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Salary hikes have remained weak across Western Europe, even in
countries with low unemployment rates.
A variety of factors have dampened wage growth, including
falling employment rates, outsourcing, the weakening power of labor
unions in the wage bargaining process, the retirement of baby
boomers, and slow productivity growth.
Productivity-boosting reforms could raise wage growth over the
medium term, but downside risks remain elevated.
Explaining lackluster wage growth
In recent years, wage growth has remained stubbornly weak
throughout Western Europe, even where unemployment rates are low.
There are a number of possible explanations for that
phenomenon:
A slow recovery from the 2008-09 global financial crisis and
subsequent Eurozone debt drama in many countries, keeping
employment rates depressed. As lower-wage workers who lost their
jobs during the crisis reenter the labor force, overall salary
growth is diminished.
Weak productivity gains (with Ireland and Malta being the main
exceptions).
Outsourcing to lower-wage countries in Emerging Europe or Asia.
Outsourcing is especially prevalent in the services sector, which
is often more price sensitive than manufacturing and where the cost
of shifting operations abroad is typically much lower. • The
diminished power of labor unions in the wage bargaining process,
especially given the weak inflation rates of recent years. In the
Eurozone, consumer price inflation averaged just 0.7% annually in
2013-17.
A phenomenon known in France as the "Noria" effect. As large
numbers of baby boomers leave the workforce and retire, they are
being replaced with younger workers with less experience, and
therefore lower salaries. Thus, we are seeing a shift in the age
pyramid, with fewer highly-paid people at the top and a replacement
by lower-salaried young people at the bottom.
Skills mismatches keep unemployment rates high, as the number
of people with technical degrees declines. Education reforms and
retraining programs may be needed to ensure that the workforce
meets the demands of local companies.
Is the Phillips curve still valid in Western
Europe?
In economic theory, the Phillips curve shows an inverse
relationship between the unemployment rate and wage growth:
salaries are expected to increase slowly when the unemployment rate
is high and quickly when the jobless rate is low. In the longer
term, there is believed to be a specific level of unemployment
which does not cause inflation to accelerate, known as the
non-accelerating wage rate of unemployment (NAWRU). If the jobless
rate rises above this neutral level, inflation will slow and
potentially turn to negative territory. If unemployment is too low,
inflation would accelerate.
In practice, the NAWRU is difficult to define, and few
economists believe that the "natural" rate of unemployment remains
stable in a given economy. Looking at Eurozone data from the last
20 years, the relationship between hourly wage growth and the
employment gap (measured as the difference between the unemployment
rate and the NAWRU) does not show a clear pattern.
Nevertheless, when we adjust for productivity, the pattern is
much clearer, indicating that the employment gap must fall below a
certain level before wage pressures rise more rapidly.
As demonstrated by the chart below, the slope of the curve becomes
steeper when the Eurozone's jobless rate falls more than one
percentage point below NAWRU, a point beyond which wages rise
significantly faster than productivity. Clearly, the region is
close to that inflection point today (in late 2017, the
unemployment rate was half a percentage point below the neutral
rate), but the recovery still has some traction to gain before one
can expect sustained wage pressures.
Outlook
While some analysts believe that an acceleration of wage growth
is just around the corner, others see limited prospects for a
stronger recovery. Germany is among the most obvious candidates in
Western Europe for stronger salaries. Indeed, the wage moderation
that has characterized the country since the reforms of the 2000s
appears to be ending, as heightening labor shortages give trade
unions increased bargaining power. In early 2018, new, higher
salary agreements were reached in a number of key sectors. Outside
of Germany, however, most Western European countries may see a
slower acceleration of wage growth, especially where unemployment
remains elevated.
While IHS Markit expects that most EU countries will see at
least moderate growth in nominal wages over the medium term,
downside risks exist. Looking ahead, efforts to improve the
business environment and raise productivity will be especially
important in boosting wage growth. Although many companies were
reluctant to invest amid the crises of recent years, productivity
could be raised through investments in machinery, human capital,
and public infrastructure. Nevertheless, some observers fear that
wage growth could be permanently diminished as technological
development and outsourcing threats reduce workers' bargaining
power and boost investment in capital.
Posted 25 July 2018 by Sharon Fisher, Director, Global Economics and