The role of Institutions in explaining wage determination in the Euro Area: a panel cointegration approach

Over the last 15 years, the evolution of labor costs has been very diverse across EMU countries. Since wages have important second-round effects on prices and competitiveness, and EMU countries do not have the tool of the nominal exchange rate to correct for such imbalances, understanding the determinants of the wage is a matter of increasing concern and debate. We estimate the equilibrium wage equation for the Euro Area over the period 1995-2011 using panel cointegration techniques that allow for cross-section dependence and structural breaks. The results show that the equilibrium wage has a positive relation with productivity and negative relation with unemployment, as expected. We also include institutional variables in our analysis, showing that a more flexible labor market is consistent with long-run wage moderation. Allowing for a regime break, we find that, since 2004, possibly due to increased international competition, wage determination was more strictly related to productivity, and real wage appreciation triggers a drop in the real wage. Furthermore, results point to a wage-moderating role of government intervention and concertation in wage bargaining.