The role of wage policy in Europe: Implications of the wage-led demand regime

1. The role of wage policy in Europe: Implications of the wage-led demand regime Ozlem Onaran, Middlesex University and Engelbert Stockhammer, Kingston University

2. 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

6. 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)

7. 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

8. 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

9. 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

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

11. ULC (2000 = 100; AMECO)

12. Current account (% GDP)

13. Increases in household debt

14. 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!

15. 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 • pTwould have to be set such as to avoid deflation in all countries, while allowing rebalancing

16. 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)