What Determines the Reservation Wage: Theory and Some New Evidence from German Micro Data

This paper uses micro data from the German Socio-Economic Panel to document that the wage structure in West Germany has been remarkably stable over the period 1984-97, with little variation over time in wage or earnings inequality between and within different skill groups. The paper investigates a number of possible explanations for the stability of the wage structure and concludes that it is attributable to institutional factors rather than market forces. Consequently, the rigidity of relative wages despite relative shifts in labor demand that favor skilled workers has resulted in sharp declines in employment rates for unskilled workers. The micro evidence is also shown to have important implications for interpreting trends in wage shares, capital-labor ratios and aggregate unemployment.