Wage Differentials in Italy: Market Forces, Institutions, and Inflation

During the 1970s, Italy experienced an extreme compression of wage differentials, similar to the better-known situation in Sweden. Most evidence suggests that this compression came to a stop around 1982-83, coincident with a major institutional change (in the form of the escalator clause in Italian union contracts), a major economic change (the slowdown in inflation), a major technological change (industrial restructuring and the computer revolution), and a major political change (the loss of support for unions and their egalitarian pay policies). While we cannot definitively distinguish among the relative influences of institutions, market forces, technology and politics on the evolution of earnings inequality in Italy, our analysis of skill level wage differentials and our comparisons at the individual level with the more laissez-faire system of the United States suggest that both inflation and egalitarian wage-setting institutions have importantly influenced Italian wage compression in the regular sector of the economy. Yet, this very compression may well have contributed to the flight away from the regular sector of the economy at both ends of the skill distribution, plausibly leading to a greater overall degree of inequality for the whole economy than is apparent from our analysis of wage differentials in the regular sector.