The role of institutions in explaining wage determination in the Eurozone: A panel cointegration approach

• Author: Gaetano D'ADAMO,Mariam CAMARERO,Cecilio TAMARIT
• Published date: 01 March 2016
• DOI: http://doi.org/10.1111/ilr.12004
• Date: 01 March 2016

International Labour Review, Vol. 155 (2016), No. 1

Copyright © The authors 2016

Journal compilation © International Labour Organization 2016

* INTECO Joint Research Unit, Department of Economics, University Jaume I, Castellón

de la Plana, Spain, email: camarero@eco.uji.es. ** INTECO Joint Research Unit, Department of

Applied Economics II, University of Valencia, emails: gaetano.dadamo@uv.es (corresponding au-

thor); cecilio.tamarit@uv.es. The authors gratefully acknowledge nancial support from MINECO

project ECO2014-58991-C3-2 -R, Generalitat Valenciana Prometeo action 2009/098 and the Euro-

pean Commission (Lifelong Learning Program-Jean Monnet Action references 542457-LLP-1-2013 -

1-ES-AJM-CL and 542434-LLP-1-2 013-1-ES-AJM-CL). They are also grateful to participants in

the Fourth Workshop in Time Series Econometrics (Zaragoza, 2–3 April 2014) for their enlight-

ening comments and to Josep Lluís Carrion-i-Silvestre for providing the computer codes to apply

the Banerjee and Carrion-i-Silvestre (2015) test, and for his very valuable suggestions and advice.

Responsibility for opinions expressed in signed articles rests solely with their authors, and

publication does not constitute an endorsement by the ILO.

The role of institutions in explaining wage

determination in the Eurozone:

A panel cointegration approach

Mariam CAMARERO,* Gaetano D’ADAMO**

and Cecilio TAMARIT**

Abstract. This article estimates the equilibrium wage equation for the Eurozone

over the period 1995–2 011 using panel cointegration techniques that allow for

cross-section dependence and structural breaks. As expected, the results show that

wages have a positive relationship with productivity and a negative relationship

with unemployment. The authors also include institutional variables, showing that

more exible labour markets are consistent with wage moderation. They nd that,

since 200 4, increased international competition has made wage determination more

strictly related to productivity, and that real exchange rate appreciation triggers a

drop in wages. Their results also indicate that government intervention and wage

bargaining concertation have a wage-moderating role.

Over the past 15 years, real wage trends across the Eurozone countries

have been very diverse, reecting differences in aggregate unit labour

costs (see gure 1). On the one hand, wage setting has important second-round

effects on prices and, therefore, potentially, on competitiveness: when a country

records persistently high ination – due to increasing unit labour costs, for ex-

ample – relative to the other members of the Monetary Union, it will experi-

ence real exchange rate appreciation and a competitiveness loss. On the other

hand, Eurozone countries cannot use the nominal exchange rate to correct di-

vergent price dynamics. The only way they can correct ination differentials is

International Labour Review26

Figure 1. Real compensation per employee in 11 Eurozone countries, 1995–2011

r_comp

Source: Authors’ calculations based on Eurostat data.

Time

1995q1 2000q1 2005q1 2010q1 1995q1 2000q1 2005q1 2010q1 1995q1 2000q1 2005q1 2010q1

Austria Belgium Finland

1995q1 2000q1 2005q1 2010q1 1995q1 2000q1 2005q1 2010q1 1995q1 2000q1 2005q1 2010q1

France Germany Ireland

1995q1 2000q1 2005q1 2010q1 1995q1 2000q1 2005q1 2010q1 1995q1 2000q1 2005q1 2010q1

Italy Luxembourg Netherlands

1995q1 2000q1 2005q1 2010q1 1995q1 2000q1 2005q1 2010q1

Portugal Spain

The role of institutions in Eurozone wage determination 27

via internal devaluation. Indeed, Jaumotte and Morsy (2012) recently showed

that high employment protection and intermediate coordination in collective

bargaining contributed signicantly to the large and persistent ination dif-

ferentials of several Eurozone countries in the run-up to the economic and

nancial crisis of 2008 –10.

Understanding how wage determination works in the Eurozone is there

-

fore a matter of primary concern, not least because of the emphasis that the

OECD (2004) and, especially in more recent years, the European Commission

have been putting on labour market reforms and wage exibility. Besides, since

the Eurozone countries are also characterized by quite different labour market

institutions, it is reasonable to think that their institutional frameworks, as well

as macroeconomic developments, have important effects on wages.

Against this background, this article studies the long-run determinants

of wages in 11 Eurozone countries, with a focus on labour market institutions.

Specically, we extend a classic wage equation (Blanchard, 2000) to take into

account the role of labour market regulation and wage bargaining. Thus, one

important contribution of this article is that it is the rst to estimate equilib-

rium wage equations using cointegration that also accounts for institutional

factors in the long-run estimation. Including institutional variables in the co-

integration relationship implies assuming that changes in the institutional set-

up have permanent effects on the level of the real wage. Moreover, to some

extent, this allows us to discuss what institutional set-up is best suited for wage

setting within the single currency area.

However, the main innovative feature of our analysis lies in its statistic-

al design. We estimate the determinants of wages using panel cointegration

techniques that take into account the issue of cross-section dependence in the

data and the presence of breaks both in the series and in the cointegration re-

lationships. This is extremely important, considering the institutional changes

that the Eurozone’s national labour markets have undergone during the past

20 years, not to mention the introduction of the euro itself. We also correct for

serial correlation and endogeneity.

The remainder of the article is organized into seven sections. The rst

reviews the literature on labour market institutions and their wage outcomes.

The second section presents a stylized theoretical framework, while the third

introduces the data and variables used in the empirical analysis. The fourth

section offers a comparative perspective on the Eurozone countries in regard

to wages, unit labour costs, productivity and labour market institutions. The

fth section presents the panel unit root and cointegration tests performed and

their results, and the sixth reports our regression results. The seventh section

concludes with a consideration of policy implications.

Literature review

Since the seminal work by Phillips (1958), the empirical literature has widely

studied the relationship between unemployment and wages.1 Sargan (1964)

1 For examples of such work, see Nunziata (2005), Marcellino and Mizon (2001), Alesina

and Perotti (1997), and Baltagi, Blien and Wolf (2000).