2002-10-23

Wage Formation in Sweden 2002

Wage Formation - Economic conditions in Sweden 2002

Wages and other labour costs can increase by about 4 percent per year. If Sweden becomes a member of the EMU, the rate of increase must be reduced to 3.5 percent. This more subdued rate of increase in wages, together with measures to increase the labour supply, would improve the prospects of achieving the employment target.

In the long run, wages and other labour costs can increase by 4 percent per year providing productivity in the business sector rises at an annual rate of 2.3 percent. If Sweden joins the EMU, the conditions for wage formation will change. The inflation target of the European Central Bank (ECB) is lower than the 2-percent target of the Riksbank (the Central Bank of Sweden). While the ECB does not specify a particular figure, the target as presently formulated can be taken to mean an annual increase of 1.5 percent in consumer prices. Therefore, if Sweden joins the monetary union, the long-term rate of increase in labour costs will be 3.5 percent instead of 4.0 percent. In the long term, real wages will increase by 2.0 percent per year with or without Swedish membership in the monetary union.

In the reports main scenario for 2004-2010, it is assumed that Sweden will participate in the EMU. The country joins the ERM2 collaboration on exchange rates at the outset of 2004 and becomes a member of the monetary union on January 1, 2005.

The Swedish krona has weakened substantially over the past ten years, and Swedish prices and costs are now relatively low compared to those in the euro zone. Reflecting this favourable competitive position, there have been sizable surpluses in the current account. For this reason, among others, it is assumed that the krona will be linked to the euro at a somewhat stronger rate than the current one. The calculations are based on the assumption that the central rate and the conversion rate will be SEK 8.80 to the euro.

Even with the krona linked at a nominal exchange rate stronger than the current one, and even assuming that the euro will strengthen against the dollar in the long term, it is estimated that after accession to the monetary union further increases in prices of Swedish exports in relation to prices of imports will be possible without overly diminishing the surplus on current account. Thus, there will also be some margin for increasing labour costs in relation to those in the euro zone without bringing profits down to an unsustainably low level. Consequently, for a transitional period Swedish labour costs can rise somewhat more rapidly than those in the euro zone. Thus, there will be a gradual adjustment toward long-term balance in regard to costs and the competitive situation.

In the main scenario, labour costs in Sweden increase at an average annual rate of 4.2 percent during the period 2004 2010, whereas the increase in the euro zone is 3.5 percent. In the long run, Swedish labour costs must increase at the same rate as those in the euro zone, 3.5 percent. A rate of wage increase in line with that in the euro zone corresponds to the so-called Edin norm developed by the economists of the labour-market parties. In 2001 labour costs rose by some 5 percent. Thus, a reduction in the current rate of increase is necessary.

In the alternative scenario, wage formation in 2004-2005 is characterized by extensive wage competition and thinking in terms of compensation; as a result, wages increase at a rate 1 percentage point higher than in the main scenario. Little consideration is then given to the effects of wage increases on employment and the unemployment rate. With high wage increases compared to the main scenario, the labour costs of firms will be rising faster, leading with a certain time lag to higher inflation. Since it is no longer possible to adjust the nominal rate of exchange, raising prices of Swedish exports will result in losses of market share and a gradually rising unemployment rate.

The pattern is thus the same as under previous regimes of fixed exchange rates when wages rose too rapidly. One important difference, however, is that excessively high costs in Sweden can no longer be corrected by downward adjustment of the exchange rate as was done over the past 25 years. With Sweden a member of the monetary union, the adjustment will be made instead through lower nominal wage increases than in the euro zone. Since the rate of wage increases will slacken rather slowly, the national economy will sustain substantial costs in the form of lower employment and lost output over an extended period of adjustment. In a five-year perspective, the unemployment rate will be 0.5 percentage points higher.

The conclusion: it is important for the national economy that wage formation is not in itself a source of excessive labour costs. If labour costs still turn out to be too high for example, because of increases in employer contributions or a legislated reduction in work hours the rate of wage increases should be slowed as quickly as possible in order to shorten the period of higher unemployment. Thus, maintaining and restoring macroeconomic balance will depend substantially on wage formation, and the parties on the labour market will bear a heavy responsibility in this regard.

There is considerable uncertainty about the cost level that is sustainable in the long run. For example, if Swedish productivity increases at a relatively slow rate, or if the euro strengthens more than expected against the dollar, the cost level at an accession rate of SEK 8.80 per euro may subsequently prove too high. Moreover, Sweden has a relatively large telecommunication sector with a declining price trend and now weakness in demand as well. Therefore, the low level of labour costs may to some extent constitute a necessary adjustment to this price trend. If such is the case, labour costs cannot rise significantly without leading to unsustainably low profits. Rather, if the rapid downslide in prices persists, there may be a need for a continued decrease in unit labour costs relative to those in the euro zone. Moreover, the economic outlook has deteriorated since the summer, and there is greater uncertainty. Currently, GDP growth of only 1.6 percent is forecast for this year. For continued recovery to be possible, demand in other countries must begin to pick up; as yet, however, there are no sure signs of such a tendency.

Given these various sources of uncertainty, the safest estimate for the next few years appears to be that labour costs will rise more slowly than in the main scenario.

In neither the main nor the alternative scenario is the target of an 80-percent employment ratio achieved. To meet this goal, the labour supply would have to be sufficiently high and flexible, a requirement posing a major challenge to labour-market, education, social-welfare, and health-care policies. Also, labour costs in the next few years would have to increase more slowly than in the main scenario. The current assessment is that wage formation is functioning in a manner consistent with a long-term unemployment rate of 4 percent, which means that the employment target will not be met.

In light of the above, and of various elements of uncertainty, the assessment of the National Institute of Economic Research is that an economically appropriate rate of increase in labour costs would be 3.5 percent for the next few years. It is important to emphasize that in addition to negotiated wage increases and wage drift, this rise in labour costs includes components like the effects of changes in legislated and negotiated collective contributions, reductions in work hours, and changes in the costs of sick-listing and rehabilitation borne by employers.

The parties on the labour market and their mediators can contribute to economically well-functioning wage formation in at least three respects:

- Provided the labour supply so allows, the target employment ratio of 80 percent set by Parliament and the Government can be achieved by limiting increases in labour costs to a relatively slow rate for a transitional period.
- Large variations in employment and extended periods of high unemployment can be prevented by promptly reducing nominal wage increases if unemployment goes up.
- In order to avoid higher unemployment, wage formation should not result in wage increases above a rate that is economically sustainable.

The last two items are especially important if Sweden becomes a member of the European Monetary Union. In that case Sweden will no longer have its own monetary policy that can be adjusted according to specifically Swedish conditions. Wage formation must then play an expanded role in stabilizing employment and preventing extended periods of higher unemployment. The parties on the labour market and their mediators, at both central and local levels, will thus have a greater responsibility if Sweden joins the monetary union.

Parliament and the Government can contribute to economically well-functioning wage formation in the following ways:

- by designing labour-market, education, social-welfare, and health-care policies so that the employment rate can be 80 percent without inflationary wage increases and so that the nominal rise in wages will be quickly slowed if unemployment increases
- by not adding to labour costs through higher employer contributions
- by not increasing the cost to business of such items as sickness absence, rehabilitation, or disability pensions without compensating decreases in employer contributions
- by not legislating a reduction in work hours.

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