Recent developments in the wage drift in the euro area

Prepared by Gerrit Koester and Justine Guillochon

Published as part of the ECB Economic Bulletin, Issue 8/2018.

The wage drift measures deviations between developments in actual wages and developments in negotiated wages. It is an important element in the macroeconomic analysis of employee compensation because it should be closely linked to cyclical developments in the labour market. In a tightening labour market, employers might be compelled to offer pay scales that are higher than those under collective agreements, to promote employees to higher bands within collectively agreed pay scales, or simply to pay bonuses on top of agreed wages as a way to reward and retain employees. Given recent protracted declines in unemployment and increasing signs of labour shortages, this box reviews the role of the wage drift in recent developments in employee compensation.

Aggregate wage drift is not observable, and is here derived as the difference between growth rates of gross wages and salaries per employee and those of negotiated wages. This implies that headline wage growth as measured by compensation per employee can be broken down into negotiated wage growth, the wage drift and the impact of changes in social security contributions, where the latter is defined as the difference between the annual rate of growth in compensation per employee and the annual rate of growth in gross wages and salaries per employee. The wage drift calculated in this way inevitably also picks up shifts in an economy’s employment structure, in the extent to which companies are bound by collective agreements and in average hours worked per person – thus, more than just the influence of labour market developments on pay premia.

Wage drift was the main driver of higher wage growth during the early phase of wage growth strengthening, but is now also supported by negotiated wages. From the second quarter of 2016 to the fourth quarter of 2017, the 0.4 percentage point change in the wage drift was the largest single contribution to the increase in the growth of compensation per employee, which rose from 1.0% to 1.8% (see Chart A). Over that period growth in negotiated wages was largely flat, only starting to pick up in 2018, when it increased from 1.5% in the last quarter of 2017 to 2.1% in the third quarter of 2018.The recent increase in compensation per employee growth from 1.9% in the fourth quarter of 2017 to 2.5% in the third quarter of 2018 was hence strongly supported also by growth in negotiated wages.

Changes in hours worked have not been decisive for the recent developments in the wage drift. Assuming that, on most occasions, growth in negotiated wages implicitly relates to remuneration per hour, the wage drift as calculated here can be affected by changes in average hours worked per employee, such as those resulting from overtime or shifting between full and part-time employment.^[1] Comparing changes in the contribution of hours worked per employee to growth in compensation per employee with the wage drift shows that the substantial reductions in hours worked per employee in 2008‑09 and 2012‑13 were – unsurprisingly – reflected in the strongly negative contributions of the wage drift to overall wage growth. Since 2014, however, changes in hours worked per employee have been only loosely related to changes in the wage drift in the individual quarters, indicating that changes in hours worked play a limited role in developments in the aggregate wage drift.

The wage drift tends to react relatively quickly to changes in cyclical labour market conditions. As illustrated in Chart C, there is usually only a small lag in the response of the wage drift to changes in cyclical labour market conditions as measured by the change in the unemployment rate. The direct reaction of the wage drift to the cycle is in line with the use of bonuses and special pay in periods of the business cycle characterised by increasing productivity and profitability. However, it should be noted that the typical relationships between the wage drift and cyclical labour market developments were a lot less visible during the period of subdued wage growth from 2013 to 2016. During this period, wage restraint seems to have also been applied to flexible wage elements like bonuses.

Growth in negotiated wages is typically more persistent than the wage drift. As such, it reacts less directly to changes in the unemployment rate but depends more on the level of that rate (see Chart D). In fact, in line with the broad signal that unemployment gives in respect of the state of the labour market and thus for the wage negotiation process, negotiated wages appear to react only to cumulative changes in the unemployment rate in one direction and therefore respond to cyclical labour market developments with a longer lag. Such a time lag and a higher persistence of negotiated wage growth is in line with bargaining processes in major euro area countries, which often fix wages for periods longer than one year. Moreover, overlapping calendars in sectoral wage negotiations imply that normally not all contracts are negotiated in the same year and that it may thus take some time for cyclical developments to be fully reflected in aggregate negotiated wage growth.

The higher persistence in negotiated wage growth bolsters confidence that the recent increase in wage growth will be sustained. Growth in negotiated wages reflects the fixation of pay developments for some time ahead and is thus a foundation for actual pay developments. This adds to a more confident outlook for wage growth than if the upturn were driven just by the wage drift, which reacts more quickly to changes in the labour market. While it is, in general, not impossible that the wage drift could even turn negative if unexpected adverse macroeconomic developments were to materialise, their impact would also need to be unusually large to offset the positive effect of the recently higher growth in negotiated wages. Looking ahead, recent wage agreements and the broadening of wage growth across countries and sectors support the expectation of a further pick-up in wage growth.