Wage Drift

Significant deviations between standard and effective wages (wage drift) are symptomatic for highly centralised labour markets. Flanagan (1990) reports that wage drift was responsible (in the eighties) for about 30–60 % of gross real wage growth in the Nordic countries.⁵⁸ Wage drift results either if firms (unilaterally) raise wages above standard wages, e.g. in order to avoid effi-ciency wage problems, or if local parties negotiate a mark-up over standard wages from central negotiations. Re-negotiations at the firm or regional level are customary in the Nordic countries. The existence of wage drift poses sev-eral questions on most stylised models of centralisation and wage bargaining.

The most important of these questions is whether and to what extent effec-tive wages are affectedat all by central negotiations. If standard wages had no impact, the question whether central negotiations take place all is open.

A straightforward implication for welfare considerations were that central negotiations simply are waste of time. And an important consequence for empirical studies were that the top level of wage negotiations is not a reliable indicator for the degree of centralisation.

If markups of effective wages over standard wages differ between firms, we have to explain why this occurs and to investigate whether the wage-compressing function of centralisation is effective at all. We will analyse these problems briefly within the framework of efficiency wage models and multi-level bargaining models.

Efficiency Wage Models

Schlicht (1992) analyses the relation between standard and effective wages in a pure efficiency wage model. In his setting, effective wages depend on standard wages and (imaginary) fair wages (i.e. wages perceived as fair by workers). Fair wages in turn depend on standard and average wages (paid in the respective branch/industry). Mark-ups of effective wages over standard wages are caused (as in all efficiency wage models) the dependence of productivity on wages. Schlicht obtains the surprising resultthat high wage drift results just then if standard wages have only small impact on fair wages!

58Phelps-Brown (1962) and Holmlund (1986) appear to be the first contributions point-ing directly to the relevance of wage drift and its implications.

He concludes from this that the economic models may respond sensibly to non-economic factors (which are often neglected in economic models). Of course, the model shows an impact of standard of effective wages, but the relation is somewhat unorthodox. We should notice, that the model takes standard wages as given, but not explain their determination. An integration of standard wage setting procedures into the model is possible and realised in the framework of the multi-level bargaining models which are discussed briefly in the following section.

Multi-Level Bargaining Models

We choose a more formal analysis here, since the interpretation of multilevel bargaining models hinges on details which can be demonstrated easily by inspection of central formulas. Our presentation follows Holden (1998) on the heels.

Basically, these models (e.g. Holden, 1989, 1990, 1998) are two-stage Stackelberg games. In the first stage, central authorities (of unions and employers’ associations) set a standard wage which serves as threat point (or fall-back option) for the second stage lower level (local) bargaining. In the second round of negotiations, work force (local union) and firm determine the effective wagewl =w+D by maximisation of the Nash-product.

{π(w_l)−π₀(w)} {u(w_l)−u₀(w)}

with respect to the drift parameterD. wdenotes the standard wage,u(w)≡ U(w, N(w)) the utility function of the work force, which (after substitution of the labour demand relation) can be written as a function of w alone, and π(w_l) denotes the profit function. The threat pointsu₀(·) undπ₀(·) are to be interpreted as utility of the workforce and profit of the firm during conflict.⁵⁹ The dependence of u₀ and π₀ on w is driven highly by institutional set-tings. In the Nordic countries strikes are banned if a standard wages is fixed (until the next central negotiation round takes place). This means that the union threat reduces to work-to-rule practices which lowers profits (the effect onu₀ is ambiguous a priori).⁶⁰ The first order condition of the Nash-problem is

0 = π⁰(w_l)

π(wl)−π0(w) + u⁰(w_l)

u(wl)−u0(w) =:φ

59For a rationale of this interpretation see Binmore et al. (1986) or Booth (1995), p.

150–153.

60The formulation is not realistic here, since wages and productivity are reduced (by mutual agreement) by 25 to 30% in many plants. See Holden (1990), p. 334.

By implicit differentiation we obtain the derivative d w

d w =−∂φ/∂w

∂φ/∂w

∂φ/∂w ≡∂φ/∂D must be negative (by maximisation). Consequently the sign of d w/d w is equal to the sign of

∂φ

∂w = π⁰π₀⁰

(π−π₀)² + u⁰u⁰₀

(u−u₀)² ≥0

implying that local wages w_l depend on standard wages w. The magnitude of the drift depends on how costly work-to-rule is for the firm and the work force. Clearly, if it affects only the firm, the resulting drift parameter must be strongly positive. In the end – also this can be seen directly from the formulas – all results are driven by the functions u₀(·) and π₀(·). They simply hide the efficiency wage core of the model. Therefore, a closer view at the issues reveals explicit bargaining models rather as decorative embellishment around the efficiency wage core. All the more it is surprising that the efficiency wage component is not even spelled out directly in this strand of literature.

Empirical Relevance

The relevance of standard wages for the determination of effective wages can be conducted as straightforward significance test of the standard wage in wage regression of effective wages on standard wages and control vari-ables. Holden (1998) estimates a wage equation⁶¹ with aggregated time se-ries data for four Nordic countse-ries (Denmark, Finland, Norway, and Sweden).

Specifically, he explains the change of effective wages by unemployment rates, changes of prices, productivity, the relevant tax rates, and a error correction term. The coefficient of the standard wage must be zero (or insignificant) if the effect of central wage setting is neutralized completely by local bargain-ing, and unity if local bargaining does not matter at all. Both, OLS as well as instrumental variable methods⁶²produce highly significant standard wage coefficients (all t-statistics are between 2.92 and 10.85) close to unity. Earlier investigations (e.g. Holden, 1989, 1990) deliver very similar results.⁶³

61It is specified as error-correction model.

62Instrumental variable methods are applied in order to correct bias caused by endo-geneity of central wages.

63Holden applied switching regression models to the data in order to account for possible bias due to nominal wage rigidity. We do not look into the details of these procedures here, since the mainly confirm the evidence of the simpler specifications reported above.

Wage Drift and Wage Dispersion

Since wage drift mark-ups differ between firms, regions and industries, they create possibilities for wage flexibility and (moderate) wage differentials.

Though the negative correlation between centralisation and wage dispersion seems to be the most stable stylised fact from the empirical literature (see section 2.5.5), regional, firm size, and industry wage differentials are signifi-cant also in Germany⁶⁴ and seemingly cannot be explained by heterogeneity of workers or compensating differentials alone.

Characteristics mean std. dev

By formal qualification

Less than completed occupational training 1.0 7.3 compl. occupational training, no Abitur 1.6 7.3 Abitur, no occupational training 3.1 8.3 compl. occupational training and Abitur 4.1 8.6

Technical College^∗ 3.0 6.6

College^∗ 2.9 7.8

By employment continuity

continuously employed 1.5 6.8

with employment interrupts 1.7 8.9

By occupational status

blue collar (Arbeiter) 1.1 7.3

white collar (Angestellte) 2.3 7.4

By nationality

Germans 1.6 7.3

foreigners 1.1 8.0

Source: Pfeiffer (2003)

∗: results for these qualification groups may be biased significantly since a large share of wages is censored from above in the social security data.

Table 2.2: Wage drift and its standard deviation by several characteristics, measured as relative deviation between effective and standard wages in per-cent.

The most current descriptive evidence for Germany, Pfeiffer (2003) con-firms the significance of wage drift. The author computes wage drift rates by several worker characteristics (qualification, employment continuity, oc-cupational status, and nationality) for the time period 1975-1995, based on

64For example Wagner (1997) reports maximum firm size wage effects of more than 20%, cf. also Oi & Idson (1986), Wagner (1991, 1997).

a social security data subsample (IABS), which was merged with the Ger-man statistics of standard wages (Tariflohnstatistik des Statistischen Bun-desamtes). As in many other cases, a closer look at the issue reveals several data problems and limitations. The most severe one is that some thousand (4892 in 1995) collective wage agreements exist for Germany, and that a good deal of the regional and sectoral heterogeneity is not captured in the official statistics. For example, 16 of 63 industries (mainly from the services sector) could not be assigned in the sample since the official standard wage statistics does not record them. The fact that the share of workers employed in these sectors increased from 16% to 28%, indicates noteworthy bias.

Under these reservations, Pfeiffer’s results show (see table 2.2) significant wage drift, especially for the qualified, white collar workers, and job movers.

An interesting detail of the analysis, which will be relevant in the sections below, is thatwage drift is negative for about 40% of the sample. This may – perhaps even to a great deal – be due to the mentioned data problems. Never-theless, the share is large enough to indicate significant downward flexibility in several industries and regions.

By this, also central negotiations seem to provide considerable flexibility for wage adjustment.⁶⁵ Nevertheless, the resulting wage structure may be inefficient. We will discuss some aspects of the issue in more detail in section 2.5.5.