On wage policies and unemployment

In economies where the price of labour is determined outside of competitive markets the question arises as to whether the observed evolution of wages is likely to contribute to a decline in unemployment. I develop and discuss a benchmark, the neutral wage policy, to which the actual evolution of wages can be compared. Here, neutrality refers to the unemployment rate and not to the level of employment. If the actual wage growth falls short of this benchmark then the evolution of wages is said to have contributed to a decline in the unemployment rate. This benchmark is based on fairly general assumptions on the aggregate production technology, incorporates changes in the supply of labour, and accounts for changes in the competitive environment of firms. Finally, I discuss the relation to the benchmark of the German Council of Economic Experts (1). In many economies the price of labour is determined outside of competitive markets. Negotiations between unions and employers' associations are a case in point. In these economies the question arises as to how an assessment of the results of such negotiations should be made. The present paper develops a measuring rod against which the observed evolution of real wages can be assessed in view of its implications for the evolution of the level of employment and the unemployment rate. There are at least two related observations as to why assessments of the kind presented here matter. First, in order to legitimate their stances both negotiating parties pretend to act in the public interest. Workers' purchasing power and the cost-of-labor argument put forward by unions and employers do not only benefit their respective interest groups. They are also meant to be in the public interest since they raise the level of employment. The difficult challenge is then to ask who is right. Second, the institutional framework for wage negotiations affects the bargaining power of both parties and has, therefore, an important impact on the resulting wage. If an appropriate benchmark indicated that the negotiated wage failed to be in the public interest then the political system is likely to intervene and to change this framework. For instance, if wages were considered to be too high it is likely that changes in the institutional framework would strengthen the employers' position. I refer to the benchmark developed here as the neutral wage policy, i.e., if the actual evolution of the real wage coincides with the evolution prescribed by this benchmark, then the unemployment rate remains constant; if it falls short of it, the unemployment rate declines. This concept incorporates the following features of the aggregate demand