The role of wage policy in Europe: Implications of the

wage-led demand regime

Ozlem Onaran, Middlesex University and

Engelbert Stockhammer, Kingston University

Motivation• Wage policy

– Full employment – Fair and stable income distribution– Balanced international positions

• Neoclassical/’mainstream’/NCM– Wage flexibility – in theory, wage moderation – in practice– wages merely as a cost item, and ignores the role of wages as a source

of demand• Post-Keynesian/New Economics

– Eurozone: wage-led demand• wage moderation→growth↓, unemployment↑

– Productivity-oriented wage policy– coordination of (national) wage bargaining systems– Take into account inflation target and external position– In the € area: higher wages in Germany!

3

Outline

• What is the effect of a wage cut on demand?• Theoretical background

– Wage-led vs. profit-led demand regime– Neo-Kaleckian/Post-Keynesian model

• Empirical literature• wage policy in Europe

– Imbalances: export-led growth and credit-led growth

– Wage coordination

4

Wage share and GDP growth, 1961-2010

Wage share

5

Wage share and unemployment, 1961-2010

unemployment

Wage share

Model• What is the effect of a wage cut on demand?

• Neo-Kaleckian/Post-Keynesian model

• pro-capital income distribution: + & - effects on aggregate demand

- effect on C: the relative size of the consumption differential out of wage vs. profit income

+ effect on I: the sensitivity of investment to profits

+ effect on NX: the sensitivity of net exports to unit labor costs

Total effect on demand is ambiguous

-: wage-led demand

+: profit-led demand

• Bhaduri and Marglin (1990)

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Empirical Literature• Systems approach (VAR): Deals with simultaneity, weak in identifying

effects on C and I (few if any control variables)– small effects (Stockhammer & Onaran 04, US, UK, F; Onaran & Stockhammer 05,

Korea, Turkey) or profit-led demand (Barbosa-Filho & Taylor 06, US; Flaschel & Proano 07)

• Single equation approach: Good in identifying effects, bad in dealing with endogeneity– estimate separate C, I, NX functions.

• Bowles & Boyer 95; Naastepad & Storm 06; Hein and Vogel 08: OECD6/8– estimate separate C, I, X, M, P functions

• Onaran, Stockhammer, Grafl 11, Stockhammer, Onaran, Ederer 09; Ederer & Sto. 07, Sto. & Ederer 08, Sto./Hein/Grafl 10: US, Eurozone, France, Austria, Germany respectively

• US: effects of financialization

• Most find wage-led private domestic demand regimes – Onaran et al11, Stockhammer et al09, Storm&Naastepad06, Hein&Vogel08,

Sto.&Ste09

Empirical findings: Euro area• Stockhammer, Onaran, Ederer, CJE 2009• low degree of openness (X/Y: 12%) -> wage-led regime• Estimate the effects of functional income distribution

consumption, investment and net exports• A 1%-pt decrease in the wage share (WS) leads to• Consumption ↓ by 0.4%-pt (as a ratio to GDP)• Investment ↑ by 0.1%-pt (as a ratio to GDP)• Domestic private demand ↓ by 0.3%• Net exports ↑ by 0.1%-pt (0.06-0.13%-pt )• Aggregate demand (private) ↓ by 0.2%→EU as a whole has a wage-led demand regime, although

some individual member states may have a profit-led regime

Wage policy in the Euro area

• Race to the bottom: declining wage shares (22 wage pacts aimed at improving competitiveness)

• Fall in wage share has led to a stagnation of domestic demand• 2 growth models in response: credit-led and export-led

growth• → imbalances within the Euro area

Credit-led Export-led

Center (US, UK) Germany, Austria (Japan)

Periphery Greece, Ireland, Portugal, Spain

(China)

Germany: GDP, priv. cons., adj WS (1994 = 1)

0.92

0.93

0.94

0.95

0.96

0.97

0.98

0.99

1.00

1.00

1.05

1.10

1.15

1.20

1.25

adj.

wag

e sh

are

GD

P, c

on

sum

pti

on

Priv cons.Ger

GDP.Germany

Adj WS.Ger

ULC (2000 = 100; AMECO)

Current account (% GDP)

Current account (% GDP), avg. 2000-07 

Germany 3.8 Greece -8.5

Austria 1.7 Portugal -8.9

Netherlands 5.6 Spain -5.8

    Italy -1.3

    Ireland -2.1

Increases in household debt

Increase in HH debt (in % GDP) 2000/04 and 2000/08

2000/08 2000/08

Germany -11.34 Ireland 61.72

Netherlands 29.1 Greece 18.26 2000/05

Austria 7.21 Spain 32.53

Italy 18.09

Portugal 21.31

How can the €-zone re-balance?

• How much rebalancing is necessary?– ULC 25-30%– German wage growth has to be 2.5%-pts. above

mediterranean wage growth for 10 years!• 1 deflation

– Big contraction in PIIGS to bring down GDP and ULC and thus, ultimately, CA-deficit

– But: that means rising debt ratios!• 2 inflation

– Expansion and/or wage inflation in Germany – Higher inflation target in € area!

Wage coordination• European system of coordinated wage bargaining• As part of a new policy economic policy mix• Aim:

– ensure that living standards of the working class are growing– Prevent excessive inflation– Prevent/counteract imbalances

• wj = xj + pT + a(ULCEU – ULCj) – w..wage growth, x..productivity growth, pT..inflation target,

ULC..unit labour costs, – Subscripts EU and country j– pT would have to be set such as to avoid deflation in all

countries, while allowing rebalancing

Wage policy - conclusions• Focus on wage flexibility is misplaced

– Does not guarantee full employment– Unable to guarantee a fair and stable distr of income– Unable to avoid international imbalances

• Productivity-oriented wage policy to stabilize effective demand

• Coordination of wage bargaining systems to prevent a race to the bottom

• In the Euro area: wage policy has to take into account current account positions

• To avoid a deflationary adjustment: substantially higher wage growth in Germany (mediterranean wages +3%-pts. for 10 yrs)