Petra Marotzke (Deutsche Bundesbank) 29 September, 2016, Open Seminar in Eesti Pank

1. Wage adjustment and employment
in Europe
Petra Marotzke (Deutsche Bundesbank)
Robert Anderton (ECB)
Ana Bairrao (ECB)
Clémence Berson (Banque de France)
Peter Tóth (Národná Banka Slovenska)
29 September, 2016
Note: The paper represents the authors‘ personal opinions and does not
necessarily reflect the views of the institutions with which they are affiliated.

2. Motivation
• Severe labour market conditions in Europe often attributed to
downward nominal wage rigidity
• Empirical analyses of the behaviour of wages and the impact of
nominal wage rigidity on employment in Europe
• Firm-level survey data of the Wage Dynamics Network:
2010-2013 period
mostly qualitative data („strong decrease“, „moderate“…)
firms’ perceptions of shocks which—combined with data on
wage adjustment— provide a tool to measure wage rigidities
Wage adjustment and employment in
Europe
2

3. Outline
1. Intro: Causes, measurement and impact of wage rigidity
2. Simplified relationship between wages and employment
3. Survey data
4. Evidence of downward nominal wage rigidity
5. Downward wage rigidity and employment
6. Concluding remarks
Wage adjustment and employment in
Europe
3

4. Downward nominal wage rigidity
(DNWR) - causes
• Institutional factors such as a high degree of union coverage and
employment protection (e.g. Holden and Wulfsberg 2008; Anderton and Bonthuis 2015)
• Employers fear that wage cuts would reduce their employees’
motivation (Stiglitz 1974, Solow 1979, Akerlof 1982, Du Caju et al 2015)
Wage adjustment and employment in
Europe
4
1 Intro

5. DNWR - measurement
• Asymmetric wage distribution:
– Wage freezes (e.g. Babecký et al. 2010,2012)
• all wage freezes would be wage cuts under flexible wages
• drawback: firms that freeze wages might be more flexible
than firms that increase wages
– %freezes/(freezes + cuts) (proposed by Dickens et al. 2007)
• drawback: firms that neither cut nor freeze wages are not
considered
• Here: Asymmetric wage response to change in demand
Wage adjustment and employment in
Europe
5
1 Intro

6. DNWR and firm-level employment
• Firms which freeze wages
– have flexible base wages: less likely to reduce employment (Dias et al. 2013)
• DNWR = deviation of notional from actual wage change:
– no solid results for impact on layoffs in the US (Altonji and Devereux 2000)
– increases probability of layoffs in the UK (Barwell and Schweitzer 2007)
– higher turnover in Italy (Devicienti et al. 2007)
• Here:
– IV ordered probit model of employment and wage adjustments to fall
in demand
– wage reduction significantly lowers the probability of a decrease in
employment at the firm level
Wage adjustment and employment in
Europe
6
1 Intro

7. Simplified relationship between wages and
employment
• Wage equation derived from Cobb-Douglas production function:
= 1 −
yields development of employment
∆ ln = ∆ ln + ∆ ln − ∆ ln
• If wages are completely rigid and prices remain unchanged:
∆ ln = ∆ ln
• In this simple model, a wage reduction could mitigate the fall in
employment induced by a negative demand shock
Wage adjustment and employment in
Europe
7
2 Simplified relationship

8. Survey data
• Harmonised questionnaire developed in the context of the ESCB
Wage Dynamics Network
• Firm survey conducted simultaneously in 25 European Union
countries during June to September 2014
• Questions referring to:
– general firm characteristics in 2013
– perceived shocks during the 2010-to-2013 period
– employment and wage development between 2010-2013
• w/o public sector: 24,750 firm responses
• Full estimation sample: 17,530 responses; EU 28 except
Denmark, Finland, Sweden, and Ireland
Wage adjustment and employment in
Europe
8
3 Survey Data

9. Estimation sample: variables
• Changes during 2010-2013:
Wage adjustment and employment in
Europe
9
3 Survey Data
Full sample Neg. D shock
17,530 7,706
Level of demand
Strong decrease 14% 32%
Moderate decrease 30% 68%
Unchanged 24% -
Moderate increase 27% -
Strong increase 5% -
Employmenta
Strong decrease 6% 11%
Moderate decrease 20% 32%
Unchanged 42% 41%
Moderate increase 27% 15%
Strong increase 4% 2%
Base wages
Strong decrease 2% 3%
Moderate decrease 6% 11%
Unchanged 31% 37%
Moderate increase 57% 45%
Strong increase 4% 4%
a
own definition based on payroll composition weighted average of permanent/ temporary or fixed‐term employees/ agency workers and
others

10. Wage adjustment and employment in
Europe
10
3 Survey Data
Full sample Neg. D shock
Firm characteristics 17,530 7,706
Sector Manufacturing 35% 32%
Electricity, gas, water 1% 1%
Construction 10% 11%
Trade 22% 24%
Business services 29% 29%
Financial intermediation 2% 2%
Arts 1% 1%
Ownership Mainly domestic 81% 84%
Mainly foreign 19% 16%
Size less than 19 employees 30% 36%
20-49 employees 23% 24%
50-199 employees 25% 23%
200 employees and + 22% 17%
Payroll composition Lower skilled 41% 42%
Higher skilled 59% 58%
Job tenure > 5 years 60% 65%
Permanent contracts 90% 91%
Temporary contracts 9% 9%
Agency 1% 0.3%

11. 11
3 Survey Data
Full sample Neg. D shock
Further changes in the economic environment 17,530 7,706
Lower access to external financing 25% 40%
Customers’ ability to pay decreased 44% 66%
Availability of supply decreased 16% 26%
(Very) relevant: Credit not available or conditions too onerous to
finance working capital 35% 44%
finance new investment 34% 42%
refinance debt 28% 36%
Costs and adjustments
Labor cost share in total costs 37% 38%
Performence related share (bonuses) 8% 8%
Share of firms paying bonuses 67% 61%
Wages were frozen in at least one year between 2010 and 2013 20% 26%
Wages were cut in at least one year between 2010 and 2013 7% 10%
Firing costs are a (very) relevant obstacle in hiring workers with a permanent,
open-ended contract
46% 55%
Wage setting
Share of workers covered by any collective pay agreement 54% 61%
Firm level (coll. agreement) 29% 29%
Outside firm level (coll. agreement) 37% 45%
Wage adjustment and employment in
Europe

12. 12
3 Survey Data
Wage adjustment and employment in
Europe
Employment Base wages or piece work rates
Base wages or piece work rates given employment development:
Strong decrease Moderate decrease Unchanged Moderate increase Strong increase Total
Strong decrease 13% 16% 37% 31% 3% 100%
Moderate decrease 3% 16% 38% 40% 3% 100%
Unchanged 1% 8% 43% 45% 4% 100%
Moderate increase 0% 4% 26% 65% 4% 100%
Strong increase 1% 2% 14% 58% 26% 100%
Total 3% 11% 37% 45% 4% 100%
Employment given
wage development:
Strong decrease Moderate decrease Unchanged Moderate increase Strong increase Total
Strong decrease 46% 16% 10% 7% 9% 11%
Moderate decrease 35% 48% 32% 29% 23% 32%
Unchanged 16% 29% 47% 40% 41% 41%
Moderate increase 2% 6% 10% 22% 16% 15%
Strong increase 0% 0% 1% 2% 11% 2%
Total 100% 100% 100% 100% 100% 100%
Employment and wage adjustments
when the level of demand goes down

13. Evidence of DNWR
Ordered probit model of base wage adjustments
∗
= + +
• = if < ∗
≤ ; are cut points
• = 1, … 5: strong decrease, moderate decrease, unchanged,
moderate increase and strong increase
• : share of workers covered by a collective pay agreement
• : comprises the five demand categories and dummies for firm
size, sector, country
• Price indices captured by sector and country dummies
Wage adjustment and employment in
Europe
13
4 Evidence of DNWR

14. 14
• Influence of wage bargaining process on DNWR
• Asymmetric demand elasticities for wages (z-tests)
• Bunch around unchanged base wages in response to negative
demand shock (significant marginal effect)
4 Evidence of DNWRMarginal effects on the probability of observing the outcome
(1) (2) (3) (4) (5)
base wages base wages base wages base wages base wages
VARIABLES strong decrease moderate decrease unchanged moderate increase strong increase
collective pay agreement -0.004*** -0.012*** -0.028*** 0.033*** 0.012***
(0.001) (0.002) (0.005) (0.006) (0.002)
demand
strong decrease 0.016*** 0.042*** 0.081*** -0.117*** -0.022***
(0.002) (0.004) (0.006) (0.010) (0.002)
moderate decrease 0.006*** 0.016*** 0.037*** -0.048*** -0.011***
(0.001) (0.002) (0.005) (0.007) (0.002)
unchanged (reference)
moderate increase -0.006*** -0.023*** -0.073*** 0.071*** 0.031***
(0.001) (0.002) (0.006) (0.006) (0.002)
strong increase -0.009*** -0.035*** -0.130*** 0.107*** 0.068***
(0.001) (0.002) (0.010) (0.006) (0.007)
Observations 17,530
p-value 0.000
Pseudo R-squared 0.110
Robust standard errors in parentheses
*** p<0.01, ** p<0.05, * p<0.1

15. Share of workers covered by collective
pay agreements (estimation sample)
Wage adjustment and employment in
Europe
15
4 Evidence of DNWR
EE 8 PT 62
LT 16 GR 69
UK 20 RO 72
PL 20 AT 75
HU 20 SI 80
BG 21 NL 90
MT 21 FR 94
LV 22 BE 95
CY 28 ES 97
CZ 34 IT 99
SK 38
DE 44 Total 62
HR 47 EA 74
LU 52 non-EA 29

16. Wage adjustments and employment
when demand falls – IV ordered probit
Employment equation
∗
= + " + "
• = if # < ∗
≤ #
Wage equation
∗
= + +
• Instrument for wage adjustments: collective pay agreement
• Assumption:
"
~ %
0
0
,
1 '
' 1
, ' ≠ 0
Wage adjustment and employment in
Europe
16
5 DNWR and employment

17. Collective agreements as an IV
Wage adjustment and employment in
Europe
17
5 DNWR and employment
• Assumption: collective bargaining has no direct effect on employment
• Boeri and van Ours (2013): the view that bargaining is over wages and
employers take the wage as given when “choosing the employment
levels” is a “standard (and realistic) characterization of collective
bargaining”
• Venn (2009): collective bargaining in Europe seldom covers
severance pay and notice periods different from legislation

18. 18
5 DNWR and employment

19. Further significant determinants of wage
and employment adjustments
• Negative on employment/wages
– Decrease in the availability of supplies
– Fall in the customers’ ability to pay
– Lower access to external financing
• Flexible wage components (dummy = 1 if bonuses/total wage bill > 0)
– positive on wages and employment
→adjusted prior to adjusting base wages and employment
• Firing costs: positive on wages
• Credit constraints w.r.t.
– refinance debt: negative on employment/wages
– finance investment: positive on employment
Wage adjustment and employment in
Europe
19
5 DNWR and employment

20. Robustness
• Separate estimation for EA and non-EA countries
• Exclusion of covariates
• Inclusion of the percentage of higher skilled workers and of
workers with more than five years of tenure
• Inclusion of persistence of demand shock
• Two-stage least squares: treat ordinal wage and employment as
continuous variables
suggests that wages are endogenous
conclude from the test statistics that our instrument is valid
yields negative relationship between wages and employment
Wage adjustment and employment in
Europe
20
5 DNWR and employment

21. Conclusions (1/2)
• Evidence of wage rigidities in Europe between 2010 and 2013:
– collective pay agreements reduce probability of downward
wage adjustment; implies more DNWR for countries with
larger shares of employees covered
– asymmetric demand elasticities for wages
• Negative effect of DNWR on firm-level employment when
rigidities induced by collective pay agreements
• Suggests that exit clauses in case of demand shocks could
mitigate negative employment effects at the firm level
Wage adjustment and employment in
Europe
21
6 Conclusions

22. Conclusions (2/2)
• Limitation of data: only includes survivors
• Macro level:
– No direct conclusions as wage adjustments and the incidence
of unemployment impact aggregate demand
– Opposing theories about the impact of wage rigidity on
employment
– Empirical papers: no or small negative impact of DNWR
• Outlook: Comparing degrees of DNWR between countries
Wage adjustment and employment in
Europe
22
6 Conclusions

23. Thanks for your attention
What is the impact of wage flexibility on
employment and output
23