Unequal Pay or Unequal Employment? What Drives the Skill-Composition of Labor Flows in Germany?

Regional economic prospects to some extent seem to hinge on the region’s human capital endowment and, thus, its ability to attract skilled labour. For any related policy, it is thus important to better understand the determinants of skill-selective migration.

As the main selection mechanism, the existing literature suggests that individuals move to regions that best reward their skills in terms of wages. For this reason, skilled individuals with a choice between two regions that have the same average wage rate should prefer the region with the higher wage inequality, while unskilled individuals should avoid such regions. While this selection mechanism has been empirically confirmed for the US, evidence within the German context is much weaker. We suspect that regional wage rigidities resulting from central wage bargaining prevents a wage-based selection mechanism and, therefore, propose an additional employment-based selection mechanism. The main idea is that income differentials rather than wage differentials determine skill-selective migration. Since the probability of being employed is not equally distributed across the workforce, but tends to increase with the skill level, unskilled individuals should avoid regions with a high employment inequality. In fact, an extended framework predicts skilled workers to be disproportionately attracted to regions with higher mean wages and employment rates as well as higher regional wage and employment inequalities. We test these predictions for gross labour flows between 27 regions in Germany. For this purpose, we estimate the observable skill level of an average labour migrant for each gross flow across a ten year period. In addition, we estimate the parameters of the regional wage and employment distributions for each region and year. Using both a labour flow fixed effects model as well as a GMM estimator, the findings suggest that regional differentials in the employment distribution turn out to be important. In particular, a region attracts an increasingly skilled inflow of migrants, the higher is its average employment rate (i.e. the lower its unemployment rate). The same is true for an increasing employment inequality.

The less equal employment chances are spread across the regional workforce, the more a region attracts an increasingly skilled inflow of migrants. In contrast, regional differentials in the wage distribution exert no significant effect on the skill composition of labour flows in Germany. For this reason, the extended model has a much better predictive power for the observed net skill transfer between, for example, eastern and western Germany, than the standard wage-based model.

Hence, this paper suggests that when wages tend to be rather inflexible at a regional scale, the spatial allocation of human capital may be driven by regionally varying employment chances rather than wages. These findings are relevant beyond Germany whenever regional wage rigidities prevent flexible wage adjustments. Moreover, policies that aim at preventing brain drain phenomena should not focus on fostering wage convergence alone, but need to take into account the effects of regionally varying employment chances as well.

Arntz, Melanie, Terry Gregory and Florian Lehmer (2011), Unequal Pay or Unequal Employment? What Drives the Skill-Composition of Labor Flows in Germany?, ZEW Discussion Paper No. 11-074, Mannheim.