Has The OECD Joined The Campaign For Higher Wages?

Ronald Janssen

Weak wages produce a weak recovery

Trade unions tend to see wages not as a factor of competitiveness but as an engine that drives demand, growth and jobs. The Economic Outlook published this week by the OECD supports this view as it explains the lacklustre economic that is going on via the stagnation of wage dynamics.

The OECD’s point of departure is that the economy still finds itself in a ‘low growth trap’. Growth is forecast to remain limited to just 2 percent across the OECD and 1.7 percent for the euro area.

After stressing that the extent to which the recovery can gain sufficient momentum to escape this trap will be a key issue, the OECD explicitly turns to the important role of wages by stating that ‘a durable and stronger upturn in household incomes and consumption requires stronger wage growth’.

Here, however, the OECD is rather downbeat by acknowledging that the transmission channel from lower unemployment to higher wages is broken. Despite falling unemployment rates, wage growth has been ‘remarkably stable’, in other words very modest. Moreover, the OECD does not expect this to change rapidly in 2017 and 2018 with real wage growth would remain stuck at around 0.5 percent.

What explains this broken link between unemployment and wages?

The OECD sees three reasons:

• Echoing recent publications from Eurostat and the ECB (see here), the OECD considers that the traditional statistics on unemployment rates are no longer a correct measure of remaining labour market slack. Indeed, behind these statistics lies the fact that the number of involuntary part-time work has shot up over recent years and is still well above pre-crisis levels. Combined with measures of marginally attached workers (which are also above pre-crisis levels), this makes for a substantial labour market reserve that works to keep wage dynamics down. As can be seen from the graph below, whereas unemployment and short-term working (economic part-timers) have come down since the financial crisis, involuntary part-time working and the number of marginally attached workers have risen. These are OECD-wide numbers but zooming in on particular economies highlights how dramatic the situation can be. In Italy, for example, the number of marginally attached workers (3.2 million) is currently higher than the number of unemployed (3 million), resulting in a broader unemployment rate of 24 percent. With rates as high as that, it is no wonder that wage dynamics are ‘down and out’.

• On top of labour market slack his other factors weaken workers’ bargaining power. For the OECD, the culprits here are technological change that automates routine tasks but there is also globalisation in the form of off-shoring labour intensive activities into global supply chains (see left side graph below). The role of past reforms that weakened wage formation systems by decentralising collective bargaining to company level or by limiting the opportunities for legally extending collective bargaining is, however, not considered by the OECD.

• A third reason goes back to the standard argument that explains low wage growth by dismal productivity performance. Here, the OECD even manages to turn that argument upside down by explicitly recognising that ‘for the typical worker, rising productivity may no longer be sufficient to raise wages’, as productivity growth has decoupled from wage growth over the past two decades, especially in the lower part of the earnings distribution.

Conspicuously absent: Policies to strengthen wages

The recognition that low wage dynamics are holding back the economy and that this also has to do with the weaker bargaining position of labour and with the fact that wages for the typical worker are systematically lagging behind productivity should logically lead to suggest policies and reforms that support wages by (re)strengthening bargaining systems.

That is unfortunately not the case. The OECD in its Outlook remains absolutely silent on this issue, perhaps with the exception of a very implicit reference to the role of minimum wages. Indeed, the statement that the ‘subdued nature of economy-wide wage growth contrasts with the pick-up in the annual growth of minimum wages in some major economies’, may be read as a cautious pointer to adopting stronger minimum wages. In fact, in other recent publications such as the 2017 ‘Going for Growth’ report and the EDRC review of Japan , the OECD does indeed recommend the US, South-Korea and Japan to increase their minimum wages.

Macroeconomic policy to come to the rescue?

Instead, the OECD focusses entirely on the first factor of labour market slack, arguing that wage pressure should eventually show up as labour markets continue to tighten. To fully eliminate existing labour market slack, the OECD is calling for a policy mix where a gradual reduction of monetary policy support is offset by a more active use of fiscal policy along with more ambitious structural reforms. This raises serious questions.

Why take the risk of withdrawing monetary policy support if labour market slack is still pervasive while core inflation is stuck substantially below price stability targets? What will be the implications of ‘tapering’ off quantitative easing (QE) in the euro area? What if this substantially weakens the QE monetary policy lifeline for distressed Euro Area members such as Italy or Spain? What if fiscal policy does not step in, with the Euro Area sticking to the Stability Pact or strides off in the wrong direction with a ‘trickle up’ strategy whereby the rich in the US get tax cuts while all the rest get welfare cuts?

And, importantly, what are ‘more ambitious structural reforms’ supposed to mean? This turns out to be about getting displaced workers into a job by shifting funds towards active labour market programs and this within a given budgetary envelope. In other words, this is about financing active labour market spending by reducing unemployment benefits (see also this OECD paper).

Let’s also keep in mind the other flagship OECD publication of 2017 ‘Going for Growth’ report released earlier this year. It recommends traditional structural reforms that reduce job protection, unemployment benefits, sector level bargaining and mechanisms of legal extension of collective bargaining (see table below).

OECD recommendations in Going for Growth 2017

To conclude, the OECD’s Outlook is not consistent. While the positive role wages play in supporting economic recovery is recognised, the OECD fails to draw the proper conclusions. Instead of arguing in favour of reforms that strengthen labour’s bargaining position, the OECD in the end does the opposite by again insisting on reforms that weaken workers’ bargaining position. If policy-makers were indeed to follow this, the recovery will not be buttressed but weakened.