Testing incentives for illegal employment: Implicit contracts vs trade union bargaining

Politicians and trade unions raise the issue of illegal employment in order to provoke support, voters feel negatively touched by the presence of illegal employment, often also associated with illegal immigration. In addition there was a severe discussion in Germany about passing a minimum wage in the German construction sector in order to keep foreign firms from wage-dumping on German construction sites. There exists a general impression that illegal alien employment poses a major threat for the national social security system and that more illegal aliens can not be tolerated. Schoorl et al. (1996) estimate 277.000 unregistered illegal aliens in Germany. Similar arguments are raised concerning the problem of illegal employment in general in the presence of mass unemployment. This paper deals with the question of whose interests are effected in which way by illegal employment. Hence, the focus is not on absolute numbers but on the reasons of illegal employment. The West-German construction sector serves as our example. Two different settings of labour market designs are analysed. One is the implicit contract model and the other a traditional model of trade union bargaining. Each approach delivers incentives to demand, supply or tolerate illegal employment for the participating agents. Whereas in the implicit contract framework, illegal employment serves as a buffer to smooth legal employment over different states of the economy, the trade union model leads way to employment of illegally employed workers in order to maximise the utility of organised workers. So the question can be reformulated: is illegal employment a permanent phenomenon caused by the institutional setting of a unionised labour market or is it a transitory phenomenon caused by different states of nature in a long-term contractual arrangement?