This paper examines Romania’s external stability risks. Recent Romanian data indicate high increases in real wages, not matched by comparable productivity gains. Both the government and the National Bank of Romania (NBR) have highlighted the importance of a responsible and stabilizing wage policy for macroeconomic stability in the country current juncture. A three-pronged approach is recommended that encompasses capacity building and improved transparency, a medium-term framework for fiscal policy, and increased use of independent fiscal expertise.

Abstract

This paper examines Romania’s external stability risks. Recent Romanian data indicate high increases in real wages, not matched by comparable productivity gains. Both the government and the National Bank of Romania (NBR) have highlighted the importance of a responsible and stabilizing wage policy for macroeconomic stability in the country current juncture. A three-pronged approach is recommended that encompasses capacity building and improved transparency, a medium-term framework for fiscal policy, and increased use of independent fiscal expertise.

II. Wage-Price Setting in Romania and Other New EU Member States

Core Questions and Findings
  • What were the main drivers of the recent surge in Romania’s real wage growth ahead of labor productivity growth? A cross-country analysis of wage-setting behavior in new EU member countries (NMS) points to four main factors accounting for growing real unit labor cost in Romania: (i) real wage catch-up from the period before 2005, when real wages lagged significantly behind productivity growth; (ii) a tightening of labor market conditions, owing to strong labor demand, but also exacerbated by large-scale emigration; (iii) loose public sector wage policies, which have added to private-sector wage pressures via demonstration effects; and (iv) rigidities in the labor market.

  • What other factors seem empirically important for wage setting behavior in Romania and other NMS? First, the estimates suggest that terms of trade shocks do not feed through to real wages. Second, there is no evidence of a direct wage catch-up effect arising from NMS countries’ lower wages relative to the euro area.

  • Is there a risk of a wage-price spiral? Parallel panel estimates of a price-setting equation suggest strong and significant wage pass-through to inflation. If real labor costs in Romania continue to outpace productivity growth, they are likely to increasingly feed through to inflation, in turn generating pressure for further wage increases.

  • What do these findings imply for Romania’s macroeconomic policies and labor market reforms? First, the monetary policy stance needs to be sufficiently tight to moderate inflation pressures, but monetary policy will need to be also supported by a tighter fiscal stance. Second, public sector wage and employment policies should avoid aggravating private sector labor shortages. And third, reforms that raise labor force participation, particularly in rural areas, and facilitate more efficient matching of labor supply and demand should also help reduce wage pressures, although beneficial effects from such reforms will take time to materialize.

A. Background

Conventional wage-price setting models suggest a tight link between real wages and labor productivity. Although changes in other fundamentals may loosen this link in the short run, anchoring real wages to labor productivity is necessary in the long run to limit cost-push inflation and to promote macroeconomic stability.

Recent Romanian data indicate high increases in real wages, not matched by comparable productivity gains. Since late 2005, real wages in Romania have been increasing at an accelerating pace. In particular, the service sector, public and private, has experienced high wage growth, although productivity growth has mostly remained flat.

Both the government and the National Bank of Romania (NBR) have highlighted the importance of a responsible and stabilizing wage policy for macroeconomic stability in the country current juncture. The government’s Convergence Program notes that a rapid wage growth could undermine the sustainability of the short-run disinflation process. At the same time, the May 2008 Inflation Report by the NBR identifies continued wage rises in excess of productivity gains as one of the major inflation risks which, should they materialize, could cause inflation to exceed the NBR’s target range in 2009.

The aim of this chapter is to test the link between real wages and productivity in NMS and to examine it in the context of recent developments in Romania’s labor market. Section B and C set up the theoretical wage and price setting relations for the analysis. Section D introduces stylized facts on recent wage setting behavior in NMS. Section E presents the empirical model and hypotheses to be tested in the following Section F and G. The chapter makes use of panel data analysis. However, the econometric investigation is complemented by other qualitative evidence, given data constraints.

B. Wage–Price Setting Relations

On the demand side of the economy, firms’ labor demand is determined by a price-setting equation. Under the assumption of a Cobb-Douglas production function, prices are set by applying a markup μ over unit labor cost. In logarithms:

(1)p=ulc+μ=[w(yn)]+μ

where the markup—resulting from imperfect competition in the goods market and/or labor market imperfections—can be also defined as the ratio of the marginal product of labor, (y-n), to the real wage, (w-p).

The supply side of the economy specifies the wage setting equation, which links real wages to labor productivity and unemployment. As the equilibrium wage is the result of bargaining between firms and workers, an analysis of real wages cannot disregard the labor supply side of the economy. In absence of frictions and imperfections in the labor market, workers’ desired wage level depends on labor productivity, the unemployment rate, u, and other factors, z. Abstracting from expectations, the wage-setting equation can thus be represented as follows:

(2)wp=βu+(yn)+z

The variable z in the wage setting equation includes a range of “wage-push” factors: unemployment benefits, minimum wages, restrictions on firing or hiring, the degree of unionization, the tax wedge (both in terms of earnings and payroll taxes) as well as skills mismatch and information problems. By creating a disconnect between wages and effective total compensation, these factors affect in turn the firms’ unit labor costs and wage setting behavior.

C. Additional Considerations for Wage-Price Setting

Data Issues

One of the main obstacles in the analysis of transition economies is the limited availability and poor quality of labor market data. Due to the poor statistical quality of early series for transition economies, the sample period for the empirical analysis is restricted to 2001–07, and, to maximize series comparability, uses Eurostat as main data source8. The limited time span is enhanced by the use of panel data from 9 New Member States9; for comparison, estimates are also presented for the other EU countries (EU18).

Furthermore, accurate definition and construction of the labor market indicators is essential for a correct interpretation of the data. In particular, in the analysis of real wages and productivity data, the selection of alternative price deflators or employment series can produce widely different results.

The choice of the GDP deflator as price deflator for real wages and productivity allows consistency in the data10. Productivity is defined here as real GDP per person employed. Therefore, the GDP deflator is the correct price to be used in the construction of real wages. Given that the GDP deflator growth tends to be higher than the private consumption one during the sample period for most NMS, and especially Romania11 (Figure 1), the use of the consumption deflator would bias real wage growth upward with respect to productivity growth.

Figure 1.
Figure 1.

Relationship between GDP and Private Consumption Deflator in NMS

(Index, 2000=100)

Citation: IMF Staff Country Reports 2008, 210; 10.5089/9781451832907.002.A002

Source: Eurostat; and staff calculations.

Nevertheless, workers bargaining decision are based on the purchasing power deriving from their real wage. Therefore, in the wage setting equation the nominal wage should be rather deflated by the private consumption deflator. However, the impact of productivity on real wages would need to be corrected by the difference between GDP and consumption deflator. A useful way to rewrite the wage setting equation is therefore as follows:

(2)wpc=βu+(yn)+θ(ppc)+z,

where real wages depend on the difference between growth in the GDP deflator (p) and the private consumption deflator (pc). For θ equal to one, equation (2)’ is equal to the baseline wage setting equation and implies no pass through from a terms-of-trade shock to real wages.

Similar considerations apply to the selection of employment statistics. The use of payroll statistics or narrower estimates of employment rather than more comprehensive labor survey data could lead to underestimate the number of employees in the economy and therefore bias upwards productivity estimates.

Finally, the role of the informal economy cannot be disregarded. The increasing deshadowing of the gray economy in recent years is likely to lead to higher figures for employment and wages, although this is merely the result of broader reporting rather than changes in fundamentals.

Different Wage Setting Behavior in the Private and Public Sector

The relation between real wages and labor productivity suggested by the wage and price setting relations refers to the private sector, and mainly industry. In equilibrium, these relations suggest that deviations of real wages from productivity would be determined by the rate of unemployment, the degree of competition in the economy and a range of wage-push factors.

Wage determination in the public sector may diverge from the wage setting behavior identified for the private sector and even have a ‘wage-push’ effect on the entire economy. Shifts in public sector labor demand and a loose wage policy may have a demonstration effect on the private sector12. Furthermore, in some countries collective bargaining at the national level may set by law the minimum conditions for all of the economy, therefore generating a wage-push effect originating from the public sector.

Catch-up Process to Euro-Area Average Wages and Prices

Finally, wage setting behavior in transition economies may be affected by these countries’ convergence process. Real convergence toward comparable purchasing power could represent a further wage-push factor in most NMS starting from very low initial levels. Furthermore, increasing labor mobility across the European Union and the growing weight of remittances from abroad in households’ income could trigger an even faster nominal convergence in wages and prices.

D. Stylized Facts on Wage Setting Behavior in NMS

A first analysis of labor market data in NMS suggests that real wage growth13 has been high in most NMS but notably in Romania in the last years. While for the CEE-4 group, which is ahead in the convergence process, real wage growth has been relatively stable and on average well below 5 percent, real wages have accelerated in the other NMS (Figure 2). However, while as from 2005 the trend seems to have moderated for the Baltics and Bulgaria, real wage growth in Romania remained high.

Productivity growth14 has been persistently high in NMS, especially in the Baltic countries. The Baltics stand out from the NMS for the sustained productivity gains in recent years, averaging 7 percent. The other NMS show productivity growth around 4 percent in the last three years, although gradually increasing over time (Figure 2).

Figure 2.
Figure 2.

Real Wage and Productivity Growth in NMS

Citation: IMF Staff Country Reports 2008, 210; 10.5089/9781451832907.002.A002

Sources: Eurostat; and staff calculations.

Real unit labor costs–measuring the difference between real wage and productivity growth–have currently been decreasing in all NMS with the exception of Romania. While the increase of wages above productivity has been corrected in most countries, since 2005 wage growth in Romania has been higher than productivity (Figure 3).

Figure 3.
Figure 3.

Developments in Real Unit Labor Cost in NMS

Citation: IMF Staff Country Reports 2008, 210; 10.5089/9781451832907.002.A002

Sources: Eurostat; and staff calculations.

Recent wage setting behavior in most NMS might reflect catch up from extremely low wage levels relative to peer countries. As presented in Figure 4, euro wages in all NMS have been increasing, but with still wide differences across countries. While wages in Romania have been rapidly catching up, the pace in other countries has been much slower even when starting from lower levels as in the case of Bulgaria. The same pattern is identifiable in NMS price adjustments: Romania’s price levels have increased very rapidly, notably in 2004–05, compared to the much smoother adjustment of the other NMS. The high inflows of remittances from workers abroad–proxied in Figure 5 by private transfers and accounting for almost 5 percent of GDP in Romania–may explain part of this price and wage adjustment given its impact on households’ disposable income and thus their reservation wage.

Figure 4.
Figure 4.

Wage and Prices Developments among NMS

Citation: IMF Staff Country Reports 2008, 210; 10.5089/9781451832907.002.A002

Sources: Eurostat; and staff calculations.
Figure 5.
Figure 5.

Private Transfers in NMS

(In percent of GDP)

Citation: IMF Staff Country Reports 2008, 210; 10.5089/9781451832907.002.A002

Sources: WEO; and staff estimates.

Unemployment rates have dropped to single digits in most NMS. Unemployment rates have decreased rapidly in most NMS over the last three years (Figure 6). Large-scale migrations and robust labor demand are at the root of tight labor markets in most cases. As highlighted by the stylized wage-setting equation, the level of the unemployment rate affects directly wage setting behavior and may therefore explain part of the differences in real wage growth across countries.

Figure 6.
Figure 6.

Labor Force Developments in NMS

Citation: IMF Staff Country Reports 2008, 210; 10.5089/9781451832907.002.A002

Source: Eurostat; WEO; and staff calculations.

The decrease in unemployment has been matched by a change in the production structure, with increased needs for skilled workers. As shown in Figure 7, firms in all NMS have excess demand for qualified workers15, notably in Bulgaria and the Baltics. Romania’s shortage of skilled workers, instead, although significant, is still way below the NMS average. At the same time, with the exception of the Baltics, inactivity rates in NMS are also very high and well above the euro area average (Figure 6). Bulgaria and Romania stand out with the highest rates: however, the participation rate has been improving in Bulgaria in recent years, while it has remained quite persistently high in Romania.

Figure 7.
Figure 7.

Excess Demand of Workers with Tertiary Education

Citation: IMF Staff Country Reports 2008, 210; 10.5089/9781451832907.002.A002

Sources: Eurostat; and staff estimates.

As regards price setting behavior in NMS, stylized facts suggests that ULC and consumer price inflation have followed similar paths over the last years. In all NMS, but even more remarkably along Romania’s disinflationary path, reductions in ULC have been in general matched by lower inflation (Figure 8).

Figure 8.
Figure 8.

Nominal Unit Labor Costs and Consumer Price Inflation in NMS

Citation: IMF Staff Country Reports 2008, 210; 10.5089/9781451832907.002.A002

Sources: Eurostat; and staff calculations.

Finally, competition levels have improved in all NMS, although from very low starting levels in Bulgaria and Romania (Figure 9). As described in Section B, the degree of competition in the goods market affects the price setting behavior of firms and as a result their ability to accommodate nominal wage pressures via price increases. Enhanced competition, by reducing firms’ markup, is expected to strenghten the relation between real wages and labor productivity.

Figure 9.
Figure 9.

Competition in NMS

(EBRD Index of Competition Policy)

Citation: IMF Staff Country Reports 2008, 210; 10.5089/9781451832907.002.A002

Sources: EBRD; and staff estimates.

E. Empirical Wage and Price Setting Equations

The above stylized facts raise the question to what extent have recent increases in wages diverged from fundamentals. The disconnect between wages and productivity, notably in the case of Romania, might be due to the role of other fundamentals in the country. As presented in Section B, real wages depend also on the unemployment rate, on the terms of trade (the latter a proxy of the difference between GDP and private consumption deflator), and on a wide range of ‘wage-push’ factors. These can be summarized in two main empirical hypotheses to be tested in order to explain different wage setting behaviors across countries:

  • 1. Countries’ wage setting behavior might have been the result of tight labor market conditions. High productivity and changes in countries’ production structure increase demand for qualified workers in countries experiencing at the same time massive migration flows. Wage pressures in high-productivity sectors end up affecting also less productive sectors in the economy. Shifts in public sector labor demand, in part justified by recent EU memberships, can be a further cause of pressure on wages.

  • 2. Catch up from unusually low wage levels and a rigid structure of the labor market may be a further source of wage pressures. Countries starting from very low initial wage levels may experience higher real wage growth in order to reach the equilibrium level suggested by the long-run relation between real wages and productivity. Apart from the country-specific adjustment, further pressures on real wages may arise from a direct wage catch-up effect to euro area nominal wages. This process can be intensified by improvements in households’ incomes, and thus higher reservation wages, due to high remittances. The structural characteristics of the labor market, by affecting effective compensation or in general the economy wage setting behavior, might also alter the link between real wages and productivity: differences in tax wedges, minimum wages, and labor market rigidities, including the degree of unionization and collective bargaining in the economy, are among the main structural factors to be considered.

Part of these hypotheses can be tested empirically by means of an empirical wage equation. The stylized wage setting equation discussed in Section B is estimated in the form of an error correction model (ECM), in line with Blanchard and Katz (1999). Furthermore, as real wages are deflated by the consumption deflator, a variable accounting for the difference between GDP and private consumption deflator—and therefore proxying changes in terms of trade—is added to the final specification16. The short and long run dynamics of wages can be therefore represented by the following empirical wage equation:

(3)Δ(wtpct)=αw+βwΔ(ytnt)γECTt1+θΔ(ptpct)δut+ϕzt+εt
(4)ECTt=(wtpct)[αLR+βLR(ytnt)+θLR(ptpct)]

In the short run, real wage growth would depend on labor productivity growth, changes in terms of trade, and unemployment, as well as a series of “wage-push” factors that can be added to the regression as control variables17. In line with the seminal work by Sargan (1964) and more recent empirical studies of European countries, the specification allows for a long-run adjustment component by means of an error correction term (ECT), defined as the difference in levels between real wages and productivity.

Furthermore, as any wage increase not justified by fundamentals could lead to inflation and generate a price-wage spiral, the analysis needs to consider the firms’ price setting behavior. Any increase in wages beyond productivity affects prices, by increasing unit labor costs in the firms’ price setting equation. The extent to which increases in nominal wages will be transferred to prices will depend on the structural characteristics of the goods market and the firms’ pricing power. In particular, if wages and markups are not flexible, the process of nominal adjustment towards equilibrium will be slower and generate longer-lasting output fluctuations (see Blanchard, 1985). Empirically, the price setting equation [1] in Section B can be translated into the following specification:

(5)Δpct=αp+βpΔwtγΔ(ytnt)δECTt1+ϕΔmpt+εt
(6)ECTt=pct[αLR+βLRwtγ(ytnt)+ϕLRmpt]

The short run dynamics of inflation are explained by a level adjustment towards steady-state represented by an ECT, as in the previous wage equation, and by changes in firms’ unit cost. The latter is defined as unit labor cost–that is the nominal wage net of labor productivity–plus an import price pass-through effect. Changes in the firms’ pricing power can also be added to both the long-run and short-run specifications. The following section tests these hypotheses by means of econometric techniques and, whereas data constraints are binding, by a more qualitative analysis of stylized facts.

F. Empirical Evidence on Price-Wage Setting Behavior in New Member States

The econometric results from a panel analysis of the empirical wage equation for EU countries suggest a tight long-run relation between real wages and productivity. The empirical long-run wage setting equation is estimated separately for the 9 NMS and, for comparison purposes, the remaining 18 EU countries, including the euro area, Denmark, Sweden and the UK, over the period 2001–2007. The overall response of real wages to productivity, controlling for fixed effects, is equal to 0.86 in both samples.

A significant error correction term enters into the wage equation of EU countries and its higher level for NMS seems to provide evidence of a convergence effect. The residual of the long-run wage equation is found stationary and entered in the empirical wage equation together with the short run dynamics. As presented in Table 2, the sign of the ECT coefficient is negative implying an adjustment of real wage growth to deviation of real wages from their long-run equilibrium level. While the ECT coefficient estimated for the EU18 is consistent with the 0.25 value estimated in the literature for EU countries (Blanchard and Katz, 1999), the NMS coefficient is much higher at 0.46. This result seems justified by the very low starting wages in most NMS, notably Bulgaria and Romania. However, there is no significant evidence of a direct wage catch-up effect arising from NMS countries’ lower euro wages relative to the euro area average.

Table 1.

EU27: Long-Run Wage Equation Estimation

article image
Note: SE in parentheses. *, **, *** denote significance at 10, 5, and 1 percent level, respectively.
Table 2.

EU27: Wage Error Correction Model Estimation

article image
Note: SE in parentheses. *, **, *** denote significance at 10, 5, and 1 percent level, respectively.

Lagged deviation of euro area wage (in euros) from country wage (in euros).

The short-run relation between real wage growth and labor productivity gains is remarkably strong in NMS, and so is the relation with unemployment. The labor productivity coefficient is close to one once other control variables are included in the specification. The relation between unemployment and real wage growth is also particularly strong in NMS and with the expected negative sign, while it is hardly significant in the EU18 group. Moreover, both likelihood ratio and Wald tests cannot reject the hypothesis that the coefficient on changes in terms of trade is different from one in both EU18 countries and NMS, therefore suggesting that shocks to terms of trade do not pass through to real wage growth. Finally, higher remittances in percent of GDP contribute to real wage pressures, although the impact is relatively small. The regressor might be proxying higher disposable incomes as well as countries’ tight labor market conditions due to emigration flows: indeed, the unemployment coefficient is lower and no longer significant once the remittances variable is added to the baseline specification.18

A panel analysis across NMS of the empirical price equation shows evidence of high and significant pass-through effect from wage growth to inflation. The long-run estimation is consistent with the wage-setting analysis (Table 3); the ECT is found stationary and therefore included in the short-run estimation. The average response of inflation to wage growth is strongly significant and estimated at around 65 percent in both country samples (Table 4)19. Labor productivity growth has the expected negative sign, implying that gains in productivity by reducing firms’ unit labor costs mitigate inflationary pressures. The impact of an increase in unit labor costs on inflation in NMS would be therefore limited, as long as increases in nominal wages are matched by productivity gains.

Table 3.

EU27: Long-Run Price Equation Estimation

article image
Note: SE in parentheses. *, **, *** denote significance at 10, 5, and 1 percent level, respectively.
Table 4.

EU27: Price Error Correction Model Estimation

article image
Note: SE in parentheses. *, **, *** denote significance at 10, 5, and 1 percent level, respectively.

Import price pass-through to domestic inflation is also strongly significant. In NMS, increases in the import deflator pass through to private consumption deflator inflation by a coefficient of 31 percent. For the EU 18 group the coefficient is instead lower at 14 percent.

Finally, an additional variable controlling for firms’ pricing power in NMS enters with the expected sign in both the long-run and short-run specifications. As suggested by theory, prices are set at a higher level in countries with stronger firms’ pricing power. The latter is proxied—with an inverted sign - by the EBRD index of competition policy: as shown in Figure 8, Bulgaria and Romania have the lowest rank in the index for the entire sample period as well as for recent years. Nevertheless, the relation holds significantly only in the long run.

G. Wage-Price Setting Behavior in Romania

Stylized facts on labor market developments in NMS suggest a wide cross-country variation and, in particular, a diverging relation between real wages and productivity for the case of Romania. The panel analysis of wage setting behavior in NMS has highlighted a response of almost 65 percent of real wage growth to labor productivity gains. Nevertheless, labor market data, as presented in Section D, suggest large differences across NMS. In particular, Figure 10 shows that, as from 2005, actual real wage growth in Romania has been outpacing the value predicted by the NMS short-run dynamics. As a result, as from 2006, the actual level of real wages in Romania has surpassed its equilibrium value, according to the estimated long-run wage equation.

Figure 10.
Figure 10.

How Far are Romania’s Wages from Equilibrium?

Citation: IMF Staff Country Reports 2008, 210; 10.5089/9781451832907.002.A002

The purpose of this section is to identify possible reasons behind Romania’s specific wage developments. The analysis will therefore look into further detail to the wage setting relation for Romania by decomposing its sectoral component and analyzing recent labor developments in the country.

An analysis of sectoral data on Romanian wages20 presents similar patterns to those identified by the previous analysis for the overall economy, although poor data quality suggests caution in interpreting the results. Real wages have been growing at an average of 7 percent since early 2005, reaching 10 percent during 2007. The main increases have been registered in services and agriculture, and more recently in the booming construction sector (Figure 11). Furthermore, in levels, nominal wages in services have been consistently higher than wages in industry, construction and agriculture.21

Figure 11.
Figure 11.

Romania: Real and Nominal Wages

Citation: IMF Staff Country Reports 2008, 210; 10.5089/9781451832907.002.A002

Sources: National authorities; and staff calculations.

In the service sector, real wage increases took place mostly in the public sector. In particular, real wages in the public administration have been raised by over 20 percent in the last two years and early data releases for 2008 suggest substantial increases also in the education and health sectors (including payment of occasional bonuses). Also in level terms, average wages in the public sector in 2007 were 20 percent higher than in the industry and 10 percent higher than in the private service sector. Nevertheless, the private sector has almost matched the rapid wage increases in the public sector during the last period, with the wholesale and retail trade sector averaging a 24 percent growth in wages during 2007.

Nevertheless, wage increases in services have been associated with negligible productivity gains and have thus been one of the main drivers of the recent increases in real unit labor costs. Real ULC have increased by 7.2 percent on average in 2007. The main increases were registered in services, where real wage growth has been associated to hardly any change in productivity (Figure 12). Surprisingly, wages in the construction sector, which experienced the greatest gains in productivity (almost 20 percent in 2007), have grown much less in relative terms.

Figure 12.
Figure 12.

Romania: Labor Productivity and Real Unit Labor Costs

Citation: IMF Staff Country Reports 2008, 210; 10.5089/9781451832907.002.A002

Sources: Eurostat; and staff calculations.

Part of these developments can be justified by a rapid nominal catch up process. As already presented in Figure 4 and supported by the empirical evidence from NMS, wage levels in Romania have been converging, from very low levels, at a very high pace compared to other countries.

The tight Romanian labor market and its contribution to wage pressures in the economy is another possible explanation. Increases in employment in recent years have not been matched by increases but rather a slowdown in the labor force (Figure 13). This has led to a decline in the registered unemployment rate to almost 4 percent.

Figure 13.
Figure 13.

Romania: Labor Force Developments

Citation: IMF Staff Country Reports 2008, 210; 10.5089/9781451832907.002.A002

Sources: Eurostat; National authorities; and staff estimates.

Large-scale emigration of Romanian citizens has contributed to the strong reduction in the labor force and unemployment. Although national statistics on emigration flows tend to underestimate the number of Romanian citizens leaving the country every year, statistics from EU recipient countries offer quite a remarkable picture (Figure 13). EU countries report more than one million Romanian citizens residing in their countries, with the highest concentration in Spain and Italy. Although increasing, immigration flows from neighboring countries, notably Moldova, are still limited.

At the same time, demand for qualified workers has been robust due to changes in production towards outputs with higher technological and human capital content. As shown in Figure 7, Romania’s excess demand for skilled workers has been increasing, although the shortage is still below EU and NMS average. Furthermore, inactivity rates are still very high and show no sign of improvement. Low participation rates mainly occur in rural areas, where a large share of the working-age population has difficulties re-entering the labor force. Agricultural self-subsistence and remittances from relatives working abroad are the main sources of income for this portion of the population.

Across sectors, increases in employment have been driven by the buoyant construction sector as well as the service sector. Employment growth in private sector services, notably trade, has been the highest across sectors since 2005 (Figure 14). Employment has been decreasing in industry and, to a much higher extent, in agriculture. Employment in the construction sector has been increasing although its level - and therefore its impact on overall employment - is still small. As regards public sector services, the public administration has registered the main increases, while employment in health and education has remained stable. However, recent EU membership and the reorganization of the public administration according to EU regulations can only limitedly justify such increases.

Figure 14.
Figure 14.

Romania: Employment Growth by Sector

Citation: IMF Staff Country Reports 2008, 210; 10.5089/9781451832907.002.A002

Sources: National authorities; and staff calculations.
Figure 15.
Figure 15.

Union Density and Collective Bargaining in NMS 1/

(In percent)

Citation: IMF Staff Country Reports 2008, 210; 10.5089/9781451832907.002.A002

Sources: European Trade Union Institute-REHS; and staff estimates.1/ Survey data collected between 2000 and 2007. In Romania, collective bargaining at national level sets national minimum pay and conditions for all employees.

The structural characteristics of the Romanian labor market may also have played an important role in the relation between real wages and labor productivity. As noted already in Section C, the wage and price setting relations refer essentially to the industrial sector. However, collective bargaining at national level is likely to affect the wage setting process for the whole economy, with demonstration effects from the high- to the low-productivity sectors and, in turn, from the public to the private sector22. And indeed, Romania stands out from the other NMS for the highest union density—defined as union members as a percentage of total employees–which, although much lower than in the past, reaches 30–35 percent (against 11 percent in Estonia). Also, collective bargaining at the national level is regulated by law and sets national minimum pay and conditions which apply across the whole economy. The result is that national level agreements cover all employees—implying collective bargaining coverage of 100 percent.

Specific non-wage labor costs remain also higher in Romania compared to other NMS. for example, it is interesting to note that Romania has one of the highest tax wedges among NMS (second only to Hungary) as well as one of the lowest minimum wages (Figure 16). These “wage-push” factors create a wedge between the workers’ wage and effective compensation and may therefore hide differences in the country price and wage setting strategy. However, changes in both indicators have only been marginal over the last years and, therefore, while they are likely to have a level effect on Romanian real wages, they do not seem to justify recent increases in real wages.

Figure 16.
Figure 16.

Selected Labor Market Indicators in NMS

Citation: IMF Staff Country Reports 2008, 210; 10.5089/9781451832907.002.A002

Sources: Eurostat; and staff estimates.

Finally, indicators of labor market flexibility show that the country still lags behind most of the other NMS. Romania’s labor flexibility, as proxied by the World Bank Doing Business Indicator for “Employing Workers”, is quite low and the distance from the best performers among NMS seems on average to have widened rather than shrunk (Table 5). Poor labor flexibility may exacerbate the already tight labor market conditions in Romania, as firms cannot efficiently achieve the desired level of workers.

Table 5.

Romania: Labor Flexibility 1/

article image
Sources: World Bank; and Fund staff calculations.

For comparability, all indices normalized so that they range from 0 (lowest) to 100 (best).

Country name and index of best performers among New Member States (NMS)

Distance of Romania from NMS best performer for each index.

References

  • Blanchard, O. (1986), “The Wage Price Spiral,” The Quarterly Journal of Economics, Vol. 101, No. 3 (Aug., 1986), pp. 543565.

  • Blanchard, O., and Katz, L.F. (1999), “Wage Dynamics: Reconciling Theory and Evidence,” The American Economic Review, Vol. 89, No. 2, Papers and Proceedings of the One Hundred Eleventh Annual Meeting of the American Economic Association (May, 1999), pp. 6974.

    • Crossref
    • Search Google Scholar
    • Export Citation
  • Bosworth, B., Perry, G.L., and Shapiro, M.D. (1994), “Productivity and Real Wages: Is There a Puzzle?” Brookings Papers on Economic Activity, Vol. 1994, No. 1, pp. 317344.

    • Crossref
    • Search Google Scholar
    • Export Citation
  • Christou, C. (2007), “Wage Dynamics in the Romanian Economy,” IMF Country Report No. 07/220, Chapter II, June.

  • Feldstein, M.S. (2008), “Did Wages Reflect Growth in Productivity?” NBER Working Papers 13953, April.

  • OECD (1997), Employment Outlook. Paris: Organization for Economic Cooperation and Development.

  • Sargan, J.D. (1964), “Wages and Prices in the UK,” in Hart, P.E., Mills, G., Whittaker, J.K., Eds., Econometric Analysis for National Economic Planning, London: Butterworth

    • Search Google Scholar
    • Export Citation
  • World Bank (2007), “Labor Markets in EU8+2: From the Shortage of Jobs to the Shortage of Skilled Workers,” World Bank EU8+2 Regular Economic Report, Part II, September.

    • Search Google Scholar
    • Export Citation
8

The only exception is represented by the unemployment rate series from the World Economic Outlook database (WEO) and the wage flexibility index from the World Bank’s Doing Business indicators.

9

In the text below, we refer to the following regional groups among NMS: CEE4, including Czech Republic, Hungary, Poland and Slovak Republic; and the Baltic countries, including Estonia, Latvia and Lithuania.

10

See Bosworth et al. (1994) and Feldstein (2008) for a further discussion of price and wage measuring issues.

11

Assuming that domestic demand and private consumption deflators grow at the same rate, this result implies an increase in terms of trade - that is an increase in the relative price of exports with respect to imports, which is consistent with the increase of the technology and human capital content of transition countries’ exports during the convergence process.

13

For the cross-country sample, the real wage is defined as the nominal wage deflated by the GDP-deflator. According to the Eurostat definition, the nominal wage is the remuneration in cash paid by the employer during the reference year, before tax deductions and social security contributions payable by wage-earners and retained by the employer. All bonuses, whether or not regularly paid, are included. Severance payments as well as payments in kind are instead excluded.

14

Labor productivity is defined as gross domestic product at 1995 market prices per person employed, according to Eurostat definition.

15

“Excess demand” for skilled workers is defined as the difference between the percentage share of workers with tertiary education in unemployment and that one of workers in employment, considering only workers between 15 and 64 years old (see World Bank, 2007).

16

See, among others, OECD (1997) for a similar specification.

17

All variables are in logs.

18

Other control variables are added to the baseline specification (including the activity level, skilled-workers’ excess demand, tax wedges, minimum wages, and the World Bank Employing Workers Indicator as a measure of labor rigidity). Although all these variables are found to have a wage-push effect as suggested by the literature, lack of a sufficient time span for most indicators hampers the statistical reliability of these results, which are therefore omitted.

19

Results are robust to specifications allowing for lags of the dependent variable and the regressors.

20

Wage statistics are from the Household Labor Force Survey and nominal wages are defined as average gross salary earnings per employee per month.

21

Data for the agriculture sector are not reported, although available, to enhance the readability of the figures, given the big swings in the series.

Romania: Selected Issues
Author: International Monetary Fund