Downward nominal wage rigidity and economic sector

Economic sectors are influenced by different factors that shape the wage conditions of workers. For example, some sectors are more export oriented while others provide goods and services on local markets; some sectors are more unionised, while others are union free. DNWR depends on the economic environment and at any given time different sectors can have completely different economic environments, depending on the conditions in the market in which they operate. It would thus be interesting to test the differences in wage rigidity by economic sector. As there are 19 different economic sectors (the first level of NACE 2.2) only the static rigidity coefficients will be calculated. The results are listed Figure 37, and exact coefficient values and standard deviations are listed in Appendix 4. All coefficients are statistically significant.

A look at the figure shows that services sectors seem to be more rigid than average, while manufacturing enjoys less rigid wages. At first glance sectors known to have high union participation rates, such as education and transport, also seem to have higher DNWR. There are, however, exceptions. The health care sector is also unionised but is located in the lower end of the figure. The same applies to electricity, gas and water supply, sectors that are less rigid than average, but at the same time more unionised than average. Thus unionisation does not seem to play a significant role in explaining DNWR over the period 2002–2008.

A general conclusion seems to be that the domestic market oriented sectors that benefited the most from high economic growth are also the ones with

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higher wage rigidity while export sectors that were more strongly affected by international competition show more flexible wages.

Figure 37. Rigidity coefficients 2002–2008 (NACE 2.2), by economic sector (model (5–1))

Source: Estonian Tax and Customs Board, author’s calculations

5.7. Discussion and conclusions

The method used in previous sub-chapters allows the size of rigidity coefficient to be estimated for different subgroups in the labour market. The main con-clusions are that:

 There are remarkable differences in DNWR between employer and employee subgroups;

 DNWR is higher than average in micro enterprises with less than 10 workers, and also in the services sector and more generally in sectors that are oriented to the domestic market. As concerns employee groups, wages are more rigid for the low waged earning less than 50%

4,3% Electricity, gas, steam and air … Administrative and support service …

of the average wage, and also for older workers aged 65 and over and for workers in their prime of 35–44. There is also a gender aspect as men’s wages are more rigid than women’s;

 DNWR is below the average in medium and large companies with more than 50 workers, and also in the manufacturing sector. From employee groups, women and young workers under 25 years old tend to have lower DNWR. So do workers who earn between the average wage and two times the average wage;

 DNWR changes over time and usually has a negative relationship with the unemployment rate or changes in the unemployment rate.

However, this is not the case for all employer and employee groups.

This is especially so for older workers (65 years and older) and for those earning between 50% and 100% of the average wage;

 DNWR seems to be unrelated to changes in labour market conditions for younger workers under 24, and for people earning more than twice the Estonian average wage.

Concerning the relation between DNWR and gender, Agell & Bennmarker (2007) conduct a survey amongst Swedish company managers and show that in firms with a large share of female workers, managers consider it less probable that workers who feel underpaid will respond by reducing effort. The lower probability of such retaliation for a wage cut can be associated with risk aversion, as deciding to reject the employer’s proposal for a wage cut involves a certain degree of risk of being laid off. Several authors have shown that women are more risk averse (e.g. Croson & Gneezy (2009), Jianakoplos et al. (1998)).

Differences in DNWR by age group show that people entering the labour market have lower rigidity than those who are in their prime working age of 35–

44 years. On the other hand, after the prime age DNWR starts to decline. The most obvious explanation for the hump shape in DNWR is individual bargaining power. New entrants to the labour market are less able to dictate their working conditions than those who have gained sufficient company-specific human capital and general labour market experience. Concerning the declining DNWR for the age groups 45–64 it has to be kept in mind that Estonia regained its independence only twenty years ago. The change from a planned to a market economy made a lot of previously gained human capital obsolete. As a result people who entered the labour market in the early years of independence having gained their education in the new education system are today more competitive than those who gained their professional education during soviet times. This is also reflected in the steep decline of wages after the age 35 (see Figure 25). The only piece that does not fit in the puzzle is the high DNWR among the over–64s. The most plausible explanation is employment protection legislation; before the individual labour legislation reform that came into force in the second half of 2009, the costs associated with firing people with more than 10 years of experience included a notice period of four months topped up with a severance payment of four months of the average wage. The lay-off costs

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for people with less than five years of experience were half as much (Labour Contract Act). The share of people with more than 10 years of experience is higher among those aged over 64 than among younger people.

The differences in DNWR between wage groups are quite intuitive, as wages below 50% of the average wage are already close to the legal minimum monthly wage. Any attempts to lower wages below this level are prohibited by law.

Anyway, a significant reduction in pay below the minimum wage, even disregarding its illegality, will probably result in workers quitting their jobs, as anything below the minimum wage hardly provides the means for a decent standard of living and the support that can be received from social security system in the form of unemployment insurance for being laid off and subsistence allowance (especially for larger households with single wage earner) will motivate these people to withdraw from the labour market. So instead of wage cuts we see quits, and wages seem to be more nominally downward rigid. It must also be noted, that for persons earning wage lower than minimum wage nominal rigidity emerges in two different forms – one indicating aversion against wage cuts and other against wage increases lower than minimum wage growth.

The connection between DNWR and company size group yields intriguing results, indicating that wages in smaller companies are significantly more rigid than wages in large companies. This is contradictory to the results presented by Babecký et al. (2010), who reach exactly the opposite conclusion. Efficiency wages have so far been used for explaining differences in DNWR between small and large companies as large companies have more resources to develop pay systems and also have more need for pay systems, as the effort of each worker cannot be observed directly by the head of the organisation. This might be the reason why efficiency wages could be more widely used by larger companies (Babecký, Du Caju, Kosma, Lawless, Messina, & Rõõm, 2010, p.

95). However, there are also reasons to believe that wages that are reported to the ETCB are indeed less nominally rigid downwards than those of larger companies, due to the existence of undeclared wages. There is evidence that paying (partly) undeclared wages is significantly more wide-spread in small than in large companies (Ahermaa, 2009, p. 22). It is thus quite plausible that legal wages in smaller companies are nominally rigid downwards, while actual wages are not.

Results on DNWR by economic sector are puzzling. In our analysis the wages in manufacturing sectors show less nominal downward rigidity than those in the services sector or construction. This contradicts the results obtained by Babecký et al. (2010). Lower DNWR in manufacturing could be explained by exposure to international competition. During 2002–2008 Estonia experienced steady economic growth that was fuelled by the rapid growth of domestic demand. While export-oriented sectors had to remain competitive in the international market, domestic market oriented sectors were operating under more favourable conditions. This might also have influenced the DNWR.

All these results raise the question of whether there is a common reason for higher DNWR behind the employee groups or company types, and thus a regression analysis would be in order. Unfortunately, it is difficult to perform that kind of analysis, because the number of subgroups also determines the number of observations in the regression analysis. For example, if we would like to analyse the reasons for DNWR by economic sector, then at present there are DNWR coefficients for 16 different sectors, meaning that there are also only 16 observations that can be used in regression analysis – this is too few.

It is also difficult to find a good indicator for DNWR at the micro level. For example if wage freezes are used as proxy for DNWR, then the results of a simple regression analysis with the incidence of wage freezes on one side and a specific employer or employee group on the other side do not replicate the results previously obtained from the approach used by earlier in this thesis. The same applies if instead of freezes the probability of wage cuts is used. The reason for this is the lack of comparison with a counter-factual distribution.

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6. IMPACT OF ECONOMIC CRISIS ON