The Euro, Wages, and Prices

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In countries preparing to enter the Euro during the period from 1993 to 1998, there have indeed been signs of substantial wage moderation and a slowing down of the adjustment of nominal wages to past inflation.

A new study, The Euro and Structural Reforms (NBER Working Paper No. 14479), by Alberto AlesinaSilvia Ardagna, and Vincenzo Galasso concludes that adoption of the Euro has speeded up deregulation in the nations that participate in this common currency. While various reforms have been far more effective in deregulating product than labor markets, there are signs that wage and salary hikes eased in the run-up to adopting the single currency. The authors write that "in countries preparing to enter the Euro during the period from 1993 to 1998, there have indeed been signs of substantial wage moderation and a slowing down of the adjustment of nominal wages to past inflation." They explain this as "part of the macroeconomic efforts to meet the criteria to enter the monetary union."

The authors find that product and labor deregulation are linked. It is easier to change labor markets if product markets are deregulated first. It is also easier to deregulate product markets, which often means layoffs at less competitive companies, if nations already have made it easier for companies to fire people and, especially, created a safety net of unemployment benefits.

This study comes at a particularly sensitive time because the current recession is boosting unemployment in EU nations that, thanks to the Euro, can no longer devalue their currencies to cushion the blow. "[T]he recent financial crisis may have generated a political movement in some countries against deregulation and in favor of a return to easy and long-term state intervention," the authors caution. "It is hard to predict how much the tides will move towards re-regulation."

In some ways, it is surprising that the Euro has played a key role in structural reform. It was always viewed as the last step in a process of European integration. The earlier introduction of the European Single Market (ESM) in 1992 established the legal framework for the freer flow of trade in the European Union (EU), while the Euro itself had no direct legal impact on such policies. Moreover, the process of deregulation started in both EU and non-EU nations before the new currency came into being.

From 1975 to 2003, deregulation took place in all 21 nations the authors studied and in every sector of the economy. The group of non-EU nations (Australia, Canada, Japan, New Zealand, Norway, Switzerland, and the United States) deregulated the least, but they started the period with less regulation than the EU nations. The nations that joined the EU but did not adopt the Euro (Denmark, Sweden, and the United Kingdom) deregulated the most.

Between 1999 and 2003, though, the Euro-adopting nations (Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, the Netherlands, Portugal, and Spain) picked up the pace of reform. For them, the adoption of the Euro had an effect that was about three times larger than that of the move to the ESM. The Euro was the key to deregulating communications and energy, while the ESM had a large impact on transportation industries. All of these moves have caused the Euro and non-Euro advanced economies to converge in terms of regulatory levels. The authors conclude "the results of our econometric exercise have moved us from our prior assumptions towards believing that the Euro might indeed have had an effect in -- if not promoting, at least weakening the opposition to -- product market reforms."

The Euro's impact on labor markets has been more nuanced. By looking at the 1985 to 2003 period, the authors find that the index of reform in labor markets changed far less than it did for product markets. During this period, several countries nevertheless developed a secondary labor market in which workers had only temporary contracts and rigidities were few or nonexistent. Also, in the 1993-9 run-up to adopting the Euro, some nations experienced substantial wage moderation, which is consistent with the fiscal and inflationary discipline that they undertook to qualify for the monetary union. Several nations held down raises in government salaries during this period. After Euro adoption, they felt no such constraint, and the single currency had no more effect on wage moderation.

-- Laurent Belsie