DNWR And The Euro Area’s Experiment Of Internal Wage Devaluations

JanssenPaul Krugman picks up on the Eurostat statistics on wages and wage developments in the private sector across Europe. He concludes that the experiment of an ‘internal wage devaluation’ which the Euro Area in particular is trying to practise is very hard to achieve since downwards nominal wage rigidities (DNWR) are preventing nominal wages from falling. The figures from Eurostat indeed show that Greece is the only financially distressed Euro Area country where nominal wages have fallen between 2008 and 2012 (even by 11%). In contrast, nominal wages in Ireland and Portugal have firmly remained at their 2008 levels whereas nominal wages even increased by 8,9% in Spain (and Italy). Even if this, with ongoing inflation, represents a cut in real wages, it does not really reflect the internal wage devaluation Spanish and European policy makers are aiming for. However, two additional remarks need to be made.

First, Krugman is overlooking the fact that Greece entered Troika dictatorship as early as May 2010 and thus became first to move in structural reforms to weaken private sector wage formation processes. Reforms to give company based (and often employer organised!) associations of workers the legal competence to sign contracts cutting wages below levels set in higher level collective bargaining agreements were already introduced over the course of 2011.

In Portugal on the other hand, the Troika entered much later. In Spain, at the beginning of 2012, it wasn’t the Troika entering the country but the newly elected conservative government that introduced a radical reform of the Spanish collective bargaining system. With reforms to the wage formation system in Spain as recent as 2012, the 2008/2012 period is not entirely appropriate to judge the effectiveness of the experiment of an internal wage devaluation.

However, the important point to note is that, with the exception of the overall cut in minimum wages, Spain and Portugal have undertaken reforms that are very similar to the reforms implemented in Greece. For example, it is now possible for an employer in Spain to unilaterally decide to cut wages. All the company has to do is to notify the trade union of this and respect a period of 15 days during which negotiations are expected to take place. At the end of this negotiating period and if negotiations have not produced an outcome, the employer is free to cut wages.

With reforms such as these, there is no reason to expect a different outcome. In fact, one can already observe for 2012 an absolute standstill of nominal wages in the private sector in Spain. Another telling illustration is that, as a consequence of a labour law reform stipulating that collective agreements that reach their expiry date no longer remain valid, trade unions in the retail sectors in both Greece and Spain had to swallow painful concessions. Faced with the choice of letting the sector agreement disappear altogether, thereby allowing employers to pay any wage of their choice, or accepting a new sector agreement with lower wage standards, trade unions choose the latter. In Greece, the new sector level agreement signed at the end of 2012 provides for a nominal wage cut of 6,8%. In Spain, the collective agreement links nominal wage dynamics with the evolution of retail sales. With retail sales at the moment falling at an annual of approximately 9%, the implications for wage dynamics are clear.

So the point is not whether downwards nominal wage rigidities exist or not in the Euro Area, the point that European policy makers have in mind is to get rid of such wage rigidities by weakening wage formation systems.

Does this mean that, once labour market institutions that protect wages are gone (as Mario Draghi would put it) and nominal wages are falling, internal wage devaluations will save the single currency? The answer is still no. Mainstream economists and European central bankers still have to explain how on earth economies can deflate themselves out of the  high (private sector) debt loads several economies are facing. Faced with such high debt loads, wage deflation can only make matters worse by increasing the real burden of debt, working to squeeze domestic demand spending even more.

 A second observation is that there is no sign whatsoever of the trade off which mainstream economists are so keen to present to trade unions. The Troika economists may lecture trade unions about the need to cut wages to save jobs. However, in the case of Greece, while wages were cut by more than 11% in only two years’ time, jobs have not been saved. In Greece, the massive destruction of jobs even accelerated sharply with 14% of jobs being lost in 2011 and 2012. In the end, workers in Greece lost wages as well as jobs.

To conclude, the graph below, (courtesy of a trade union colleague from Greece), shows that the Troika interventions achieved to turn back the clock on real minimum wages in Greece by two decades. Real minimum wages in Greece are now back at the levels (or even below these levels) last seen in the mid eighties. This is what will be in the pipeline for Spain if the Troika is being let loose over there as well.