Our view is that macroeconomic moderation of wages should in no way preclude a more decentralized or individual wage setting. Indeed, this is the trend that has been observed in Denmark and to some extent also in Sweden. Starting from a tradition of uniform pay increases, pay bargaining has been comprehensively individualized in large parts of the Swedish and Danish labour markets. This has not implied a rejection of collective agreements. Individualization has taken place within the framework of collec- tive agreements: many Swedish and almost all Danish collective agreements avoid imposing a general pay increase on all firms and individuals. Instead, they just impose industrial peace and rules stating that wages should be decided upon in local discussions, possibly with some (low) guaranteed individual increase.
The model with general and undifferentiated pay increases, the level of which is subject to national co-ordination, has been quite long-lived in Finland. Central coordination may have been enhanced politically by Finland’s membership in the euro area, since wage moderation has in these conditions to be achieved without a national monetary authority that would discipline wage setters. Many Finnish unions strive for similar pay increases for their members, and this implies that relative wage differentials are rigid. Overall wage dispersion as well as wage dispersion within tasks is accordingly low.6 However, the need for macroeconomic
control of wage developments has been unnecessarily interpreted as an argument against pay differentiation. Changing technologies strengthen the case for reconsidering pay policies. Employers have indeed become increasingly unwilling to go on with pay settle- ments that do not leave room for firm-specific pay outcomes and individually differentiated pay increases7.
Developments in Finland contrast with those in Sweden, where central bargaining of pay increases was abolished after the ambitious solidarism in the 1960s and 1970s had undermined the willingness of employers and professional employees to cooperate with the LO. From the mid-1990s onwards, a new pay bargaining
Combine individual fl exibility with mac- roeconomic respon- sibility
Finland in the laggard’s role?
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routine emerged, relying on informal coordination of pay claims by sectoral bargaining cartels. Co-ordination is facilitated by a new government authority, the National Mediation Office, which provides the labour markets organizations with wage statistics and descriptions of current collective agreements. White collar and pro- fessional unions have become increasingly willing to conclude pay agreements that leave the final determination of pay to individual negotiations at the workplace. At most, such contracts set a low minimum level of pay increases. Only a minority of employees in both the business and the public sector are covered by collective and general pay increases, and almost all professional employees conduct completely individual wage discussions with their employ- ers. There is a great variety of contractual forms; some collective agreements just stipulate a peace clause or at most an “individual guarantee” of a minimum pay increase, remaining completely silent on the distribution of pay increases between individuals.The contrast is even starker between Finland and Denmark, where the role of collective agreements has increasingly been con- fined to the regulation of working hours, pensions, sickness and vacation issues. Thus, most private sector employees in Denmark now negotiate their pay directly with their employer, subject to a peace clause.
The decentralization of pay bargaining in Sweden and Den- mark has broadly coincided with increasing wage differentials between firms, in particular among white collar employees. In other words, the individual’s level of pay depends less and less on his/her observable characteristics and more and more on the firm or establishment where he/she works.8 This is a general trend, which
is visible also in Finnish earnings data, but the changes are more significant in Denmark and Sweden9. As expected, the dispersion
of wage changes across individuals is in Finland and Sweden clearly lower than in Denmark (the dispersion also in Denmark remaining clearly smaller than in, say, the US).
The change in firm-specific pay differentials can be related to institutional changes. In a recent report on Swedish wage for- mation, a clear correlation is reported between more individual contracts and changes in wage and salary distributions for many industrial sectors.10 However, the evolution of pay differentials
Most of pay is in Den- mark and Sweden ne- gotiated at the level of the workplace or the individual – subject to a collectively agreed peace clause
also depends on the business cycle. In general, salary differentials increase in booms if collective contracts allow it. In recessions, by contrast, the earnings distribution is stable. Thus, it seems that firms reward some of their key employees in periods of high growth.
At the same time, wage drift has been quite low in Sweden. The Swedish experience suggests strongly that it is possible to es- tablish wage moderation in a strongly unionized economy without imposing uniform pay increases for all individuals. In fact, more individual pay bargaining has probably limited the rate of general wage drift, since individual wage determination makes it possible for employers to adjust relative wages with lower aggregate pay in- creases, as a part of the regular bargaining process. If the collective agreements leave a lot of room for relative wage adjustments at the local level, it is less likely that wage drift in excess of collectively agreed increases will emerge. There need thus be no contradic- tion between macroeconomic objectives and more individual and firm-specific pay bargaining.
Opposition to more individual wage settlements in Finland often stems from a fear of an explosive increase in wage differen- tials. It is apparently assumed that the labour market institutions in the Nordic countries keep pay differentials (artificially) low. This conventional perception may be true to some extent, but we would not expect a very large increase in wage differentials even if pay bargaining were further individualized. There are several reasons for this. First, it is doubtful whether collective regulation could in the long term sustain a distribution of individual wages that deviates dramatically from the competitive wage structure. Second, the Nordic countries are well known for the equality of their educational opportunities and the absence of educational tracking in primary school. Thus, the relatively small wage dif- ferentials also reflect a relatively even distribution of productive abilities11.
Empirical evidence for Sweden suggests that the effect of individualization of pay bargaining on earnings differentials is rather gentle. Most groups of salaried white-collar employees in Sweden moved into individual pay determination around the years 1997–1999. This was reflected in an increase in wage dispersion,
Decentralization of wage formation has increased pay dif- ferentials somewhat – and has reduced wage drift
A further decentraliza- tion or individualiza- tion of wage bargain- ing is unlikely to lead to a big increase in wage dispersion
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1968 72 76 80 84 88 92 96 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2.6 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2.6 2000 04 Percentile ratios Percentile ratiosP90/P10 P90/P50 P50/P10
Figure 7.1
The evolution of wage diff erentials in Sweden,1968–2004
Measures of wage dispersion (P90/P10, P90/P50, P50/P10) for all wage earners.
Source: National Institute of Economic Research, Wage Formation Report (Lönebildningsrapporten 2006). 1970 1975 1980 1985 1990 1995 2000 2004 1.0 1.5 2.0 2.5 3.0 3.5 1.0 1.5 2.0 2.5 3.0
3.5Percentile ratios Percentile ratios Blue collar workers Salaried employees
Figure 7.2
The evolution of wage diff erentials in Sweden,1970–2004
Dispersion measure P90/P10 for blue collar workers and salaried employees.
Source: National Institute of Economic Research, Wage Formation Report (Lönebildningsrapporten 2006).
but not in any dramatic way (cf. figure 7.1). In particular, if the pay structures were initially very compressed, one would expect a large increase in the wage dispersion of salaried employees. Such an increase is discernible (see figure 7.2) but it is rather modest, in particular when compared to the large decrease in wage dif- ferentials that took place in the 1970s.
Finally, and as pointed out above, the Swedish experience also suggests that more individual pay bargaining leads to higher earnings for key employees in periods of high economic growth, without leading to any general downward bidding of wages (in good or bad times).
7.3 WAGE
FORMATION
AND
PRODUCTIVITY
The role of decentralized wage formation for economic develop- ments should not be exaggerated. It is unlikely to boost growth significantly or resolve the difficulties of the welfare state. How- ever, individualized pay formation can still contribute to both a better allocation of resources in the economy as a whole and to more efficiency in the provision of services. In particular, it may enhance productivity in the public sector and thereby alleviate somewhat one of the key problems highlighted in this report (cf. chapters 5 and 8).
Since public sector productivity measures are poor, there is not much data to test this hypothesis. There are econometric results, however, that lend support to the idea that labour productivity responds positively to individual incentives, at least in the busi- ness sector. Some recent studies have investigated the relationship between pay individualization and productivity growth in Sweden, exploiting the fact that an encompassing individualization of pay bargaining took place from the late 1990s onwards. The evidence is scarce so far, but it suggests that the shift to more individual wage bargaining has been associated with higher labour productivity growth.12 If available results can be generalized to public sector
employment – and this is not an implausible conjecture – they provide an important argument for reforming public sector wage determination.
A link between pay dispersion and (public sector) productivity outcomes?
Decentralized wage formation is argu- ably associated with improved individual incentives and more rapid productivity growth
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It should be also pointed out that productivity growth in the business sector has in recent years been quite high in both Sweden and Finland (see chapter 3). In Finland this is very much driven by the IT sector, in which collective agreements have since the 1980s allowed for an evaluation of individual performance as the basis of wage and salary determination.With the prevalence of uniform pay increases in Finland, and to some extent in other Nordic countries, we would expect econometric analyses to indicate high wage rigidity (particularly in Finland). International comparisons of wage flexibility indeed support the view that Finland – and also Sweden, though it has gone further in liberalising its wage bargaining system – may suffer from excessive wage rigidity.
Flexibility and rigidity of wages involve many dimensions. Real
wage flexibility at the macroeconomic level refers to the interaction
between unemployment and average real wages. Full employment can be restored quickly if the labour market is flexible, since an increase in unemployment then exerts strong downward pressure on the level or rate of change of real wages. Relative wage flexibility refers to the ability of the economy to generate adjustments in rela- tive wages when needed. For example, as new industries emerge and old ones disappear, changes in relative wages may help the reallocation of labour and provide proper incentives for individuals to change jobs. The internal pay policies of firms and incentive schemes may also require changes in relative wages between groups and individuals. Finally, nominal wage flexibility refers to the ability of the economy to generate nominal pay cuts when needed in some firms or in exceptional circumstances.
Nominal and real wage flexibility has in recent years been highlighted in a number of comparative international studies.13 In
general, all countries exhibit some rigidity, and nominal and real wage rigidity should not only be attributed to collective regula- tions14. There is also considerable uncertainty as to how correctly
individual pay changes are measured, since most data sets contain some errors. However, it is noteworthy that Finland and Sweden stand out in one major study as the two countries with the high- est degree of real wage rigidity and with nominal wage rigidity well above the average (though it may also be noted that the US Insuffi cient wage fl ex-
displays higher nominal rigidity than both Sweden and Finland). The rigidity measures for Denmark, by contrast, are amongst the lowest in the entire comparative data set15. Measurement errors
notwithstanding, Finnish and Swedish collective agreements seem to be particularly effective in protecting the real earnings of work- ers who stay with their current employer16.