Media Briefings

Wage Rigidity Increases Unemployment: Evidence From Italy

  • Published Date: November 2007


Nationwide pay agreements have restricted labour market flexibility and increased
unemployment in Italy, according to research by Francesco Devicienti and
colleagues, published in the November 2007 issue of The Economic Journal.
‘Real’ wage rigidity – where workers resist below inflation pay awards – has been the
most important source of wage inflexibility. This was an important factor that
prevented labour markets adjusting, especially during downturns.
The study finds that such rigidities led both to higher job turnover and to higher local
unemployment in Italy. But the authors note that recent changes have increased
labour market flexibility. In particular, the abolition of the price indexation clause
(scala mobile) in 1993 has lessened the problem of real rigidity.
The authors conclude that a more decentralised and flexible wage bargaining system
coupled with low and stable inflation, may help to minimise the negative effects of
wage rigidities at an economy-wide level.
Wage rigidity has traditionally been of interest to economists looking at
macroeconomic phenomena and the functioning of the labour market. Wages are
said to be downwardly rigid if institutional or behavioural factors make it difficult for
the wages of some workers to fall despite underlying supply and demand pressures
for decreases.
Firms may be impeded from adjusting wages, for example, because workers resist
nominal wage cuts. This phenomenon is called ‘downward nominal wage rigidity’.
Workers can also avert real wage cuts, as when nationwide collective bargaining
institutions impede firms from increasing wages by less than a given wage norm,
usually related to expected inflation. This phenomenon is known as ‘downward real
wage rigidity’.
Wage rigidities are standard culprits for the high and persistent unemployment that
has long plagued many European countries. The nature and extent of wage rigidity is
also important for the debate on monetary policy rules and the optimal rate of
inflation. For example, a positive rate of inflation may relax the constraint posed by
nominal rigidity, whereas more decentralised wage settings may be more relevant
when real wages are downwardly rigid.
This study uses data from the Worker History Italian Panel to estimate the relevance
of downward wage rigidity in Italy for the period from 1985 to 1999. The results show
that in Italy, downward real rigidity is larger than downward nominal rigidity, owing to
the dominant role that national collective contracts have in the wage bargaining
process.
But wage rigidities have declined over time, a pattern that is entirely consistent with
the various labour market reforms Italy has experienced and, more specifically, with
the abolition of the price indexation clause (scala mobile) in 1993.
The researchers also provide support for the view, often heard among economists,
that when firms are constrained from cutting wages as required by economic
conditions, they may resort to employment adjustments. In fact, the researchers find
that downward wage rigidities are conducive both to higher labour turnover flows and
to higher local unemployment rates.
Overall, the results suggest that a more decentralised and flexible wage bargaining
system, as well as low and stable inflation, may help to minimise the negative effects
of wage rigidities at the macroeconomic level, especially in a country where national
collective contracts are still rather influential.
ENDS
Notes for editors: ‘Downward Wage Rigidity in Italy: Micro-based Measures and
Implications’ by Francesco Devicienti, Agata Maida and Paolo Sestito is published in
the November 2007 issue of The Economic Journal.
Francesco Devicienti is at the University of Torino. Agata Maida is at the College of
Carlo Alberto. Paolo Sestito is at the Bank of Italy.
For further information: contact Francesco Devicienti on +39 011 670 6288 (email:
devicienti@econ.unito.it); Agata Maida on +39 011 670 3912 (email:
agata.maida@unito.it); or Romesh Vaitilingam on 07768 661095 (email:
romesh@compuserve.com).