Wage rigidities and business cycle fluctuations: a linked employer-employee analysis

Understanding what drives wage dynamics is important in order to explain why aggregate wages tend to be much less volatile over time than what standard macroeconomic models predict (Fig. 1). Moreover, it helps policymakers decide which policy interventions to prioritize during downturns. The relatively flat evolution of aggregate wages is usually explained through (i) the presence of wage rigidities, that is a well-known feature of many labour markets (see for example, Kahn 1997; Knoppik and Beissinger 2009; Devicienti et al. 2007; Dickens et al. 2007; and Holden and Wulfsberg 2008), and through (ii) cyclical changes in the composition of the workforce (Lemieux 2006), since lower-paid workers are usually more severely affected during recessions. Some recent literature (D’Amuri 2014; Adamopoulou et al. 2016; Daly et al 2011; Verdugo 2016) indeed finds that composition effects have driven up aggregate wages, particularly during the recent recession.

This paper focuses on wage rigidities and studies the distribution of wage changes for job stayers over the last 25 years, with a particular focus on the Great Recession. We evaluate the determinants of wage rigidities and we describe how firms, depending on their wage structure (e.g. share of bonuses on overall pay) and workforce composition, display very different levels of wage rigidity. Moreover, we study how firms reacted differently along the cycle, depending on their historical level of wage rigidity. In particular, we seek to answer whether firms which were structurally less able to adjust wages of job stayers reacted by adjusting employment more and whether these firms, by hiring new workers at a re-negotiated salary which corresponds more to the new cyclical conditions, managed to partially compress their average wage per employee, even in the presence of high levels of wage rigidity for stayers.

To measure rigidities in daily wages, we use newly available administrative employer-employee matched data for Italy that cover the years between 1990 and 2014. We rely on measures of wage rigidity based on the asymmetry of the distribution of yearly wage changes for job stayers and we find important adjustments in wages during the recessionary years (2009–2013). These adjustments were mostly driven by large firms and were mainly affecting blue collars. Moreover, using a unique hand-collected dataset on negotiated wages for employees in the metalwork industry and in the wholesale and retail industry, we document that the majority of these wage adjustments were enacted through the part of the wages that is not nationally negotiated. In addition, we show that changes in overtime hours per day are not the main driver behind our results.

In a second stage, we point out the large heterogeneity in the ability of firms to adjust wages and we study the determinants of this heterogeneity in the firm-level wage rigidity. We find that larger firms, with a higher share of blue collar workers, which belong to sectors whose wage structure is characterized by a larger amount of bonuses display more flexible wages.

Finally, we show that more rigid firms reacted to the shock by increasing turnover more, but only if they were endowed with a flexible enough workforce, i.e. with a large share of temporary workers before the crisis. Presumably firms managed, even in the presence of high wage rigidity, to lower their average cost per employee by workers’ replacement and wage renegotiation.¹

Several previous studies have documented the existence of wage rigidities before the Great Recession. An important example is Kahn (1997), who uses US data and estimates that employees would experience nominal wage reductions 47% more frequently, absent wage rigidities. Dickens et al. (2007) analyse rigidities in the USA and in 15 European countries and find that the fraction of workers subject to wage rigidity is 28% on average, with very large heterogeneity across countries (from 4% in Ireland to 58% in Portugal, Italy is in the middle of the distribution). By analysing wage rigidities during the recent downturn, we complement recent findings for the USA, the UK and Europe that find evidence of increased flexibility during the recent recession (Kurmann et al 2014; Brandolini and Rosolia 2015; Elsby et al. 2016; Verdugo 2016). We contribute to this literature by investigating more thoroughly which are the main determinants of wage rigidity/flexibility.

In addition, our paper speaks to the literature on the relationship between wage flexibility and employment. The available literature is much scarcer in this case and the evidence is mixed: Card and Hyslop (1997) find that wage rigidities have small effects on the economy, Pischke (2016) and Ehrlich and Montes (2015) find instead that wage rigidities are associated with lower employment levels. We contribute to this debate by exploiting the richness of our data in terms of variables and time span to study how firms responded to negative shocks, depending on their degree of wage rigidity and their workforce composition.

The structure of the paper is as follows: Section 2 briefly discusses the Italian institutional setting; Section 3 describes the datasets used for the analysis, and Section 4 studies the presence of wage rigidities for job stayers. Section 5 analyses separately the evolution of the nationally negotiated and the residual part of the wages. Section 6 estimates the relationship between wage adjustments, employment adjustments and the average wage per employee at the firm level. Finally, Section 7 concludes.