European wage setting is often seen as dominated by incumbent employees who are assumed to disregard the interests of the unemployed. In Discussion Paper No. 754, Research Fellow Juan Dolado and Samuel Bentolila study Spanish wage setting in an insider-outsider framework in the light of the persistently high unemployment rate and the increase in labour market flexibility resulting from the introduction of new, fixed-term labour contracts in 1984, which currently comprise a third of all employees. Temporary workers earn lower wages than permanent ones, which the authors hypothesize stems from their lack of power in wage bargaining.

Using data on a panel of large manufacturing firms over 1985-8, they test for the dependence of insiders' wages on their bargaining power and the firm's performance (`inside' factors) and on general conditions affecting their expected fallback positions (`outside' factors). They find a small estimated weight of 10% on average for inside factors, which rises with the individual sector's productivity growth. This may hinder employment growth if employment destruction in declining sectors is not matched by job creation elsewhere. Some liquidity and market power variables are also marginally significant, while aggregate labour market variables are highly significant outside factors, and there is strong evidence for membership hysteresis.
The proportion of fixed-term employment may also affect wage growth in three ways: it increases insiders' wage demands if they disregard outsiders' interests (the `buffer' effect); it has composition effects because wages may differ between worker types; and it may affect insiders' bargaining power. Dolado and Bentolila report evidence of all three effects and conclude that the government's flexibility-enhancing measures have created a two-tier labour market in which temporary employees have little say in wage formation. A percentage point increase in the proportion of temporary employment raises the growth rate of permanent workers' wages by one-third of a percentage point, which casts doubt on the compatibility of the future evolution of Spanish wages with further reductions in the unemployment rate.

Who Are the Insiders? Wage Setting in Spanish Manufacturing Firms
Juan J Dolado and Samuel Bentolila

Discussion Paper No. 754, January 1993 (HR)