Capital Stock, Unemployment and Wages in Germany and the U.K

The purpose of this paper is to examine the proposition that capital formation is an important variable in the determination of unemployment and wages in Germany and the U.K. Underlying this proposition is the notion that capital accumulation plays a central role in the adjustment process of an economy in response to shocks. Over the period under investigation, 1968q1-1995q4, Germany and the U.K. experienced big shocks which have affected their labor and product markets. The dramatic rise in unemployment in the 1980s was attributed to adverse supply shocks. However, after the reversal of the shocks, unemployment persisted which some economists explained by resorting to inflexibilities in the labor markets. It is worth noting that although the U.K. has increased labor market flexibility over the last fifteen years or so, it is only recently that success can be claimed in terms of reducing unemployment. The German government at the same time has started to reduce worker protection and increase flexibility of working hours. More recently, attention has been diverted from cures for inflexible labor markets to the effect of changes in interest rates and capital shortage on the unemployment rate that is consistent with non-accelerating inflation and wages (NAIRU). Broadly speaking, there are two main arguments on this issue: one that concentrates on the cost of capital and the other which focuses on the quantity of physical capital. The first is concerned with the determination of what might loosely be called the "long-run" NAIRU in the sense that capital grows at its equilibrium rate and that the labor market is also in equilibrium. The second is concerned with the determination of unemployment and wages during the adjustment process in the capital goods market, making the assumption that the adjustment process may take a long period of time. This concept of NAIRU might loosely be called "medium-term" NAIRU. This paper is mainly concerned with the determination of unemployment and wages during the adjustment process in the capital goods market. The focus is on the determination and comparison of wages and unemployment in both countries on the basis of the "medium-run" NAIRU concept. We argue that adverse demand shocks affect employment and investment. When shocks reverse, unemployment may not fall to previous levels, due to insufficient capital. Our empirical results show that the unemployment rate has risen in the last twenty years or so in both countries due to insufficient investment