Coordination versus flexibility in wage formation: a focus on the nominal wage impact of productivity in Germany, Greece, Ireland, Portugal, Spain and the United States

Abstract

Wage coordination between countries of the European Monetary Union (EMU) aims at aligning nominal wage growth with labour productivity growth at the national level. We analyse the developments in Germany, the EMU’s periphery countries Greece, Ireland, Portugal and Spain along with the United States over the period 1980 to 2010. Apart from the contribution of productivity to nominal wages, we take into account the contributions of prices, unemployment, replacement rates and taxes by means of an econometrically estimated nonlinear equation resulting from a wage bargaining model. We further study the downward rigidities of nominal wages. The findings show that in past times of low productivity, price inflation and reductions in unemployment still put significant upward pressure on nominal wage growth. The periphery countries are far from aligning nominal wage growth with productivity growth. German productivity is a major wage determinant, but surely not the only one. Within the context of a free bargaining process between employers and labour unions, policy-makers can effectively use the replacement rate to steer the nominal wages outcome.

Keywords:

• compensation per employee
• unit labour costs
• productivity
• labour market
• unemployment
• prices
• replacement rate
• monetary union

JEL Classification:

• C22
• E5
• E6
• E24
• J30

Acknowledgements

The views expressed here are solely the responsibility of the authors and should not be interpreted as reflecting the views of the Executive Board of Sveriges Riksbank. We thank participants of the CEPR/ECB/IfW Labour Market Workshop Wages in a time of adjustment and restructuring at the ECB in Frankfurt in December 2011. A policy-oriented summary of this article is published at http://www.voxeu.org/article/wages-and-productivity-eurozone. All remaining errors are for the authors.

Notes

1. ¹Another interesting avenue is the causal relationship from productivity to wages. Several theories argue that higher wages push up labour productivity, while others argue that higher wages depress labour productivity (see Caballero and Hammour, 1996; Fase and Tieman, 2001; Kleinknecht, 2003).

2. ²See Council of the European Union, 11 and 25 March 2011.

3. ³We interpret this negotiation power also as the value the employer or employee attaches to profits and utility, respectively (see also Fig. 3).

4. ⁴ In the original wage bargaining model of Graafland and Huizinga (1999), constant returns to scale were assumed, implying that Empirically, this restriction was later rejected for all countries under investigation (see Peeters and den Reijer, 2008), for which reason we introduced the flexibility that can deviate from 1. This parameter could even exceed 1, as argued by some referees, in which case the optimization of the wage bargaining model would fail due to nonconvexity of the objective function. However, yet, we have never found any empirical evidence for this in countries that we analyse (see also our empirical analyses in Section IV here).

5. ⁵In the literature, more definitions of wage coordination are around, see Acocella and Bartolomeo (2004) or Stockhammer (2008), but we stick strictly to the one specified in Equation 7* with

6. ⁶In the case of no negotiating power for the employer, implying , the profit function plays no role and the utility function is linear. Therefore, the after tax wage of the employee can be unlimited.

7. ⁷See Appendix A for a description of the database of time series and the previous section for graphs.

8. ⁸The lack of consistent time series on marginal tax rates across countries forces us to make this restriction. We leave analysing the marginal and average tax impact on wages to future research.