APPENDIX: The Impact of Real Wages on the Composition of Output
The purpose of this appendix is to present a model that illustrates how in a situation of excess labor supply, a decrease of real wages might lead to an increase of the share of non-tradables in production. The model does not pretend to be a description of what actually happened; rather it formalizes the mechanisms that were outlined verbally in the text. The model is partial-equilibrium; it does not include a capital stock, and, hence, investment.
Artus, Jacques R., “The Disequilibrium Real Wage Rate Hypothesis, An Empirical Evaluation,” IMF Staff Papers (1984), pp. 249–302.
Bakker, B.B. and C.G.M Sterks (1989), “De onderschatte invloed van ruilvoetverslechteringen” (the underestimated impact of terms-of-trade deteriorations), Economische Statische Berichten, 74 (1989), pp. 1017–1018.
De Gregorio, José, Alberto Giovannini, and Thomas H. Krueger, “The Behavior of Nontradable Goods Prices in Europe: Evidence and Interpretation,” IMF, WP/9¾5 (1993).
De Gregorio, José, Alberto Giovannini and Holger C. Wolff, “International Evidence on Tradables and Nontradables Inflation,” European Economic Review, 38, (1994), pp. 1225–1244.
Den Hartog, H. and H.S. Tjan, “Investment, Wages, Prices, and the Demand for Labor, a Clay-Clay Vintage Model for the Netherlands,” De Economist, Vol. 124, 1976, pp. 32–55.
Dixit, A. and J. Stiglitz, “Monopolistic Competition and Optimum Product Diversity,” American Economic Review, Vol. 67 (June), (1977).
Enders, Klaus, and Horst Herberg, “The Dutch Disease, Consequences, Cures and Calmatives,” Weltwirtschaftliches Archiv, (1983), pp. 473–497.
Wetenschappelijke Raad voor het Regeringsbeleid, “Een Werkend Perspectief” (a working perspective), Rapporten aan de Regering, 38, Den Haag, (1990).
Prepared by Bas B. Bakker.
An appendix provides a model to explain why the sheltered sector might have profited more from wage restraint than the open sector.
The increase in revenues from natural gas may also have played a role in the real appreciation of the Dutch guilder (Dutch disease). In this mechanism, the higher revenues from gas would have increased the balance on current account, thereby exerting upward pressure on the exchange rate and damaging the competitiveness of the non-gas sector (Enders and Herberg (1983)).
As noted by Artus (1984), the increase in the share of labor costs in value added does not necessarily mean that the real rate was too high, as the increase could be warranted by, for instance, long-run changes in production techniques or in the relative availability of capital and labor.
The disability scheme was introduced in 1967. At that time it was expected that there would be no more than one hundred thousand disability benefits recipients. However, until 1993, the number of recipients increased each year, to a peak of 920 thousand in 1993.
The participation rate of women used to be rather low in the Netherlands (Wetenschappelijke Raad voor het Regeringsbeleid, 1990), but has increased strongly, and by 1992, the participation rate for women was above the EU-average (see SM/95/76, Supplement 1). Most women work part-time; survey results suggest that this reflects a preference among women.
The decline in labor supply in 1984 and 1985 is due to the fact that from 1984 onwards, the unemployed aged 57 ½ and older were no longer required to look for a job, and thus were withdrawn from the labor force.
Although moderate wage growth is seen as a very important factor, there might also have been other factors that contributed to Dutch employment growth. For instance, apart from the moderation of general wage increases, there was also a change in behavior of relative wages. Whereas, in the seventies, the minimum wage grew much faster than the average wage, in the eighties this was the other way around. An increase in the relative level of the minimum wage might have negatively affected employment growth in the seventies; the subsequent decline might have stimulated employment. Also, the wedge decreased somewhat in the eighties—although its level is still very high compared to other OECD countries (OECD, 1995).
The Dutch Central Planning Bureau has disaggregated the economy in a sheltered sector and an exposed sector: the sheltered sector roughly corresponds to services, and the exposed sector to manufacturing. Specifically, the open sector consists of agriculture, manufacturing, utilities, and transport, storage and communication; the sheltered sector consists of wholesale and retail trade, restaurants and hotels, finance, insurance, real estate and business services, and community, social and personal services.
In the 1970-1994 period, wage growth in the sheltered and exposed sector and sheltered sector was very similar. Thus, differences in output growth in both sectors are not due to differences in wage developments between both sectors.
It is well known that, over time, as real wages in the various sectors of the economy increase at roughly the same rate, the relative price of sectors with low productivity growth—such as services—go up. (Baumol effect). Thus, even in an economy where wage growth is not excessive (for instance, in the sense that labor markets clear, and average wage increases are in line with average productivity increases) we would observe a correlation between the growth of real wages and the increase in the relative price of services.
To the extent that differences in real wage increases between the seventies and eighties were the result of underlying productivity differences, we would not necessarily associate them with differences in the relative performance of the services sector. However, we argued previously that the low wage growth in the eighties was not the result of lower underlying productivity increases, but was in large part a correction on the excesses of the seventies.
This raise refers to a situation in which relative prices are constant. As relative prices of services increase over time (due to both real wage increases and lower total factor productivity increases in services), we would, with a same development in real output, expect an increase in the share of services in nominal output.
The negative impact excessive real wages might have on employment has been amply discussed in the literature (see, for instance, Bruno and Sachs (1985)).
De Gregorio et. al. used their model to explain the evolution of the relative price between tradable and nontradable goods in a group of European countries.
The presence of a fixed costs insures that each variety is produced by a single firm, and that the total number of varieties and firms is finite.
In the tradeable sector, real wages determine production, which in turn determine employment; in the non-tradeable sector real wages determine prices, which determine demand which in turn determines output and employment.
L could, for instance, be interpreted as labor supply. This interpretation would suggest that if labor supply rises, wage demands will decrease.
The underlying mechanism here is that non-tradeable prices decrease when wages decline, and tradeable prices are given, and hence do not change.