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by Valentino Piana (2001)



1. Significance
2. Types of wages
3. Determinants
4. Impact on other variables
5. Long-term trends
6. Business cycle behaviour
7. Data
8. Formal models
9. Related papers


Wages are the most common earnings of people. Perceived by workers, clerks, managers, and employees in general, wages and salaries constitute the core element in income for the majority of active people.
Similarly, many pension schemes are based on wage levels and dynamics.

By contrast, the self-employed do not receive wages, but sell directly their labour in the market. The property and enterprise owners obtain income from rents, dividends, and other financial instruments' gains. The unemployed in certain countries and under constraints receive public financial support.

In another perspective, wages are a major determinant of production costs.

Types of wages

Nominal wages are written down in contracts between the employee and the organization. Real wages somehow correct nominal wages for prices of goods and services bought by the employee. In specific institutional settings, nominal wages may be automatically and frequently adjusted to certain inflation measures, resulting in a more or less constant real wages.

Part of the wage may be paid in nature (e.g. fringe benefits), but the core is usually paid with money. Some firms use "stock options" as part of the remuneration package.

A part of firms' labour cost is given to the State in terms of taxes and contributions to social funds for retirement and unemployment. Thus, in many countries there exists a large discrepancy between gross and net wages.


Wage levels result from individual and collective negotiations between the employees (and their representatives) with the management (and the owners) of firms.

In public bodies, laws and negotiations decide wages. A government wanting to cut public expenditure might try to freeze or reduce public wages, whereas a stimulus-oriented policy might include increases.

Firms and organizations pay wages to employees usually depending on working time and/or on results (production made or objectives reached). Individual wage often depends on occupied position in the organization as well as on education, cumulated experience and seniority. Wages for the same job outside the firm may serve as a (conventional or mandatory) reference point in wage-setting routines.

Wage differentiation is a widespread phenomenon: different occupations and different industries pay working time at uneven rates. Even wage segregation is common: certain jobs are "socially" attributed to a certain gender or ethnicity, which in turn might strive to widen the jobs it is "allowed" to perform.

Wage structure for occupations, industries and regions is subject to very slow long-term change. Imitation of wage increase in other parts of the country is a common force in action.

Wage rates for the same position can be different between "normal hours" (e.g. 40 hours a week) and overtime, i.e. the hours exceeding regular working hours. Usually overtime are paid better, as it occurs when the work is performed during the night or festivities (e.g. Sundays). A part of the remunaration can be linked to results, both on an individual and collective term of reference.

Wages are changed at discrete intervals of time, often a year, possibly within a multi-year perspective plan.

Wage dynamics are linked to the following main determinants:
1. the balance of strength between employees and employers, which in turn depends on labor organization, solidarity and effective mobilization;
2. previous and current profitability of employers;
3. labour productivity increases;
4. sales and employment perspectives;
5. shortage of workers or, more often, abundance of unemployed;
6. past and forecasted inflation trends;

The legal framework about industrial relations, including the right to strike and its possible limitations, the type of trade union allowed or historically prevailing, the number of working hours and (effective or ineffective) limitations to child labour is very important for actual results in negotiations. Legal requirements, like minimum wages, are important in many countries.

This in turn make the electoral process very important for wages, with trade associations and trade unions (and their respective constituencies) spending and organizing support to candidates in exchange for favourable laws.

The potential of wage increase may differ from industry to industry, with export-oriented and foreign-owned companies possibly being the first target for requests and strikes to achieve such goals.

Diffusion across companies and sectors of wage rise requests follow a spontaneous S-shape or are dependent on the spread of trade union members organisation.

For certain jobs, international levels of wages and immigration may be additional determinants, with a large pool of emigrants exerting downward pressure on current domestic wages, on the one hand, and being the source of international remittances, on the other.

More analytically, a firm's labour market can be purposefully separated in internal market (within firm) and external market (in other firms and the unemployed). Internal market is ruled by hierarchy (with different layers of workers, some being at the fringe and other at the core of the firm, with all degrees of low, middle and management strata) and put in motion with career processes, together with firm-specific wage policy. To a certain degree, external conditions exert only a marginal role in internal negotiations. In fact, employees have cumulated firm-specific skills, difficult to find ready on the market. Seamless effective work requires mutual trust, which in turn depends on stability of work for, at least, a core of employees.

By contrast, external market is relevant when employees choose a voluntary dismiss for getting better conditions outside. When a relevant turnover takes place, the management is possibly forced to choose another wage policy.

The unemployed may be characterised by a much lower wage expectations than the employees and they are prone to more flexible working conditions, but they lack competence and are often characterised by lower productivity.

This analysis explains on the one hand, why a higher unemployment may brake wages but also, on the other hand, why wages can grow even if there exists unemployment.

Impact on other variables

Higher wages mean higher income in most families; thus their consumption will usually grow as well.

Total consumption will depend on consumption attitudes of the other families, in particular of whose income heavily relies on dividends. Immigrants may save part of their income to send remittances home.

If total consumption grow, this will boost sales throughout the industries, increasing productivity. This, in turn, is conducive to a further growth in wages.

Through the Keynesian multiplier, income increase will be followed again by consumption, giving rise to a positive feedback loop.

If sales do not increase enough and the share of labour costs on total costs is large, which is not always the case, the increase in wages will be reflected in an increase of labour cost per unit of output. This, however, if the final markets are not very competitive, brings forth a very credible risk of inflation, with the involved reduction of real income. A wages-prices spiral will begin, with only nominal increase of both, keeping real things to a large extent untouched (but provoking a lot of social conflict).

Increases in nominal wages will boost payroll tax revenue, thus, other things equal, they will reduce public deficit.

On a more micro level, it is important to remember that wage level and dynamics are a key feature for individual motivation to work.

Long-term trends

Since GDP and work productivity have an upward trend as a general rule, one could imaging the same for real hourly wages. Instead, many countries experience a long-run stagnation if not even a fall, due to persistent weak organised labour, uncapable of finding effective ways to attract and mobilize workers, especially in small and medium-sized enterprises.

This dynamics might be hidden to the personal experience mostly because, during the work life, there is a progressive increase of competence, possibly accompanied by changes in the workplace, so that, individually, one sees his own wage rise.

In certain countries, wage increase are concentrated in periods during which they sharply rise.

Business cycle behaviour

Individual personal negotiations will fix wages for a dispersed number of persons with uncertain business cycle behaviour. Collective overlapping negotiations will fix wages for one or more years in advance, making usually them unresponsive to short-term labour market fluctuations.

Still, it is quite intuitive that a situation of full employment, healthy firm performances and good perspectives will tend to raise wages. Recession, with its gloomy perspectives for labour will tend to brake wage dynamics.

Even before nominal wages are adjusted to the labour market conditions, recession usually shrink working hours, and especially overtime. This quite automatically reduces workers' income and the weighted average of wage rates.

If recession goes further, some firms will fire people. The sequence in which fringe and core workers are fired will move the average wage rate in that industry. If fringe workers are fired before the core, then this tend to rise the average rate. Some core worker can however receive part of their wages as bonuses from the economic conditions of the firm: this component will usually go down or disappear as the latter deteriorates.

But falling nominal wages are powerful depressors of labour commitment and productivity; they put a pressure on workers to leave the firm looking for a better one, or even to emigrate if the situation is too bad in the whole domestic economy.

In short, wages are moderately pro-cyclical. If labour is weak, recovery periods may only unevenly impact wages. If, on the contrary, labour is strong, higher productivity and profits and will be reflected in higher wages. This may spread expansionary forces and allow the system to enter in a booming phase. In this moment, an increase in minimum wages is very effective in raising domestic demand (and tax revenue) without inflationary pressures, as there is still room in the production capacity and investments ramp up to widen it.

Weighted wage rates will go up as the expansion continues, since overtime become more common (and they are better paid), to give place to employment increases as the firm is sure that there will be demand for its products for the foreseeable future (or at least the duration of the work contract).

If wage pressures are too strong, inflation may rise. In a context lacking different instruments, the central bank may decide to adopt a restrictive monetary policy, possibly with a "soft landing" idea in mind. "Hard landing" is a distinctive possible outcome, instead, with its recessionary developments.


World wages for job and industry (1983-1999)

Wages microdata: a random sample with age, education, sex, marital status, sector, occupation and other variables

US wages for job and industry (1998)

Wages in New York

Income sources (profits, labour) by income level of household (2012)

Data for all the variables in IS-LM model
EU data for all the variables in IS-LM model (Germany, France, Italy, Spain, UK, Switzerland and other 13 European countries)

Formal models

An interactive map of how the economy works according to a basic macroeconomic scheme: the IS-LM model

The individual firm dynamics in a competitive market

Related papers

Fairness, reciprocity, and wage rigidity

Executive compensation and firm performance in Korea

New Technologies, Workplace Organisation and the Age Structure of the Workforce: Firm-Level Evidence


Key concepts
  Labour market