The Adjustment Effects of a Skilled Labour Supply Shock

Over the last decades many countries have seen rapid changes in the returns to skills and in income inequality. Theory predicts that a sudden increase in the supply of skilled workers is likely to reduce skilled wages. In the longer run skills can adjust, increased skills can have spillovers such as on innovation, and the competitiveness of the economy may change as skilled work becomes cheaper. We know little about the size and speed of adjustments of wages and skills to a skilled labour supply shock, and its spillovers and effects on the local economy.

I propose to study these responses by focusing on the labour supply shock induced by the mass migration of relatively skilled East Germans to West Germany after the fall of the Berlin Wall in 1989. The insights from this research have important implications for policies on wages, employment, skills and competitiveness in response to structural economic transformations, not only for Germany but for most other countries. In particular, the project will address the following main questions.

(1) Does a larger number of skilled workers reduce the wages of skilled workers? What are the dynamics of wage and employment adjustments in the short and longer run? For understanding these responses better, I will also examine productivity effects and changes due to differential rent sharing, as the bargaining power of skilled workers changes with their relative supply.

(2) What are the spillovers of increasing the supply of skilled workers in the economy? One effect of price adjustments is that the incentives to acquire skills and to work in specific occupations change. I will document these effects, for example, by using data on the task intensity of specific occupations. By constructing a new dataset on patenting in East and West Germany, I will also examine to what extent larger numbers of skilled workers foster local innovation.

(3) Do changes in the skill composition affect the long-term trajectory of a local economy by changing its comparative advantage? I will assess the creation and growth of firms in response to the skilled labour supply shock, and analyse the difference in responses across firms and industries for tradable and non-tradable goods.

A particular strength of the proposed analysis is its research design, which uses a historic event to generate quasi-experimental variation in the data. After the Berlin Wall fell in November 1989, around two million East Germans moved to West Germany until the early 1990s, increasing the West German labour force by over three percent by 1992. This large-scale immigration provides a particularly useful case study of a large skilled labour supply shock because the migration from East to West Germany after 1989 was sudden and unanticipated, and East and West Germans speak the same language.

Evidence on the causal effects of labour supply shocks is scarce because it is difficult to isolated causal outcomes from confounding endogenous factors such as prevailing local economic conditions. To overcome this difficulty, I propose to construct data on the historical settlement patterns of East Germans in West Germany, which I use to predict the location of newly arriving East Germans after the fall of the Berlin Wall. For implementing this research design, I will extract novel information from two detailed secure-access administrative datasets, which have not been used in this context before.

The scientific output of the proposed research is aimed at publication in top academic journals, and I expect my contributions to advance the academic as well as the policy debate on the evolution of skills, wages, and comparative economic advantage in response to labour market shocks. A thorough understanding of these effects is crucial for workers, firms, governments and international institutions to make informed policy choices.

Besides its intellectual merit, the results from the proposed research have immediate policy relevance. Knowledge on how an increase in the number of skilled workers impact on wages, employment, innovation and the productivity of local labour markets is crucial for informed policy making in the UK and elsewhere. From the onset of the project period I aim to maximise impact by building links and contacts with potential beneficiaries and users of the research. Potential beneficiaries include:

1) The academic community: The scientific output of the proposed research is aimed at publication in top academic journals, and I expect the findings of this project to advance significantly the academic debate on the effects of skilled workers on the economy. The results of this research can further serve as an empirical basis for developing theoretical models of the labour supply and firm responses in fields of economics such as labour and public economics, the economics of innovation and productivity, and trade and migration economics.

2) Governments, organisations, the broader policy community and NGOs: Output from the proposed research will be beneficial for policy makers in the UK and abroad. The research questions addressed in this project are particularly timely, with labour markets around the world facing significant structural changes due to import competition, outsourcing, migration or automation. Knowledge about labour supply and demand effects for workers of difference skill groups is crucial for drafting policies in response to such changes. Institutions such as UK government departments, ministries of other countries, the European Commission, the Organisation for Economic Co-operation and Development, the World Bank, the International Monetary Fund, and NGOs and think tanks may employ the findings of the proposed research to make economic predictions, to devise better measures that can ameliorate inequality and skills shortages, and more generally to advise countries on the implementation of labour market policies.

3) The media and the general public: The findings of the proposed research are likely to be of utmost interest to the media, the general public, the business community and worker unions. The results from the proposed research have direct relevance for informing the media and the general public about the effects of structural labour market changes, and thereby will contribute to more informed debates about important policy choices. For economic agents such as workers, entrepreneurs and firms, better understanding and predictions about the consequences of changed numbers of skilled workers in an economy will improve decision making.