Economics, 3rd Edition

Real Wage Flexibility

A great deal of research has been done on real wage flexibility in Europe and virtually all of it concludes 

that continental European labour markets are among the most rigid in the world, while the UK labour 

market, at least since the 1980s, has become one of the most flexible. One reason for this is the fact that 

all European Union countries have minimum wage laws, although this is not the whole story since the 

UK also has a minimum wage. Perhaps a more important reason is the high degree of collective wage 

bargaining that is common in continental Europe – i.e. wage agreements that cover a large number of 

workers. Figures on the degree of unionization of the labour force are quite deceptive in this sense: for 

example, in the early 2000s, in the UK, Italy and Germany about 30 per cent of the workforce belonged to 

a trade union, while in France the figure was around 10 per cent. Continental European unions, however, 

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often have collective bargaining and other workplace rights that UK trade unionists can only envy. The 

power of unions and the inflexibility of the labour market is something that has been a concern in France 

for some time and in 2013, an agreement was reached between the government and unions on reforms 

to the country’s complex and strict labour laws. The agreement was greeted with mixed responses with 

some saying it did not go far enough and others suggesting the agreement marked the end of workers’ 

rights in France.

The introduction of the single European currency may also have had a negative effect on European 

wage flexibility, since many European collective wage agreements between workers and a firm in one 

country will also often extend to the firm’s workforce in other European countries, and a single currency 

brings transparency in wage differences across countries, as well as price transparency. To return again 

to our example of a negative demand shock in Germany and a positive shock in France, a company with 

employees in both countries would find it hard to reduce real wages in Germany while raising them in 

France.

Furthermore, European labour law is generally very much more restrictive in many continental European 

countries than it is in the UK or the USA, as is the level of payroll taxes, so that a firm’s costs of either 

 reducing the workforce or increasing it can be very high. This means that, even if there were movements 

in the real wage, firms would be slow to expand or contract their output in response, so that shifts in 

aggregate supply will be slow to come about.

On the whole, therefore, adjustment to asymmetric shocks through real wage movements is unlikely 

to be significant in the euro area.