Rethinking wage policy in the face of the Euro crisis. Implications of the wage-led demand regime

Abstract

Ten years after its introduction, the Euro is in an existential crisis. The crisis is the outcome of economic policies that have aimed at labour market flexibility and financial integration. This paper argues, firstly, that the aggregate demand regime in the Euro area is wage led. While an increase in wages (other things equal) does have a negative effect on investment and on net exports, it does have a positive effect on consumption. As the Euro area is a relatively closed economy, the consumption effect overpowers the investment effect and the export effect. Secondly, we argue that in the Euro area two growth models have emerged: a credit-led and an export-led model. These have given rise to the imbalances that are at the heart of the Euro crisis. Wage flexibility has proven insufficient to prevent these imbalances. Thirdly, we advocate a system of coordinated wage bargaining that aims at wages rising in line with productivity growth and a substantially upward-revised inflation target. If the project of European economic integration is to survive, it needs a drastic change in direction. An important building block of this redirection is a rethinking of the role of wage policy.

Keywords:

• Euro crisis
• European integration
• wage policy
• Keynesian economics

JEL Classifications:

• E12
• E20
• E24
• E42
• E61

Acknowledgements

An earlier version of this paper was presented at the conference Economic Policies of the New Thinking in Economics, Cambridge, April 2011. The authors are grateful to the participants of the conference, to Paul Auerbach and two anonymous referees for comments. The usual disclaimers apply.

Notes

1. Adjusted wage share attributes the average wage rate to the self-employed; thus it is equal to labour compensation per employee × total employment/GDP at factor costs (source: AMECO).

2. Real unit labour costs are calculated as the adjusted labour compensation as a ratio to GDP at market prices (as opposed to GDP at factor costs; the two measures are 99% correlated).

3. Nominal unit labour costs are calculated as the real unit labour cost multiplied by the price deflator.

4. See Onaran and Galanis (2011) for Germany, France, Italy; Stockhammer and Stehrer (2011) for Germany, Finland, France, Luxemburg, Netherlands, Sweden, Ireland; Naastepad and Storm (2007) for Germany, France, Italy, Netherlands, Spain; Hein and Vogel (2008) for Germany, France, Austria, Netherlands; Bowles and Boyer (1995) for Germany and France; Stockhammer, Hein, and Grafl (2011) for Germany; Ederer and Stockhammer (2007) for France; Stockhammer and Ederer (2008) for Austria.

5. Onaran and Galanis (2011) for Germany, France, Italy; Naastepad and Storm (2007) for Germany, France, Italy, Netherlands, Spain; Stockhammer, Hein, and Grafl (2011) for Germany; Hein and Vogel (2008) for Germany and France. Using a structural VAR methodology, Stockhammer and Onaran (2004) find that the total effect of distribution on aggregate demand in France is insignificant. Bowles and Boyer (1995) find profit-led regimes in Germany and France, but their results suffer from econometric problems such as unit root issues; they do not apply difference or error correction models. In addition, outside the Euro area. both the US (Onaran Stockhammer and Grafl 2011; Onaran and Galanis 2011; Hein and Vogel 2008; Bowles and Boyer 1995) and the UK (Onaran and Galanis 2011; Hein and Vogel 2008; Naastepad and Storm 2007; Bowles and Boyer 1995) are found to have wage-led aggregate demand regimes. Naastepad and Storm (2007) is the only study that finds a profit-led demand regime in the US; however, this is due to a perverse domestically profit-led demand regime.

6. See Hein and Vogel (2008) for Austria and Netherlands; Stockhammer and Ederer (2008) for Austria.