The European Wage Structure, 1980- 2005: How much flexibility do we have?

Abstract: High unemployment has been a problem in Europe for three decades. The orthodox view points to the institutional rigidity of national labor markets in Europe as a principal cause of high unemployment, and to labor market ‘flexibilization ’ as the cure. An alternative view argues that the problem of unemployment in Europe indicates macroeconomic policy failure – an insufficiency of aggregate effective demand, given the wage structure. Both of these perspectives accept that the European wage structure is inflexible. This paper examines the rigidity of the European wage structure at the continental level, using average wages by sectors within countries as the unit of observation. We analyze the variation in the movement of relative European wages from 1980 to 2005 with a combination of cluster and discriminant analysis, which permits us to isolate the largest variations, and then to focus in on progressively smaller one. We find that there is variability in the European wage structure, and that the variations we observe are mainly associated with differing rates of change of investment, consumption and overall GDP growth between countries. This source of flexibility is usually ignored in analyses of European labor markets, but as Europe has become an integrated continental economy, it deserves to be taken into account. Doing so casts doubt on the labor market flexibilization prescription for European unemployment, since there appear to be no cases where falling relative wages led to higher employment, as the LMF hypothesis would predict