narrowly defined sectors including services which are virtually undocumented. Our findings suggest that perfect competition in both product and labour markets is widely rejected. Levels of the price-cost margin and union bargaining power tend to be higher in some service sectors depicting however substantial heterogeneity. Dispersion within sector and across countries tends to be higher in some services sectors assuming a less tradable nature which suggests that the Single Market integration is partial particularly relaxing the assumption of perfect competition in the labour market. We report also figures for the aggregate economy and show that Eastern countries tend to depict lower product and labour market imperfections compared to other countries in the EU. Also, we provide evidence in favour of a very limited adjustment of both product and labour market imperfections following the international and financial crisis.
This article investigates how changing production processes and increasing market power at the firm level relate to a fall in Germany’s manufacturing sector labour share. Coinciding with the fall of the labour share, I document a rise in firms’ product and labour market power. Notably, labour market power is a more relevant source of firms’ market power than product market power. Increasing product and labour market power, however, only account for 30% of the fall in the labour share. The remaining 70% are explained by a transition of firms towards less labour-intensive production activities. I study the role of final product trade in causing those secular movements. I find that rising foreign export demand contributes to a decline in the labour share by increasing labour market power within firms and by inducing a reallocation of economic activity from nonexporting- high-labour-share to exporting-low-labour-share firms
This article examines how trade shocks shape labour market imperfections that create market power in labour markets and prevent an efficient allocation of labour. I develop a framework for measuring such labor market distortions in monetary terms and document large degrees of those distortions in Germany’s manufacturing sector. Import competition can only exert labor market disciplining effects when firms rather than workers have labour market power. Otherwise, export demand and import competition shocks tend to fortify existing distortions by amplifying labour market power structures. This diminishes the gains from trade compared to a model with perfectly competitive labour markets.
We investigate how adopting the euro affects exports using firm-level data from Slovakia and Estonia. In contrast to previous studies, we focus on countries that adopted the euro individually and had different exchange rate regimes prior to doing so. Following the New Trade Theory we consider three types of adjustment: firm selection, changes in product varieties and changes in the average value of the exports that compose the exports of individual firms. The euro effect is identified by a difference in differences analysis comparing exports by firms to the euro area countries with exports to the EU countries that are not members of the euro area. The results highlight the importance of the transaction costs channel related to exchange rate volatility. We find the euro has a strong pro-trade effect in Slovakia, which switched to the euro from a floating exchange rate, while it has almost no effect in Estonia, which had a fixed exchange rate to the euro prior to the euro changeover. Our findings indicate that the euro effect manifested itself mainly through the intensive margin and that the gains from trade were heterogeneous across firm characteristics.
