In Germany, there is currently intensive discussion about the shortage of skilled workers. Despite employment peaks, according to surveys by the Ifo Institute, almost 50 percent of companies say they are limited by a shortage of skilled workers. Also a high. From an economic point of view, there is a simple answer to scarcity: price increases.
Transferred to the labor market, shortages could be overcome by raising wages. What would be the consequences? Some companies would withdraw from the market. Some unpleasant activities would be eliminated or automated. Workers are moving into jobs with higher wages and higher productivity. For individual companies that cannot keep up with the competition, this would be bitter. Overall, however, this results in a profit. In addition, people with higher wages are more willing to take a job.
It can be argued that the labour market is not a fully functioning market, and that the conclusion drawn is therefore misleading. From the perspective of evidence-based research, this is right and wrong at the same time.
Increased competition for labour
It is true that the labour market is not a market with perfect competition. Frictions are not the exception, but the rule. Many employees have specific skills and are not readily interchangeable. At the same time, employees often cannot easily switch from one employer to another. This results in market power of employers and also of some employees, who, unlike in perfect competition, are not price takers, but influence wages themselves. This perspective helps to better understand many surprising findings: for example, that there are vacancies and unemployment at the same time. Or that the minimum wage in Germany, at least so far, has not led to severe job losses.
Now to the crucial question: does the fact that the labour market is not a perfect market mean that competition and wage increases in the current situation are merely redistributive or even harmful? From the perspective of labour market research, there is much to suggest that the opposite is true. Labour shortages are therefore an expression of the fact that the wages offered are lower than productivity, i.e. what the employee could generate for the company.
Low-wage sector is subsidised
It is precisely the frictions on the labour market that ensure that workers are not deployed where they are most productive. The productive e-mobility start-up cannot grow sufficiently if the required female engineers remain with the established automotive supplier due to friction. More competition could thus lead to a double dividend: workers are increasingly deployed where they are more productive, and wages and working conditions improve, especially where they were too low from a market economy point of view. If employees with low incomes benefit disproportionately, inequality also decreases.
This is exactly the conclusion suggested by a recent study from the USA, where, despite a more favorable demographic structure, there are also complaints about a shortage of skilled workers. During the pandemic, many workers there had reoriented. This increased mobility has increased competition for labour, led to brain drain from relatively low-paid jobs and wage increases, especially in the low-wage sector. Inequality declined.
What are the costs of increased competition for labour? One concern is that higher wages lead to higher prices, so real wages stagnate. Price increases are to be expected, but the study from the USA, for example, suggests that stronger competition for labour leads to rising real wages for a large proportion of employees.
Counteracting the shortage of skilled workers through wage increases
In Germany, the low-wage sector is also subsidised by transfers such as top-ups. This means that the food delivered by the app driver is already more expensive for society as a whole than the bill shows. Wage increases in this area reduce subsidies.
Another concern is that more competition for labour could lead to a brain drain from socially important but regulated sectors – such as kindergartens or care. Here, political decisions rather than markets determine how performance is evaluated. Accordingly, politicians have a duty to design pay and working conditions in such a way that sufficient workers are available. For example, for the care industry, a study suggests that many workers would even work more if wages and working conditions improved. Keeping wages low elsewhere just to keep workers in those areas would be wrong.
Overall, this means that more competition for workers and the associated improvements in wages and working conditions can contribute to solving the shortage of skilled workers. This is not to say that reforms of the immigration system, child care or spouse splitting should be put on the back burner. But precisely because demographics are likely to reduce the supply of labour, competition is important. The legislator can remove barriers to competition and review measures such as short-time working, which may counteract job changes. Above all, however, it is up to the social partners themselves: where there is a shortage of workers, they can counteract the shortage by raising wages.
Clemens Fuest is President of the Ifo Institute and teaches economics at LMU Munich.
Simon Jäger is director of the Institute for the Study of Labor (IZA) and associate professor at the Massachusetts Institute of Technology.