Wages, productivity and employment:A review of theory and international data

The relationship between wages and productivity (or more specifically, the relationship between wage growth and productivity growth) has become one of particular policy relevance in recent years, in light of the recent economic crisis and emerging imbalances between Eurozone countries. With this background, this paper explores the relationship between productivity growth and wage growth and its importance for employment outcomes, drawing on two main sources: 1) First we briefly review the economic literature which sets out, from a theoretical perspective (and we also refer to empirical evidence in the literature where it is available), the short-, medium- and long-run associations between wages and productivity, and implicitly the importance of productivity-orientated wage setting for employment outcomes. The medium- and long-run relationship is particularly affected by the system of industrial relations and wage–setting, and the extent to which it allows for sufficient flexibility to align wages and productivity (including downward adjustment of wages if productivity decreases) in order to achieve high employment levels and internationally competitive industries and services. Since there is great institutional variety across EU member states (and the other countries included in this review), our account is necessarily selective. 2) Then, we present an analysis of international data illustrating this relationship in the short-run (before and after the 2009-2010 recession), as well as in the medium- and long-run. OECD data for 2010 suggest that wages grew much less than productivity in countries with severe output contractions during the recession (e.g. Ireland and Estonia). This is evidence of wage flexibility at the aggregate level in these EU member states, which might contribute to the eventual restoration international competitiveness. However it is necessary to stress at the outset that our analysis faces significant limitations. In particular, data for 2010 are available only at the level of aggregate economies or EU member states and for a limited number of countries. In addition, we cannot control for many other important variables influencing productivity. A fuller analysis at the level of sectors (in particular those exposed to international competition) would be an important supplement to understand the potential effectiveness of wage moderation strategie