The Economic and Social Review, Vol. 21, No. 1, October, 1989, pp. 87-102
The Real Wage Gap and its Development over
Time: The Irish Experience 1960-1987*
P A T R I C K P. W A L S H
University College, Dublin
F R A N K A . W A L S H and E R N E S T I N E W O E L G E R
DKM, Dublin
I I N T R O D U C T I O N
T
he high i n f l a t i o n and high u n e m p l o y m e n t occurring t h r o u g h o u t theO E C D in recent years have resulted f r o m a complex i n t e r a c t i o n o f con t r a c t i o n a r y supply and demand factors as o u t l i n e d b y B r u n o and Sachs ( 1 9 8 5 ) . Their e m p i r i c a l w o r k showed the "real wage gap" t o be a very i m p o r t a n t supply side factor i n d e t e r m i n i n g u n e m p l o y m e n t since the late 1960s. I n this paper we measure the real wage gap for I r e l a n d , explain its development over t i m e and compare results w i t h the O E C D experience.
The paper is b r o k e n i n t o four sections. Section I I explains the concept o f the real wage gap and the theoretical underpinnings o f the analysis. This section w i l l also b r i e f l y o u t l i n e the three major c o n t r i b u t i n g factors t h a t determine the size o f the wage gap. Section I I I explains the m e t h o d o l o g y B r u n o (1986) used t o measure the real wage gap and the three major shortcomings i n using i t . As a result the size o f the calculated real wage gap m a y be seriously under stated or overstated. However, the general t r e n d t h a t emerges w i l l be accurate.
Paper p r e s e n t e d at the T h i r d A n n u a l C o n f e r e n c e o f the I r i s h E c o n o m i c s A s s o c i a t i o n .
*We w o u l d like to t h a n k F r a n k B a r r y for p r o p o s i n g t h i s r e s e a r c h a r e a a n d for h i s h e l p a n d e n c o u r a g e
m e n t a n d B r e n d a n W a l s h for his u s e f u l c o m m e n t s o n this p a p e r . T h e v i e w s e x p r e s s e d in t h i s p a p e r are
T h e Cobb Douglas technology is used t o decompose the wage gap i n t o its three c o n t r i b u t i n g factors. This allows the explanation o f the dynamics o f the wage gap. Section I V outlines the data used, the estimation technique and the regression results. Using the m e t h o d o l o g y o f Section I I I , the t r e n d i n the Irish wage gap is calculated f r o m 1960 t o 1987. The decomposition o f changes i n the Irish wage gap i n t o its three c o n t r i b u t i n g factors is also cal culated for the same p e r i o d . T h e development o f the Irish wage gap over t i m e is explained b y breaking the p e r i o d 1960-87 i n t o three subperiods. The impor tance o f the three c o n t r i b u t i n g factors is then analysed. I n Section V we com pare the Irish results as estimated b y us t o those estimated b y Bruno ( 1 9 8 6 ) .
I I R E A L W A G E G A P I N T H E O R Y
T h e real wage gap is defined as the percentage deviation o f the actual real wage prevailing i n the economy f r o m the warranted real wage that gives f u l l e m p l o y m e n t . Assume a w e l l behaved p r o d u c t i o n f u n c t i o n in value added:
V = F ( L , K ) (2.1)
Where:
(1) V = Value added as a measure o f n a t i o n a l income (2) L = T h e level o f e m p l o y m e n t
(3) K = T h e capital stock.
Assuming o u t p u t market clearing and competitive firms, the real p r o d u c t wage equals the marginal p r o d u c t o f labour:
M PL = ( W / P J (2.2)
Where:
Py = A value added price index.
The warranted real wage t h a t gives f u l l e m p l o y m e n t is the marginal p r o d u c t o f labour at f u l l e m p l o y m e n t :
M P j = ( W / Pv)f (2.3)
T h e real wage gap i n log linear a p p r o x i m a t i o n is defined as:
W* = ( w - pv) - ( w -P y)f (2.4)
(1) Excessive real wage demands above the marginal product of labour
at-full employment: A p e r i o d o f high e m p l o y m e n t and t i g h t labour mar
kets can raise real wage aspirations and shift power t o labour i n wage bargaining. This c o u l d lead t o excessive real wage demands above the marginal p r o d u c t o f labour at f u l l e m p l o y m e n t and create a wage gap. (2) A terms of trade shock: D u r i n g the 'seventies there were t w o major supply shocks w h i c h led t o supply push i n f l a t i o n . This had the same effect o n the economy as a technical regress. I t was n o t w i d e l y under stood b y unions t h a t terms o f trade shocks cause a d o w n w a r d shift i n the labour demand schedule. L a b o u r was used to n o m i n a l wage increases in line w i t h i n f l a t i o n w h i c h was demand p u l l b y nature up t o 1973. However, i n the face o f supply push i n f l a t i o n , labour w o u l d have t o adjust real wages downwards to m a i n t a i n the economy at f u l l employ m e n t . Failure t o do so was the failure o f workers t o recognise the origin and nature o f i n f l a t i o n (what we call " i n f l a t i o n i l l u s i o n " ) , thus generat ing a wage gap.
(3) A low growth trap: I f adjustment o f real wages i n response t o a terms o f trade shock is n o t instantaneous, the existence o f a wage gap can generate a bigger gap via the l o w g r o w t h trap. The f o l l o w i n g briefly out lines this process:
. A wage gap -> a r e d u c t i o n i n p r o f i t a b i l i t y -» a r e d u c t i o n i n the g r o w t h o f investment -> a r e d u c t i o n i n the g r o w t h o f capital accu m u l a t i o n -> a r e d u c t i o n i n the g r o w t h o f the capital stock -*• a r e d u c t i o n i n labour p r o d u c t i v i t y g r o w t h .
This shows h o w a wage gap can cause a p r o d u c t i v i t y s l o w d o w n , m a k i n g further real wage reductions necessary t o m a i n t a i n the economy at f u l l em p l o y m e n t . Therefore wage m o d e r a t i o n can go hand i n hand w i t h an increasing
Bruno and Sachs (1985) used the Cobb Douglas p r o d u c t i o n f u n c t i o n t o estimate the real wage gap.
wage gap.
I l l M E A S U R I N G T H E R E A L W A G E G A P
Vt = ( eX tLt)a Kt<1 -° ) (3.1)
Where:
(1) ea X t
(2) <* (3) ( 1 - a ) (4) a + ( l - a )
ensures V w i l l grow over t i m e even i f K and L are f i x e d . L a b o u r share in value added.
F r o m the Cobb Douglas:
M PL = a A PL « Vt/ L . (3.2)
A t f u l l e m p l o y m e n t :
M PL f = a A PL f (3.3)
Using (2.2) t o ( 2 . 4 ) :
W* ( W / Pv) / a Vt f/ L /
f
(3.4)
T a k i n g logs gives:
W * = ( w -P v) - ( vt f- lt f) - L o g a (3.5)
W i t h the Cobb Douglas the p r o b l e m o f estimating the marginal p r o d u c t o f labour at f u l l e m p l o y m e n t comes d o w n to calculating the average p r o d u c t o f labour at f u l l e m p l o y m e n t .
B r u n o (1986) assumes f u l l e m p l o y m e n t , i.e., ( vt- 1J = ( vt f- lt f) at the cyclical
peaks o f 1 9 6 0 , 1973 and 1985. He takes the average g r o w t h rates o f ( vt~ lt)
d u r i n g 1960-73 and 1973-85 to represent the respective f u l l e m p l o y m e n t t r e n d ( v / - l / ) . T h is assumes ( v / ~ l / ) grows at a constant exponential rate between 1960-73 and a different constant exponential rate between 1973-85.
This procedure yields an index for ( vt f- lt f) . B r u n o subtracts the log o f a and
an index for ( vt f- lt f) f r o m the estimated M PL t o give a real wage gap index.
He t h e n normalises the resulting real wage gap t o be zero o n average d u r i n g the l o w inflation-high e m p l o y m e n t p e r i o d o f 1965-69 for twelve O E C D countries.
Note: When calculating the wage gap index f r o m the Cobb Douglas tech
nology the resulting index is independent o f econometrics as a cancels o u t in the calculation o f W * .
There are three major shortcomings i n using the above m e t h o d o l o g y :
(1) There is an i m p l i c i t assumption that the labour supply curve is per fectly inelastic. I f this is n o t so, the wage gap w i l l be overstated. T h i s is i m p o r t a n t for a c o u n t r y like Ireland where the labour supply curve is believed t o be relatively elastic. I f the labour supply curve is perfectly
W * = L o g a + ( vt- lt) - ( L o g a + ( v / - 1 / ) )
W * - ( vrlt) - ( vt f- lt f)
(3.6)
inelastic, the real wage must fall by-exactly the same a m o u n t as the M PL
to m a i n t a i n f u l l e m p l o y m e n t response to a terms o f trade shock. I f the labour supply curve is n o t perfectly inelastic the fall i n the real wage warranted t o m a i n t a i n f u l l e m p l o y m e n t is less t h a n the fall i n the M PL.
I f the real wage remains constant a smaller wage gap w i l l result the more elastic the labour supply curve. Thus the i m p l i c i t assumption t h a t the labour supply curve is perfectly inealstic may overstate the calculated wage gap.
(2) The measurement o f the wage gap is p r o b a b l y understated as i t overstates ( vf- - lf) . B r u n o assumes that at cyclical peaks (v-1) = ( vf- lf) .
While 1978 was a cyclical peak it was far f r o m a f u l l e m p l o y m e n t year w i t h l ? g < lf 7 g. T h i s w o u l d mean that the average p r o d u c t o f labour i n
1978 c o u l d be higher t h a n f u l l e m p l o y m e n t average p r o d u c t . I n t u i t i v e l y , excessive real wage demands w i l l drive inefficient and labour intensive firms o u t o f business, thus raising measured p r o d u c t i v i t y o f labour above the f u l l e m p l o y m e n t level.
T h e Cobb Douglas technology can be used to illustrate this p o i n t . Tak ing logs o f ( 3 . 1 ) , we get:
vt = Xat + a\ + ( l - a ) kt 1 (3.8)
Subtracting lt f r o m b o t h sides:
(Vlt) = Xat + ( l - a ) ( kt- lt) (3.9)
A t f u l l e m p l o y m e n t :
( vt f- l / ) = X a t + ( l - a ) ( kt- It f) (3.10)
Subtracting (3.10) f r o m ( 3 . 9 ) :
( V U = ( vt f- l / ) - ( 1 - a ) ( lt- l / ) (3.11)
Thus i f lt< lt f, t h e n ( vt~ lt) > ( vt f- lt f) at cyclical peaks. Thus the m e t h o d
ology w i l l overstate ( vt f- lt f) w h i c h w i l l understate the real wage gap.
However, B r u n o proved that the t r e n d i n the wage gap is n o t affected. (3) The assumption o f u n i t a r y elasticity o f s u b s t i t u t i o n ( o = l ) i m p l i c i t in using the Cobb Douglas tends t o overstate the wage gap i f CT<1. A rise i n real wages t h e n w o u l d also result i n a rise i n labour's share i n value added for a given degree o f capital deepening. B r u n o (1986) recalculated
required knowledge o f the capital stock. The smaller a, the larger the r e d u c t i o n i n the real wage gap, b u t B r u n o proves t h a t the general t r e n d remains the same.
There are t w o assumptions w h i c h may overstate the wage gap and one w h i c h may understate i t . T h e net effect o n the size o f the wage gap is there fore ambiguous. However, w h i l e the size o f the wage gap may be over or under stated, the general t r e n d that emerges w i l l be accurate. As a result o f this, our paper w i l l emphasise the dynamics o f the real wage gap rather than its size i n any year.
T h e Cobb Douglas allows the decomposition o f the changes i n the real wage gap i n t o the c o n t r i b u t i n g factors and the analysis o f its development over t i m e .
Using
W* = ( w - p j - ( vt f- lt f) - L o g a (3.5)
let
( w - pv) = ( w - pc) + ( pc- pv) (3.12)
where:
(1) pv = a value added price index
(2) pc = a consumer price index
(3) ( w - pc) = real c o n s u m p t i o n wage
S u b s t i t u t i n g (3.12) i n t o (3.5) gives:
W* = wc + ( pc- pv) - ( vt f- l / ) - L o g a (3.13)
T a k i n g first differences as a p r o x y for the percentage g r o w t h rate i n each vari able gives:
W* = wc + (Pc-Pv) - ( V / - 1 / ) (3.14)
E q u a t i o n (3.14) breaks the g r o w t h i n the real wage gap i n t o three factors:
(1) wc: Real c o n s u m p t i o n wage g r o w t h is a f u n c t i o n o f u n e m p l o y m e n t .
A rise i n wc other things being equal w i l l raise the wage gap.
(2) ( pc~ pv) : T h e r a t i o o f the g r o w t h i n consumer t o producer prices is
a f u n c t i o n o f supply shocks. For a constant real c o n s u m p t i o n wage a rise in ( pc~ pv) w i l l cause g r o w t h i n the wage gap. I t w i l l also cause a p r o f i t
produc-t i v i produc-t y is a f u n c produc-t i o n o f capiproduc-tal a c c u m u l a produc-t i o n w h i c h is a f u n c produc-t i o n o f pro f i t a b i l i t y . Changes i n ( vt f- 1 ^ ) also determine the g r o w t h i n the real wage
gap. Falling labour p r o d u c t i v i t y is a sign t h a t the e c o n o m y has fallen i n t o a " l o w g r o w t h t r a p " .
I V I R I S H E X P E R I E N C E
T o calculate the wage gap for I r e l a n d we estimate a Cobb Douglas produc t i o n f u n c t i o n . We assume t h a t capital grows at a constant e x p o n e n t i a l rate. O u r f u n c t i o n a l f o r m is given as:
Vt = A L ^ eX t (4.1)
Where:
(1) V = V a l u e added as a measure o f n a t i o n a l income w h i c h is defined as the volume o f GDP ( N a t i o n a l I n c o m e and E x p e n d i t u r e A c c o u n t s ) .
(2) L = E m p l o y m e n t . This comes f r o m the labour force survey w h i c h relates to the 5 t h o f A p r i l each year and is available o n an annual basis f r o m 1 9 7 1 onwards. We generated an index o f e m p l o y m e n t using the above data since 1 9 7 1 . For 1960-71 Sexton's estimates o f the labour force ( i n Conniffe and K e n nedy ( 1 9 8 4 ) ) were used. We t h e n used linear i n t e r p o l a t i o n t o b r i n g the estimates t o an end year basis.
A log linear a p p r o x i m a t i o n o f (4.1) is estimated b y G L S :
vt = a + a\ + Xt (4.2)
Results f r o m the G L S estimation are given i n Table 1. These regression results give a statistically significant labour share i n value added o f 0.57.
Table 1: Regression Results
a a. X R2 DW Rho
3.214 0.56791 2.6878 0.9962 1.8356 0.81
(0.66) (2.02) (18.08) (7.31)
T o calculate the wage gap we used the d e f i n i t i o n i n ( 3 . 5 ) :
W* = ( w - p j - ( v / - lt f) - L o g a
As o u t l i n e d i n Section I I I , the p r o b l e m o f estimating the marginal p r o d u c t o f labour at f u l l e m p l o y m e n t comes d o w n to estimating the f u l l e m p l o y m e n t average p r o d u c t . F o l l o w i n g Bruno's m e t h o d o l o g y , b u t using cyclical peaks more appropriate t o the I r i s h experience, we take the average g r o w t h rates o f
( vt- lt) d u r i n g 1960-69, 1969-78 and 1978-87 t o represent the respective f u l l
e m p l o y m e n t t r e n d ( vt f- lt f) . This assumes that ( vt f- lt f) grows at a constant
exponential rate between 1960-69 and at different constant rates between 1969-78 and 1978-87, i.e., between the cyclical peaks 1960, 1969, 1978 and 1987.
This procedure yields an index for (v f- l( f) . Given this index and an esti
mate o f a, we subtract b o t h f r o m the actual marginal p r o d u c t o f labour t o give us a real wage gap i n d e x . We normalise the resulting index to equal zero d u r i n g 1964-67 w h i c h was a p e r i o d o f l o w u n e m p l o y m e n t and i n f l a t i o n i n I r e l a n d .
The f o l l o w i n g trends emerge f r o m Figure 1 w h i c h gives the results o f the I r i s h real wage gap.
(1) T h e wage gap was o n a d o w n w a r d t r e n d i n the early and mid-60s, declining sharply between 1964-67.
(2) Between 1967 and the first o i l shock i n 1973 the wage gap was o n a sharp u p w a r d t r e n d .
(3) Surprisingly, the first o i l shock i n 1973 was f o l l o w e d b y a fall i n the wage gap w h i c h c o n t i n u e d up u n t i l 1976. After this the wage gap began t o rise again leading up to the second o i l shock.
(4) I m m e d i a t e l y f o l l o w i n g the second o i l shock the wage gap fell again b u t began rising after 1979. Since then its behaviour has been m i x e d b u t overall i t has been on an u p w a r d t r e n d .
Calculating the decomposition o f the wage gap (results presented in Table 2) allows us t o explain the t r e n d observed i n Figure 1.
T o analyse the decomposition o f the wage gap we have b r o k e n the results i n t o three distinctive subperiods.
(1) The p e r i o d leading up t o the first o i l shock i n 1973. (2) The inter o i l shock p e r i o d .
Figure 1: The Irish Real Wage Gap 1960-1987
6.4
'60 '61 '62 -63 '64 '65 '66 '67 '68 '69 7 0 71 72 73 74 7 5 7 6 77 7 8 7 9 '80 '81 '02 '83 '84 '85 '86 '87
I '
-•2.3
(1) 1960-73
I n this p e r i o d , the gradual dismantling o f p r o t e c t i o n i s m , the subsidisation o f f o r e i g n ' c a p i t a l intensive i n d u s t r y and the decline o f agricultural employ m e n t led t o steady strong g r o w t h i n p r o d u c t i v i t y as is seen b y the size o f ( vf- lf) i n Table 2. T h i s was the m a i n c o n t r i b u t i n g factor t o the sharp decline
in the wage gap i n the mid-60s. T h e terms o f trade also m o d e r a t e d the wage gap, reflecting the ending o f p r o t e c t i o n i s m (see Figure 2 b e l o w ) . Real con s u m p t i o n wage g r o w t h at an average rate o f 3.3 per cent f r o m 1960-66 was n o t strong enough t o lead t o a rise i n the wage gap.
T h e wage gap grew strongly i n the late '60s. While p r o d u c t i v i t y g r o w t h and the terms o f trade f o l l o w e d the t r e n d o f previous years, real c o n s u m p t i o n
wages accelerated sharply (see w£ Table 2 ) . This was a reflection o f r a p i d l y
rising e m p l o y m e n t ,1 industrialisation and u n i o n i s a t i o n . This u p w a r d t r e n d
c o n t i n u e d up u n t i l the first o i l shock.
A n interesting feature o f the t r e n d i n the wage gap is the decline w h i c h t o o k place i m m e d i a t e l y preceding the first o i l shock despite the large increases
1. T h e u p w a r d t r e n d in e m p l o y m e n t i n the face of a r e a l wage b o o m has b e e n a t t r i b u t e d to the
Table 2: Decomposition of Changes in the Irish Wage Gap
Period W* = W +
c
' (P - P )
v C V '
( Vf- Lf)
1960-61 - 0 . 4 2.9 0.3 - 3 . 6
1961-62 - 0 . 4 3.3 0.0 - 3 . 7
1962-63 - 0 . 3 4.6 -0.4 -3.8
1963-64 -0.1 6.0 - 2 . 2 - 3 . 9
1964-65 - 2 . 7 1.0 0.3 - 4 . 0
1965-66 - 2 . 9 2.1 - 1 . 0 - 4 . 0
1966-67 - 0 . 7 5.6 - 0 . 7 - 4 . 2
1967-68 3.6 7.8 0.1 - 4 . 3
1968-69 1.8 7.5 - 1 . 3 - 4 . 4
1969-70 0.2 4.4 -0.7 -3.5
1970-71 - 0 . 5 4.4 - 1 . 3 - 3 . 6
1971-72 2.8 10.6 - 4 . 0 -3.7
1972-73 - 0 . 5 6.9 -3.6 - 3 . 7
1973-74 -0.5 -6.1 9.4 - 3 . 8
1974-75 - 0 . 6 4.6 - 1 . 3 - 3 . 9
1975-76 - 2 . 7 3.9 -2.6 - 4 . 0
1976-77 1.8 5.5 0.4 -4.1
1977-78 0.1 6.9 - 2 . 6 - 4 . 2
1978-79 - 1 . 9 1.0 - 0 . 4 - 2 . 6
1979-80 0.1 -0.3 3.0 - 2 . 6
1980-81 1.3 1.4 2.5 -2.6
1981-82 0.1 1.2 1.6 -2.7
1982-83 - 0 . 9 2.0 - 0 . 2 - 2 . 7
1983-84 3.3 4.6 1.4 -2.7
1984-85 0.2 2.7 0.3 - 2 . 8
1985-86 - 3 . 7 0.8 - 1 . 7 - 2 . 8
1986-87 1.5 3.7 0.6 - 2 . 8
i n real c o n s u m p t i o n wages. D u r i n g this p e r i o d the terms o f trade grew r a p i d l y under an i n t e r n a t i o n a l c o m m o d i t y price b o o m (see Figure 2) and this exerted significant d o w n w a r d pressure o n the wage gap as shown by a 3 per cent
average annual decrease i n ( pc- pv) between 1970-73.
(2) 1973-79
1973-74 saw the first o i l shock w h i c h caused a severe worsening o f the
terms o f trade reflected i n ( pc- pv) = 9.4 per cent in Table 2. Ireland's reaction
1 4 0 . 0 0
1 2 0 . 0 0
1 0 0 . 0 0
8 0 . 0 0
6 0 . 0 0
4 0 . 0 0
-2 0 . 0 0
0 . 0 0
Figure 2: The Irish Terms of Trade 1960-87
•
v.,—
i i i i i i i i i i i i i i i i i i i i
60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81 82 83 84 85 86 87
response t o terms o f trade shocks i n I r e l a n d . Real c o n s u m p t i o n wages fell i m m e d i a t e l y f o l l o w i n g b o t h o i l shocks, i.e., b y 6.1 per cent i n 1973-74 and b y 0.3 per cent between 1979-80. These were the o n l y t w o years i n the entire sample t h a t t h e y d i d fall. The fact that real c o n s u m p t i o n wages con t i n u e d o n a strong u p w a r d p a t h the f o l l o w i n g years also suggested t h a t the fall was n o t part o f any deliberate adjustment. P r o d u c t i v i t y g r o w t h remained strong w i t h a new r o u n d o f rationalisation i n Irish i n d u s t r y i n the wake o f EEC e n t r y . O u r terms o f trade were also i m p r o v e d b y EEC e n t r y .
(3) 1979-87
T h e i m p a c t o f the second o i l shock o n the terms o f trade was less severe than the first shock. I n response real c o n s u m p t i o n wages fell slightly b y 0.3 per cent i n d i c a t i n g short-run n o m i n a l wage stickiness. Real c o n s u m p t i o n wages have been o n a lower t r e n d since. The rise i n u n e m p l o y m e n t f r o m 5.5 per cent o f the labour force i n 1971 t o 17.7 per cent i n 1987 may be partially responsible in the light of growing sensitivity o f wages to u n e m p l o y m e n t (see O E C D report o n Ireland 1988).
T h e wage gap increased i n the '80s despite the fall i n real c o n s u m p t i o n wages due t o the lower t r e n d o f p r o d u c t i v i t y g r o w t h and the m i x e d p a t t e r n o f the terms o f trade. I n contrast to the p e r i o d f o l l o w i n g the first o i l shock i n t e r n a t i o n a l interest rates rose sharply f o l l o w i n g the second. W i t h a rising wage gap and high cost o f investment, the l o w g r o w t h trap analysis becomes more relevant i n this p e r i o d . The rate o f g r o w t h o f investment was o n a d o w n w a r d t r e n d . Investment fell at an annual average rate o f 3.6 per cent between
1982-87. This is reflected i n the s l o w d o w n o f p r o d u c t i v i t y g r o w t h .
I n summary, there were three i m p o r t a n t factors w h i c h served t o moderate the effects o f the terms o f trade shocks on the wage gap in I r e l a n d : (1) short-run n o m i n a l wage stickiness i n response t o terms o f trade shocks; (2) exceptional p r o d u c t i v i t y g r o w t h up t o 1978; (3) favourable terms o f trade developments.
V C O M P A R I S O N OF I R I S H A N D O E C D R E S U L T S
Table 3 shows the decomposition o f the real wage gap for five major sub-periods for the U K and the US ( t w o countries w i t h very different labour market structures), and for the O E C D as a whole (estimated b y B r u n o , 1986) and for I r e l a n d as estimated b y us. This allows us t o p u t the Irish experience i n t o an i n t e r n a t i o n a l c o n t e x t .
T h e t r e n d for the O E C D countries studied b y Bruno was best captured b y the five subperiods 1964-70, 1970-74, 1974-78, 1978-80 and 1980-83 as given i n Table 3. I n order to allow a comparison we averaged our estimates over the periods used b y B r u n o . However, some o f the characteristic features o f the t r e n d i n the Irish wage gap, as shown in Table 2, are thus less obvious.
Table 3: Decomposition of Changes in the Wage Gap
Annual Percentage Rates of Change
W* W
c
+ ( Vf- Lf)
1964-70 i
U K 0.6 3.8 1.0 -4.3
US -0.8 1.5 1.2 -3.5
O E C D Av. 0.1 4.9 1.0 -6.0
Ireland 0.1 4.9 -0.8 -4.0
1970-74
U K 2.2 5.0 1.0 -3.8
US 0.9 1.1 2.9 -3.1
O E C D Av. 1.8 5.5 1.8 -5.4
Ireland 0.3 4.0 0.1 -3.7
1974-78
U K -2.2 2.3 -1.9 -2.6
US -0.1 2.0 -0.1 -1.9
O E C D Av. 0.3 3.1 0.9 -3.7
Ireland -0.4 5.2 -1.6 -4.0
1978-80
U K 4.2 5.0 1.9 -2.6
US 1.7 -1.5 5.3 -1.9
O E C D Av. 1.0 1.1 3.6 -3.7
Ireland -0.9 0.4 1.3 -2.6
1980-83
U K 1.4 2.7 1.3 -2.6
US -0.2 0.6 1.1 -1.9
O E C D Av. -1.1 1.4 1.1 -3.7
Ireland 0.1 1.5 1.3 -2.7
1983-87
Ireland 0.3 3.0 0.1 -2.8
(1) 1964-70
I n the U S , the wage gap fell due t o modest wage demands o f 1.5 per cent compared t o O E C D average o f 4.0 per cent. O n the other hand, the U K ex perienced high wage g r o w t h o f 3.8 per cent w h i c h , together w i t h below average p r o d u c t i v i t y g r o w t h , caused the wage gap t o grow above the average.
(2) 1970-74
H i g h rates o f c o n s u m p t i o n wage g r o w t h , i n h e r i t e d f r o m the previous p e r i o d d i d n o t slow d o w n i n the face o f the first o i l shock i n the O E C D as a w h o l e . A deceleration i n p r o d u c t i v i t y g r o w t h due t o the l o w g r o w t h trap and the terms o f trade shock caused the wage gap t o accelerate i n the O E C D countries. I t grew at 1.8 per cent p.a. as against 0.1 per cent i n 1964-70. These trends are p a r t i c u l a r l y evident i n the U K w i t h wage g r o w t h at 5.0 per cent p.a. and p r o d u c t i v i t y g r o w t h slowing d o w n f r o m 4.3 per cent t o 3.8 per cent. Wage gap g r o w t h i n the US at 0.9 per cent was w e l l below the O E C D average, b u t had still increased compared t o the previous p e r i o d .
I r e l a n d was sheltered f r o m the f u l l impact o f the first o i l shock b y a number of factors, i n particular b y very favourable terms o f trade ( 0 . 1 per cent as compared t o 1.8 per cent for the O E C D o n average) and lower t h a n average wage g r o w t h . Wage g r o w t h had actually slowed d o w n as compared t o the pre-shock p e r i o d (4.0 vs. 4.9 per cent). Irish p r o d u c t i v i t y g r o w t h i m p r o v e d c o n t r a r y t o the O E C D experience. This reflects the absence o f the l o w g r o w t h trap i n I r e l a n d . I r e l a n d thus experienced a very small increase i n the wage gap g r o w t h at 0.3 per cent, w e l l below the O E C D average o f 1.8 per cent.
(3) 1974-78
I n the p e r i o d between the first and second o i l shock, the real wage gap fell i n m a n y countries, as wage demands moderated f r o m 5.5 per cent to 3.1 per cent for the O E C D o n average. The benefit o f this was offset b y declining p r o d u c t i v i t y . A s a result the wage gap i n the O E C D d i d n o t r e t u r n t o its pre-shock g r o w t h rate o f 0.1 per cent.
T h e Irish wage gap fell i n the inter-shock p e r i o d due t o exceptional pro d u c t i v i t y g r o w t h and favourable terms o f trade movements. This cancelled the fact t h a t wages grew m o r e strongly than i n the O E C D o n average and faster t h a n i n the previous p e r i o d .
(4) 1978-80
i n the O E C D . Wage m o d e r a t i o n i n the O E C D as a w h o l e helped t o keep wage gap g r o w t h at bay at 1.0 per cent, w h i c h was none the less higher t h a n i n the previous p e r i o d . P r o d u c t i v i t y g r o w t h was still slow i n t h a t p e r i o d for the O E C D at 3.7 per cent as against 6.0 per cent i n the late 1960s.
Ireland's wage gap fell again i n this p e r i o d ( - 0 . 9 per cent) when'wages grew at a very modest level at 0.4 per cent as compared t o 5.2 per cent i n the inter-shock p e r i o d . P r o d u c t i v i t y g r o w t h for Ireland at 2.6 per cent was slower t h a n i n any p e r i o d discussed i n Table 3.
(5) 1980-83
The slowing d o w n o f relative i m p o r t prices was a m a i n factor i n the declera-t i o n o f declera-the wage gap i n declera-the early 1980s. I n pardeclera-ticular, declera-the real appreciadeclera-tion o f the US$ i n the early 1980s sharply i m p r o v e d A m e r i c a n terms o f trade f r o m 5.3 per cent t o 1.1 per cent p.a. and had a major impact o n relative i m p o r t prices i n the US as compared t o Europe. P r o d u c t i v i t y g r o w t h still had n o t reached pre-shock levels i n all countries except I r e l a n d where i t p i c k e d up again f r o m 2.7 per cent compared t o 2.6 per cent previously. Real wages i n Ireland accelerated i n this p e r i o d leading t o a rise i n the wage gap c o n t r a r y to the O E C D experience.
(6) 1983-1987
Bruno's estimates o f the real wage gap cover the p e r i o d up t o 1983. H o w ever, the O E C D i n a labour m a r k e t study (Economies in Transition, 1989) shows t h a t overall, the "real labour cost g a p " was reduced i n most O E C D countries during the p e r i o d 1975-1987.
Our estimates for Ireland show an increase i n wage gap g r o w t h between 1983 and 1987 o f 0.3 per cent as against 0.1 per cent previously. This was fuelled b y faster wage g r o w t h and the fact t h a t p r o d u c t i v i t y g r o w t h was still slow.
V I C O N C L U S I O N
Our w o r k shows t h a t the t r e n d i n the Irish real wage gap has been different to the O E C D experience. The three m a i n reasons f o r this are:
(i) N o m i n a l short-run wage stickiness i n response t o terms o f trade shocks. (ii) E x c e p t i o n a l l y good p r o d u c t i v i t y g r o w t h up t o 1 9 7 8 .
(iii) Favourable terms o f trade developments.
the real wage gap can actually e x p l a i n . I t is u n l i k e l y t h a t the wage gap can account for t o t a l u n e m p l o y m e n t i n I r e l a n d over the p e r i o d analysed.
We therefore believe t h a t w o r l d aggregate demand is an i m p o r t a n t c o n t r i b u t i n g factor t o the u n e m p l o y m e n t e q u a t i o n . The inclusion o f this variable w o u l d , however, break the assumption o f perfect c o m p e t i t i o n i m p l i c i t in the m o d e l used b y B r u n o and Sachs ( 1 9 8 5 ) .
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