6. IMPACT OF ECONOMIC CRISIS ON DOWNWARD NOMINAL
6.2. General evidence of downward nominal wage rigidity in national
Labour costs can adjust to shocks in demand through three different channels: a reduction in the number of people employed, a reduction in working hours, and cuts in wages. All these channels were also at work during the recent crisis in Estonia. Average wages fell in 2009 by slightly less than 5% (see Figure 41).
Figure 41. Year-on-year growth of average monthly salaries and number of employed Source: Statistics Estonia
This picture is reinforced by an international comparison of average wage dynamics during the present crisis. Unfortunately the information available through Eurostat on average wages is not recent enough to allow analysis of the events of 2009, so Figure 42 is based on an OECD database47 that has been updated with information on Estonian, Latvian and Lithuanian average gross wages from their statistical offices. All wages are in national currencies and current prices. Despite the fact that real GDP for several countries had already started to decline in 2008, the effect on wages mostly emerged in 2009. This is the reason why the change in real GDP is calculated for the period 2007/2009, while the change in nominal wages is calculated for 2008/2009.
The slope of the diagonal line in the third quarter of Figure 42 indicates Estonian nominal wage elasticity to real GDP. In comparison with countries where real GDP declined then there are only two examples where nominal wages responded more strongly to real GDP decline than they did in Estonia, and those are Lithuania and Belgium. For most of the countries struggling with
47 Source: http://stats.oecd.org/Index.aspx -15%
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contracting real GDP, the nominal wage to real GDP elasticity was negative, meaning that the decline in real GDP led to modest nominal wage increases.
Figure 42. Average gross nominal wage growth (2008/2009) and real GDP growth (2007/2009) in selected OECD countries48, Latvia and Lithuania
Source: Eurostat, OECD database, Statistics Estonia, Statistics Latvia, Statistics Lithuania, author’s calculations
On the other hand, the main channel of adjustment was employment, which fell in 2009 on average by nearly 10% (see Figure 41).The average number hours worked also declined, by 3.5% in 200949. In all, the adjustments in the total working hours dropped significantly more than average wages did.
As the reduction in employment was so severe, it could be argued that this indicates downward wage rigidity – if wages had been flexible enough, the decline in employment would not have been so extensive. The reduction in the number of people employed was the second largest amongst the 27 members of
48 Information on average yearly wages was available for Austria, Belgium, the Czech Republic, Denmark, Estonia, Finland, France, Germany, Hungary, Ireland, Italy, Luxembourg, Netherlands, Poland, Portugal, Spain, Sweden, the United Kingdom.
49 Estonian Labour Force Survey 2009, author’s calculations. A word of caution is probably in order, as the Labour Force Survey figures on hours worked are usually not considered to be very reliable.
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European Union. The slope of the diagonal line in Figure 43 indicates Estonian employment elasticity to real GDP. Countries located in the grey triangle above the line have higher employment to real GDP elasticity than Estonia when experiencing a fall in GDP. There were only seven countries, Hungary, Ireland, Latvia, Lithuania, Portugal, Spain, and Romania, where employment responded to a GDP fall more intensively than it did in Estonia.
Figure 43. Employment and GDP growth in Europe, 2007–2009 Source: Eurostat, author’s calculations
Another statistic that to some extent should reflect wage rigidity is the dynamics of the labour share in GDP. It could be argued that if wages were perfectly flexible, then during an economic crisis the labour share in GDP would remain more or less stable as the decline in value added would translate into a reduction in labour costs.
Figure 44 shows that for Estonia, this was not the case. The share of labour costs in GDP rose considerably from an average of 45% to nearly 54% of GDP in the first quarter of 2009. At the same time the share of operating surplus and mixed income also declined significantly. The proportions of labour costs and operating surplus started to converge to their previous levels only in the second quarter of 2009, indicating that there was something that delayed the adjustment process considerably.
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Figure 44. GDP by income approach, share of selected components in total GDP Source: Statistics Estonia
It is also interesting that these developments did not start immediately before the crisis, but had already begun in 2007. This means that at least part of this was caused by the demand for labour during the peak year of the boom in 2007.
Nevertheless, the share of labour costs rose throughout the whole of 2008, even though real GDP went through a significant contraction.
Of course, there are other reasons why even with flexible wages a severe decline in employment can happen. One of these reasons can be rapid structural changes; as the crisis hit the construction sector significantly harder than it hit other sectors there was a surplus of labour with skills that were not immediately usable in other sectors. Even if the wages in construction had adjusted more, there was just no need for the total capacity of construction services – the number of people employed in construction fell from 82 thousand (in 2007) to 48 thousand (in 2010).
In general, it seems that despite our earlier findings which showed Estonia as a country with relatively flexible wages and average nominal wage decline in 2009, the crisis led to a severe across-the-board reduction in the number of people employed, and even when the size of the decline in real GDP is taken into account, the reduction in employment was a significant one.
This raises the question of DNWR during the crisis. The calculations of DNWR presented in the previous chapter come from the period of economic boom. Is it possible, that during the crisis the wages were more rigid than our previous findings suggested? In the following chapter the micro-data of wage changes during 2008/2009 will be analysed in order to understand the magnitude of wage cuts during the crisis.
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2002 2003 2004 2005 2006 2007 2008 2009 2010 Compensation of employees Operating surplus and mixed income