Working Paper
Escaping the Unemployment Trap - The Case of East Germany
This paper addresses the question of why prolonged regional unemployment differentials tend
to persist even after their proximate causes have been reversed (e.g., after wages in the highunemployment
regions have fallen relative to those in the low-unemployment regions). We
suggest that the longer people are unemployed, the greater is the likelihood of falling into a
low-productivity "trap," through the attrition of skills and work habits. We develop and
calibrate a model along these lines for East Germany and examine the effectiveness of three
employment policies in this context: (i) a weakening of workers’ position in wage
negotiations due to a drop in the replacement rate or firing costs, leading to a fall in wages,
(ii) hiring subsidies, and (iii) training subsidies. We show that the employment effects of these
policies depend crucially on whether low-productivity traps are present.
Key Words
- Calibration
- East Germany
- labor market traps
- labor markets