Research results
How government spending shifts the balance of power on the labour market
Symbolic image: Government spending brings movement to the labour market. Employees are more willing to change jobs and companies compete for potential employees. Wages can rise as a result. // Photo Colourbox
The published study focuses on the question: How do government spending programmes - such as for infrastructure, education, research and climate protection - affect employment and gross domestic product? To answer this question, the authors Christian Bredemeier (University of Wuppertal), Babette Jansen (University of Antwerp, Belgium) and Roland Winkler (University of Jena) focused on the labour market. In doing so, the team chose a new approach. In the models usually used to analyse and predict economic developments, the labour market is often only represented in a very simplified way.
"Our study shows that government spending not only has an effect via the familiar demand mechanism, which describes the fact that demand for goods and services increases, companies produce more, hire more staff and the economy grows," summarises Christian Bredemeier, Professor of Applied Economics at the University of Wuppertal. "Spending also changes the balance of power on the labour market, which boosts wages and, once again, economic development."
What's behind it all
The starting point for the considerations is an everyday observation: workplaces differ, for example in terms of working hours, commuting distances or the working atmosphere. Because such aspects are important to employees, they do not immediately change jobs just because another company pays a higher salary. This behaviour gives employers leeway when setting wages: they can reduce their employees' salaries below the level that actually corresponds to their work performance and productivity.
In their study, the researchers now show that increasing government spending can change this situation. Why? Additional government spending must be financed. Accordingly, citizens expect that - sooner or later - they will have to pay higher taxes or receive lower state benefits. In such a situation, every additional euro of income becomes more important for employees.
They are now more willing to change jobs for better pay or give up certain amenities. For companies, this means that they lose some of their wage power and have to compete more fiercely for labour. The consequences: higher wages, more hiring and a stronger increase in employment and production. "We are finding that these movements on the labour market mean that the economic effects of government spending are significantly greater than previously assumed," emphasises Professor Bredemeier.
Reviewed and confirmed
The authors also tested their new prediction using data from the USA. There, too, they found that production and working hours increase after unexpected increases in government spending - and there are indications that employees react more strongly to better wage offers. The mechanism described is therefore also confirmed here.
Christian Bredemeier: "If you want to understand the effect of government spending, you also have to look at power relations on the labour market. Our study shows that this is precisely where a large part of the effect arises."
Christian Bredemeier, Babette Jansen, Roland Winkler, Labour Market Power and the Effects of Fiscal Policy, The Economic Journal, 2026; , ueag023, https://doi.org/10.1093/ej/ueag023.
Link to the publication: academic.oup.com/ej/advance-article/doi/10.1093/ej/ueag023/8472856
How was the work done?
The work combines theoretical and statistical methods to analyse economic relationships in a realistic way.
DSGE models: Usually computer-simulated models that describe how an economy functions as a whole. They take into account developments over time and unexpected events such as crises. What is new is that labour market characteristics such as working conditions and company power have also been included.
Extended VAR models: Statistical methods that show how economic variables - such as consumption, employment and investment - influence each other. This takes into account the expectations that households and companies have about the future. This makes it easier to assess the effects of government spending.
Complementary log-log regressions: Methods that can be used to analyse how likely rare events are, such as a job change. The method precisely estimates the extent to which wage differences lead to movements between jobs and thus provides a key measure of the intensity of competition for labour.
