Co-movements between public and private wages in the EU: What factors and with what policy implications?

Marzinotto, Benedicta; Turrini, Alessandro Article Co-movements between public and private wages in the EU: What factors and with what policy implications? IZA Journal of European Labor Studies Provided in Cooperation with: IZA – Institute of Labor Economics Suggested Citation: Marzinotto, Benedicta; Turrini, Alessandro (2017) : Co-movements between public and private wages in the EU: What factors and with what policy implications?, IZA Journal of European Labor Studies, ISSN 2193-9012, Springer, Heidelberg, Vol. 6, Iss. 2, pp. 1-16, https://doi.org/10.1186/s40174-016-0074-1 This Version is available at: https://hdl.handle.net/10419/195019 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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Benedicta Marzinotto 1* and Alessandro Turrini 2 * Correspondence: [email protected] 1 Department of Economics and Statistics, University of Udine, Via Tomadini 30/A, 33100 Udine, Italy Full list of author information is available at the end of the article Abstract This paper assesses the relationship between public and private wages in the EU, as measured by general government and manufacturing compensations, respectively. We find that the long-run relation between the two is stronger when the government is a large employer. Manufacturing compensations are better aligned with productivity and unemployment when general government compensations, to which they generally respond, are set through bargaining. Finally, manufacturing compensations react in the same way whether those in the general government sector are increased or cut, a relation that seems to hold also under fiscal consolidation provided the government is a large employer. JEL Classification: C32, E24, E62, H59 Keywords: General government compensations, Wage setting, Cost competitiveness, Fiscal consolidation, Co-integration 1 Introduction The Euro debt crisis has revived interest in the relation between fiscal policy and the labour market. Vulnerable countries face the multiple challenge of fixing distressed public finances, whilst having to improve cost competitiveness so as to reduce external imbalances as well as reabsorb excessive unemployment. These objectives are generally hard to reconcile, especially in high-debt countries where, for example, a fall in prices would come with a rise in real debt levels. Under specific circumstances, though, a fiscal consolidation strategy based on cutting excessive government wage expenditures could support cost competitiveness and possibly employment in the traded sector, if changes in public wages spill over to the private traded sector. This very same transmission channel is evoked in the fiscal-adjustment literature that has tried to quantify the differentiated output effects of consolidations based on their composition (Perotti 1996; Alesina and Perotti 1997; Lane and Perotti 1998; Alesina et al 2002; Ardagna 2004). 1 In parallel and more generally, a growing body of research has been looking at the long- and short-run relation between government wages and the labour market in “normal”times broadly finding that the two wages are indeed inter-related (Afonso and Gomes 2014; Giordano et al 2011; Perez and Sanchez-Fuentes 2011; Lamo, Perez and Schuknecht 2012, 2013). IZA Journal of European Labor Studie s © The Author(s). 2017 Open Access This article is distributed under the terms of the Creative Commons Attribution 4.0 International License (http://creativecommons.org/licenses/by/4.0/), which permits unrestricted use, distribution, and reproduction in any medium, provided you give appropriate credit to the original author(s) and the source, provide a link to the Creative Commons license, and indicate if changes were made. Marzinotto and Turrini IZA Journal of European Labor Studies (2017) 6:2 DOI 10.1186/s40174-016-0074-1 This paper assesses the relationship between public and private wages, as measured by general government and manufacturing nominal compensations, respectively, on a sample of 17 European Union (EU) countries from 1980 to 2013 applying dynamic ordinary least squares (DOLS) to panel data for the long-run and an error correction model (ECM) for the short run. We focus specifically on the spill over of government to manufacturing compensations so as to address the question of the possible effects of certain fiscal policy measures on cost competitiveness via the supply side. Moreover, attention is devoted to the manufacturing sector because much of the literature on wage leadership is indeed concerned with the signalling that comes from wage bargainers in the manufacturing sector. Our estimation strategy aims at determining the strength of the relation between sectoral compensations across government sectors of different size, at assessing whether the way in which government compensations are set has any impact on the nature of the interaction with the private traded sector, and finally at establishing whether such relation is symmetric holding both when government compensations are increased and when cut and whether periods of large cuts (or fiscal consolidations) make a difference. Whilst our focus is on the relation going from general government to manufacturing compensations, we nonetheless also assess interactions in the opposite direction as a way of validating our results. From a policy perspective, that government compensations spill over to the private sector is a non-trivial question. First of all, the strength and the persistence of the spill over says something about the supply-side effects of aggregate demand management, allowing for a more sophisticated modelling of the overall economic impact of government spending. More to the point, the issue is especially relevant in the euro area context where countries have lost the ability to recoup cost competitiveness by means of devaluation but have scope to decide on the composition, efficiency and equity of their government spending. Finally, our research provides an indication of the relevance of wage setting modalities in the public sector. A bargained model seems more efficient on thesupplysidebutsurelyadefinitive answer requires additional research on the most satisfactory trade-off between efficiency, equity and the need to achieve budgetary targets. We add to the existing literature in three important respects. First, we explicitly consider the role of government sector size and estimate whether government compensations exercise a stronger impact on the labour market when the government is a large than when it is a small employer. This would mostly allude to an explicit market mechanism, an issue that has been only tangentially treated in the existing literature. Second, we account for wage setting modalities in the government sector distinguishing between compensations set by government decision and those set through collective bargaining. Whilst largely ignored by the literature, the latter seems like a crucial issue because it is an indication of the extent to which changes in government compensations are the result of exogenous fiscal policy decisions or rather part of the broader economy-wide wage setting system. Third, we provide some evidence on whether the spillover from the government to the private tradable sector is symmetric and whether periods of fiscal consolidation make a difference. We find that general government compensations exercise a long-term impact on manufacturing compensations that is stronger for large public sectors. The long-run sector-size effect disappears when looking at real compensations, independently of Marzinotto and Turrini IZA Journal of European Labor Studies (2017) 6:2 Page 2 of 16 whether government compensations rise or fall. This may be alluding to the fact that the long-run relation is crucially affected by second-round effects via inflation. By contrast, in the short-run, there is no size effect, with each 1% increase (fall) in government nominal compensations leading on average to 0.25% increase (fall) in manufacturing compensations, independently of whether the general government is a large or a small employer, a coefficient that is consistent with results from other studies (Afonso and Gomes 2014). Having classified countries based on the prevailing public wage setting mode, we find that the size of the spill over from the government to the tradable sector is not affected by public wage setting neither in the long nor in the short run, but manufacturing compensations are better aligned with productivity and more responsive to unemployment when government compensations, to which private sector compensations respond, are set via bargaining. This result may allude to the fact that any bargaining process is “closer to the market”than unilateral government decision and hence closer to what might happen in the private tradable sector. We further look at whether the relationship between general government and manufacturing compensations is symmetric. We use an asymmetric ECM as in Granger and Lee (1989) to verify whether the null hypothesis of symmetry is rejected against an alternative of asymmetry. We find evidence of symmetry, with a change in real government compensations leading to the same labour market effect independently of whether the change consists of a rise or a fall in real government compensations. Moreover, it appears that government wage consumption and the labour market tend to be decoupled under fiscal stress, unless the government sector is a relatively large employer. The rest of the paper is structured as follows. Section 1 reviews the literature on the relation between, first, fiscal policy and competitiveness and, second, more generally, on the public-private wage link. Section 2 describes our sample and empirical strategy. Section 3 discusses the results. Section 4 looks at asymmetries and at the role of fiscal consolidation episodes. Section 5 concludes. 1.1 The public-private wage link in the literature There is a well-established literature on the relationship between changes in government wage expenditures, competitiveness and external positions. Lane and Perotti (1998) show that a rise in government wage consumption reduces traded sector output via a rise in private sector wages, which would lead to a deterioration in the current account, if there exist adjustment costs that prevent consumption and investment of traded goods from falling rapidly. 2 Lane and Perotti (2003) find further evidence that higher government wage spending impacts on the supply side by raising the real product wage, thereby depressing profitability. 3 To the extent that a rise in public compensations is financed with resources drawn from the private sector that may take the form of increased labour taxes, the literature on the impact of labour taxes on private sector costs is equally relevant. So, for example, Alesina and Perotti (1997) look specifically at the effects of changes in labour taxes on unit labour costs and find that in a bargaining model higher labour taxes increase unit labour costs, unless wage negotiations are conducted by a monopoly union that is large enough to internalise the consequences of higher output prices on real consumption and employment. Marzinotto and Turrini IZA Journal of European Labor Studies (2017) 6:2 Page 3 of 16 Focusing on dynamics around fiscal consolidation episodes, Alesina et al. (2002) and Ardagna (2004) argue that fiscal adjustments based on a reduction in the government wage bill induce a fall in real wages also in the private sector, thereby improving profitability and investment. Along similar lines, Barrios and Langedijk (2010) show that the downsizing of the government wage bill leads to more successful fiscal consolidation specifically under fixed exchange rate regimes, where the internal adjustment relies only on costs and prices, a result that is particularly relevant in the euro area context. More generally, there is a growing body of research that has looked at the long- and short-run relationship between public and private wages in “normal”times, whether at stake is co-movement, interaction or a clear causal link going from one sector to the other, when for example, one of them is a wage leader. This research is less specific about the origin of changes in public/private wages and mainly devoted to understanding how different sectoral wages relate one to the other using a variety of statistical techniques ranging from co-integration and error correction models to vector autoregressive (VAR) systems or both. Afonso and Gomes (2014) test the relationship between real general government and private wages on a panel of 18 OECD countries using a simple 2SLS estimation and allowing for an error correction term. Their analysis is mostly about the interaction between public and private wages and provides only indirect evidence on causality. They find that the interaction goes both ways and that each 1% increase in real public sector wage growth raises private sector real wage growth by 0.3%. Lamo et al. (2007, 2012, 2013) use different statistical techniques to analyse co-movement in the short-, medium- and long-term but include also a causality test. They find strong crosssectoral correlation between public and private wages, with coefficients as high as 0.8. To test causality, they implement a standard Granger causality test in a VAR framework and find that generally private wages have a stronger impact on public wages than vice versa. More specifically, the public sector acts as a wage leader only in the Netherlands and plays an important role, though not as far as leading, in Greece, Italy, Portugal and Finland. Finally, they juxtapose cross-country heterogeneity in coefficients to institutional settings and find that the role of the public sector is stronger, the greater the government’s involvement in collective bargaining, the larger the public sector and the lower the competition from outside. Perez and Sanchez-Fuentes (2011) analyse the short-term relation between public and private wages in a VAR framework and find evidence of signalling especially by the private sector including early on during actual wage negotiations. These studies are generally not explicit about the exact transmission channel from one sector to the other and tend to capture different dynamics that are at play at the same time. Results can be interpreted more easily if one or more potential transmission channels are first identified and then modelled in the empirical analysis. This is one of the specific objectives of the present paper. We identify below potential market-driven and institutional channels, stressing which ones would be more relevant for the interaction going from the government to the private sector and which ones matter for movements in the opposite direction. Subsequently, we propose a simple method for testing empirically the strength of the market channel as well as of onespecificinstitutionalchannel. Marzinotto and Turrini IZA Journal of European Labor Studies (2017) 6:2 Page 4 of 16 As concerns the possibility of changes in public wages impacting on the private sector, various channels may operate. First, large swings in public wages alter the supply of labour available to the labour market, inducing a change in the equilibrium wage if the labour market is perfectly competitive and in the absence of impediments to mobility. This is likely to be always true in the long-run with the two wages expected to be co-integrated with a slope coefficient of one. Second, rising public wages may crowd out private employment, increasing average productivity and thus wages in the private sector (Algan et al. 2002). Third, changes in public wages affect the outside option of unionized private sector workers, putting pressures on the bargaining process (Afonso and Gomes 2014), even when public and private employment remain separate. Fourth, changes in public wages that are compensated by an adjustment in labour taxation would mechanically alter private labour costs (Holmlund 1993; Forni and Giordano 2003). Indirectly, they may even alter wage demands if the wage bargaining system is such that wage setters have no incentive to internalise the consequences of their actions—i.e. where there is no centralization in wage bargaining (Alesina and Perotti 1997). Similar albeit not identical transmission channels may be identified for the potential spill over going in the opposite direction, namely from the private to the public sector. First, wage bargaining in the private sector can have demonstration effects, whether it is the same union negotiating both wages or whether there are two different unions (Maffezzoli 2001; Ardagna 2007). Confirming this hypothesis, Perez and Sanchez-Fuentes (2011) find evidence of signalling by the private sector already in the negotiation phase for France and Germany in the period before 1999. Second, numerous EU countries have wage bargaining practices that grant wage leadership to the private sector. This is the case of the so-called Scandinavian wage determination model, with the exposed sector acting as leader or pattern setter for all other sectors including the government (see also Holm-Hadulla et al. 2010). Third, established practices can make public wages responsive to private ones. For example, in the Netherlands, there is a formal rule imposing that the growth rate of private wages is automatically applied to public sector wages (Hartog and Oosterbeek 1993). We propose to isolate any market-driven mechanism by accounting for governmentsector size, where the assumption is that the larger the role of the general government sector as an employer, the stronger the impact on the labour market via both prices and quantities. The underlying assumption is that in the long-run, there is no impediment to cross-sectoral mobility that could create a disconnect between government and traded sector compensations. When it comes to institutional channels, however, we expect much greater cross-country heterogeneity, which complicates the exercise of finding a common testable hypothesis. Wage-setting practices would formally or informally grant wage leadership to one or the other sector, where the most common practice is that the exposed sector acts as a pattern setter for the rest of the economy. The reverse situation where private sector compensations follow those in government sector is less common. Would that happen, the possible institutional channels of transmission are imitation effects inducing private sector unions to follow public sector unions or fairness effects for which an “all-sector”union tends to negotiate similar Marzinotto and Turrini IZA Journal of European Labor Studies (2017) 6:2 Page 5 of 16 increases for their affiliates in different sectors. Against these possibilities, though, a crucial dimension is likely to be the nature of public wage setting, namely whether general government compensations are set by government decision or by collective bargaining, with the institutional transmission channels described above operating in the case of bargaining only. Our strategy is thus to distinguish between compensations set by the government itself and those agreed through collective bargaining. That way, we should be able to isolate the operation of the institutional transmission channels and possibly differentiate them from alternative more market-driven channels. 2 Data and empirical strategy Forthepublicsector,weusegeneralgovernmentcompensationsfromtheOECD Economic Outlook constructed by dividing general government final wage consumption expenditures (CGW) by general government employees (EG). 4 Figures on general government are drawn from the System of National Accounts (SNA) and refer to public offices at all levels of government, non-market publicly owned hospitals, schools and social security organizations. We obtain comparable data for a sample of 17 EU countries over 1980–2013. 5 We approximate the traded sector by manufacturing. In the long-run, nominal compensations in the two sectors should be cointegrated with a slope coefficient of one. To systematically analyse long- and short-run effects of general government compensations on the manufacturing sector, a co-integration approach is developed in a panel-data setting linking manufacturing compensations to a number of determinants, including compensations in the general government sector. The long-run relation is estimated in levels using dynamic ordinary least squares (DOLS), whilst the error correction mechanism (ECM) representation allows estimating the short-run relation between compensation growth, shocks in explanatory variables and the deviation from the dynamic long-run relation. The long-run wage (compensation) equation should be interpreted as an equilibrium relation and is specified as: lnwit ¼αiþβ1lnwpit þβ2lnprit þβ3uit þβ4lncpiit þεit ð1Þ where iand tare the index country and time, respectively, wdenotes the level of nominal compensation per employee in the manufacturing sector, wp is the level of nominal compensation per general government employee, pr is the real value added per person employed in the manufacturing sector, uis the unemployment rate, cpi is the consumer price index, and εis the error term. All variables are in logs except for the unemployment rate. Compensations in the manufacturing sector are expected to be positively related to government compensations, prices and labour productivity and negatively related to unemployment. Co-integration is tested using DOLS with one lag and one lead for each regressor. We include country fixed effects not only to control for time-invariant country-specific factors but also because some variables are expressed as index numbers and would thus not be comparable across countries unless they are transformed. Marzinotto and Turrini IZA Journal of European Labor Studies (2017) 6:2 Page 6 of 16 Given Eq. (1), the short-run (error-correction) wage (compensation) equation is specified as follows: Δlnwit ¼δiþθ1Δlnwpit þθ2Δlnprit þθ3Δuit þθ4Δlncpiit þγ^ eit−1þεit ð2Þ where êis the lagged error correction term and all other variables except unemployment are expressed in log changes. A significant and negatively signed error correction term is taken as evidence of co-integration between government and manufacturing compensations; its coefficient captures the speed of adjustment back to equilibrium (see Table 6 in the Appendix). 3 Results 3.1 The long-run effects of government sector size Table 1 shows the results of the long-run (column 1) and short-run (error-correction) wage equation (column 2) estimated on the whole sample. With the exception of the Table 1 Long-run and short-run relation between manufacturing and general government compensations per employee, EU countries 1980–2013 (1) (2) Dynamic long-run relation Error correction model Dependent variable: log of manufacturing compensation per employee, level (long-run relation) and change (ECM) Δlog government compensations p.e. 0.249*** [7.117] Δlog productivity in manufacturing 0.188*** [5.426] Δunemployment rate −0.00162* [−1.578] Δlog consumer price index 0.693*** [19.51] Log of consumer price index 0.687*** [9.410] Log of government compensations p.e. 0.435*** [7.968] Log of productivity in manufacturing 0.209*** [9.004] Unemployment rate 0.0057*** [3.421] Lagged error correction term −0.122*** [−3.140] Constant −1.087*** 0.00715*** [−7.009] [3.273] Observations 407 407 R 2 0.98 0.631 Number of countries 17 17 Estimation method: dynamic OLS with fixed effects and Newey West standard errors and ECM with standard errors robust with respect to heteroskedasticity and non-independence within country clusters. Sample: EU countries, except AT, BG, CY, DE, EL, HR, LT, LV, MT, RO and SI Robust t-statistics: ***p< 0.01; **p< 0.05; *p< 0.1 Marzinotto and Turrini IZA Journal of European Labor Studies (2017) 6:2 Page 7 of 16 unemployment rate, all the variables exhibit the expected sign and are statistically significant. The ECM equation shows that deviations from the long-term relation are corrected over time, as indicated by the negative and significant coefficient of the error correction term, which is indeed supportive of co-integration amongst the variables. Moreover, the short-term response of manufacturing compensation growth has the expected sign for all the variables and is significant also for the unemployment rate. It is found that every 1% increase in general government compensations is associated, in the long-run, with a 0.4% increase in manufacturing compensations. 6 Short-run effects are slightly weaker at almost 0.25%. Our results are in line with those of analyses that have used similar estimation techniques (Afonso and Gomes 2014). Our first hypothesis is that the relationship between nominal compensations in the government and those in the manufacturing sector is importantly conditioned by size, here measured by the ratio of general government to total employment. The greater the importance of the government sector as an employer, themorelikelythatchangestogovernment compensations affect average conditions on the market and mostly so in the long-run when inter-sectoral mobility can be considered to be unconstrained. In order to test for the operation of this market-based channel, the EU sample is split in two groups: countries in which the average share of government to total employment is above the whole sample’s median and countries where it is below the median. 7 Table 2 provides results for the two groups. It is found that manufacturing and government compensations share a significant long-run relationship especially in large government sectors: for each 1% rise in government compensations, manufacturing compensations grow by 0.7% when the government is a large employer, but by only 0.2% when it is a small employer. The relation goes both ways. When testing it in the other direction, namely from manufacturing to general government compensations, it is found that the long-run elasticity of government with respect to manufacturing compensations is of 0.8%, thus much stronger than the 0.4% elasticity of manufacturing with respect to general government compensations. This confirms results from, for example, Lamo et al. (2007) (2012), where it is found that the private sector is more likely to have an impact on the public sector than vice versa, including in the long-run when covariates are accounted for. Secondly, in line with expectations, we find no difference between large and small government sectors; as a matter of fact, this dimension should be relevant only when it comes to assessing the impact of the public on the private traded sector. 8 By splitting the sample in two groups, we are de facto assuming two completely separate regimes and hence isolate the size of the spill over for each of them. We do not expect that the size of the government sector has significant marginal effects on the inter-sectoral spill over but that after a certain threshold level, the spill over from one sector to another is more important. 9 Still, as part of our robustness checks, we have also interacted government compensations with a dummy that captures above-median government sectors finding that the relationship between government and manufacturing compensations is indeed amplified when the government is an important employer. 10 Marzinotto and Turrini IZA Journal of European Labor Studies (2017) 6:2 Page 8 of 16 Appendix Acknowledgements We thank Alfonso Arpaia and Pedro Cardoso for the useful comments and discussions and as the anonymous referee and editor for the helpful remarks. Responsible editor: Martin Kahanec Competing interests The IZA Journal of European Labor Studies is committed to the IZA Guiding Principles of Research Integrity. The authors declare that they have observed these principles. Disclaimer The views expressed in this paper do not reflect necessarily those of the European Commission. Author details 1 Department of Economics and Statistics, University of Udine, Via Tomadini 30/A, 33100 Udine, Italy. 2 European Commission and IZA, Brussels, Belgium. Received: 9 September 2016 Accepted: 16 December 2016 References Afonso A, Gomes P (2014) Interactions between private and public sector wages. J Macroecon 39(A):97–112 Alesina A, Ardagna S, Perotti R, Schiantarelli F (2002) Fiscal policy, profits, and investment. Am Econ Rev 92(3):571–589 Alesina A, Perotti R (1997) The welfare state and competitiveness. Am Econ Rev 87:921–939 Algan Y, Cahuc P, Zylberberg A (2002) Public employment and labour market performance. Econ Policy 17:7–66 Ardagna S (2004) Fiscal stabilizations: when do they work and why. Eur Econ Rev 48:1047–1074 Ardagna S (2007) Fiscal policy in unionised labour markets. 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European Economic Review 37 (1): 97–114 Table 6 List of variables Variable Definition Source Nominal compensations per employee in the general government Calculated as the ratio of government final wage consumption expenditures (CGW) to government employment (EG) OECD Economic Outlook Real compensations per employee in the general government Deflated by the price deflator of GDP at market prices AMECO Nominal compensations per employee in the manufacturing sector Calculated as the ratio of total compensations of employees to total employees in the manufacturing industry Eurostat Real compensations per employee in the manufacturing sector Deflated by price deflator of gross value added in the manufacturing industry AMECO Productivity Gross value added at 2005 prices per person employed Eurostat Consumer price index National consumer price index for all items AMECO Unemployment rate Standardized unemployment rate Eurostat Government sector size Ratio of general government to total employment OECD Economic Outlook Marzinotto and Turrini IZA Journal of European Labor Studies (2017) 6:2 Page 15 of 16 Holmlund B (1993) Wage setting in private and public sectors in a model with endogenous government behavior. 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Eur Econ Rev 42:887–895 Maffezzoli M (2001) Non-Walrasian Labor Markets and Real Business Cycles. Review of Economic Dynamics 4(4):860–892 Perez JJ, Sanchez-Fuentes AJ (2011) Is there a signaling role for public wages? Evidence for the euro area based on macro data. Empir Econ 41(2):421–445 Perotti R (1996) Fiscal consolidation in Europe: composition matters. Am Econ Rev 86(2):105–110 Submit your manuscript to a journal and benefi t from: 7 Convenient online submission 7 Rigorous peer review 7 Immediate publication on acceptance 7 Open access: articles freely available online 7 High visibility within the fi eld 7 Retaining the copyright to your article Submit your next manuscript at 7 springeropen.com Marzinotto and Turrini IZA Journal of European Labor Studies (2017) 6:2 Page 16 of 16