Wage adjustments during a severe economic downturn

In this article we present the recent developments of the wage distribution in Portugal. The behaviour of nominal wages reflects the effect of a severe contraction of economic activity which translated, above all, into a marked increase in the proportion of zero nominal wage changes (wage freezes). The consequences of the pentup wage deflation may decisively influence the future development of the Portuguese labour market. Introduction The Portuguese labour market has recently been confronted by very severe economic shocks that translated into a dramatic destruction of jobs and into historically high levels of unemployment, thus revealing a weak resilience. The adjustment of the labour demand was exploited in the study of Carneiro, Portugal and Varejao (2014). In this article, we will focus on wage developments, looking in particular to the reaction of nominal and real wages to breaks in economic activity, comparing the wages of newly hired workers with the wages of job stayers. The bulk of the empirical research that has analysed the behaviour of wages based on microeconomic data has been focused predominantly on ongoing labour relations. In contrast, the rigidity of wages of newly hired workers has received much less attention in the literature.3 This occurs despite the recognized importance of wages of this particular labour force group for job creation and to understand the behaviour of wages over the business cycle (see Pissarides, 2009): the newly hired workers are the workers in the adjustment margin that decisively affect firms’ hiring decisions. An important branch of this research distinguishes the wages of newly hired workers from the wages of job stayers analysing their different behaviour over the business cycle. These studies show that the wages of the newly hired workers are considerably more sensitive to the economic cycle. However, since the number of workers in ongoing jobs is higher than the number of new hires, the aggregate wage becomes invariably more rigid. These studies have highlighted the idea that the wage response to aggregate labour conditions differs considerably between workers in ongoing jobs and the newly hired workers. Vroman (1977) shows that the patterns of real wage increases for job stayers and job changers are broadly consistent with the theory of the Philips curve formulated by Robert Hall.4 Devereux and Hart (2006) and Barlevy (2001) study the wages of job changers and both conclude that their wages are much more sensitive to the cyclical swings than the wages of incumbent workers. Pissarides (2009) provides a survey of these and other empirical micro labour studies and finds that the wages of job changers respond much stronger to unemployment than the wages of workers in ongoing jobs. Carneiro et al. (2012) use matched employer-employee data for Portugal in the period from 1986 to 2005 and find that, after controlling for both firm and worker heterogeneity, entry wages are much more procyclical than wages of job stayers.5 The main objective of this study is to update the analysis of the cyclical behaviour of entry wages and assess the extent to which firms’ internal factors are important for determining the wages of newly hired workers. In particular, we analyse the relative importance of internal and external factors BANCO DE PORTUGAL • Economic Bulletin • December 2014 62 (such as the wages of workers with similar qualifications and experience or the availability of workers with similar characteristics on the market) for determining entry wages. Bils et al. (2014) present evidence that supports the notion that entry wages are partly determined by the wages of stayers. As Blanchard and Summers (1987) point out, if wages are essentially determined by internal factors (such as the internal pay scale or the wages of workers who are in the same job title), this may generate hysteresis in the economy, so that the impact of economic shocks can last longer. In this context, the relevant theoretical framework of this article is tributary of the well-known insider-outsider theory. This theory emphasizes the idea that established workers (insiders) have most often better employment opportunities than the outsiders. One reason for this to happen is the costs that firms have to bear when they replace insiders by outsiders. These costs include, for example, those related to hiring, firing or training new employees (see Lindbeck and Snower, 2001, Cahuc and Zylberberg, 2004, and Teulings and Hartog, 2008). The specific character of insiders’ qualifications and the presence of hiring and firing costs give a comparative advantage to insiders that they can explore to negotiate wages above those that outsiders would be willing to receive, without threatening their job post. The result is that these potential workers may become unemployed involuntarily or have their professional possibilities limited to less desirable jobs. A number of studies has confronted the insider-outsider theory and the empirical evidence. One of these lines of research has tested the extent to which wages are affected by firms’ internal conditions and not only by external conditions (Holmlund, 1991 and Lever 1995 present good summaries of the first studies in this area). Generally, empirical tests are consistent with the hypothesis that both the internal factors and the external factors affect the wages of newly hired workers. Recent developments in nominal and real wages aggregates Computing wage aggregates based on the information of the individual records from the Quadros de Pessoal, we can see in Charts 1 and 2 that in the latest period nominal wages have maintained a weak growth trajectory (grew 1.1 per cent in 2011 and 0.9 per cent in 2012), while the aggregate Chart 1 • Behaviour of nominal wages (1986-2012) Chart 2 • Behaviour of real wages (1986-2012)