Unemployment, Hours, Taxation and the Welfare State– A Quantitative Assessment of Institutional Changes∗

This paper addresses, within a structural matching model with heterogeneous risk-averse agents, whether key mechanisms identified in the literature can quantitatively account for the different labor market experiences between the US and Germany. The set of facts a successful theory of the labor market should jointly explain are the strong increase in unemployment rates in Germany by five percentage points, the strong decline in average hours worked per person employed by fifteen percentage points, the decline in labor force participation rates relative to the US by six percentage points and the (almost) constancy of the German wage distribution relative to the big increase in wage inequality in the US. We focus on the role of taxation, the unemployment benefit system, union behavior, the increase in turbulence and the welfare state. We show that these explanations imply a positive relation between unemployment and hours worked. Therefore neither of the mechanisms can explain the rise in unemployment and the fall in hours worked jointly. We highlight that the increase in the social assistance level in Germany can quantitatively account for the wage compression as well as the labor force participation differential between the two countries. However, it cannot explain changes in unemployment rates or hours worked. JEL Classification System: E31,E32,E24,J6