Exports and Unemployment: Evidence from the German Länder

The connection between external trade and unemployment is often addressed by politicians but seldom by economists. Among the latter, the idea of promoting exports in order to reduce unemployment counts as a relapse into the dark ages of mercantilism. Economists tend to orthogonalize external trade and unemployment: the real wage clears the labor market, the real exchange rate balances external trade. This paper goes against this prevailing attitude and investigate the link between unemployment and external trade. Our database focuses on German Länder (federal states) and their performance in unemployment and external trade since German unification in 1990. Western and Eastern states exhibited enormous differences in these areas. Eastern states were hard hit by the collapse of Soviet bloc trade in the early 90s while Western states were hit by the collapse of world trade in the wake of the recent financial crisis. Using panel econometrics we find that trade openness as measured by state wise exports and/or imports has a significant negative impact on statewise unemployment. We discuss to what extent this reflects mercantilist tendencies embedded in the political economy of the Federal Republic. Simple mercantilism is rejected, i.e. we find that statewise trade balances have no significant impact on unemployment. The paper closes with a discussion of factors that might explain the observed link between external trade and unemployment.