4 Ian Babetskii
2. The Concept of Flexibility
The notion of labor market flexibility is of course a very broad one. In principle, the labor market
can accommodate shocks via two main channels: either quantities (adjustment in workers and in
working time), or prices (wages), or a combination of both. Due to limited and even declining
mobility of workers within the new member states, and given the formal restrictions on the free
movement of labor for new EU members, it is unlikely that migration can be considered an
efficient tool for coping with adverse shocks1. Hence, more interest is focused on wage flexibility.
Hyclak and Johnes (1992), Boeri et al. (1998), and Blanchflower (2001) argue that wage
flexibility is a key determinant of labor market flexibility. Besides, adjustment in prices might
seem quicker and less costly than adjustment in quantities. The European Commission (2003, p.
155) stresses the importance of wage flexibility in the following paragraph:
“Obviously, wages as the price of labour have a key role to play in determining the
overall balance of supply and demand on the labour market. Furthermore, the
formation of economic and monetary union (EMU) is often taken to put further
demands on the flexibility of wages to compensate for the lack of (national)
instruments to deal with economic disturbances. If wages are too rigid, the necessary
adjustment will come slowly and with considerable economic and social costs.”
Wage flexibility can be expressed in nominal or real terms. Nominal wage flexibility is the
responsiveness of nominal wages to changes in the price level or inflation. Real wage flexibility
can, in turn, be defined as the responsiveness of real wages to various shocks (e.g. shocks in
productivity, unemployment, past wages, etc.). Wage flexibility characterizes different aspects if
measured using aggregate or micro data. Due to a lack of available data across countries, this
paper does not attempt to perform econometric estimates of wage flexibility at the micro level.
Nevertheless, micro-foundations can be introduced by looking at institutional characteristics of
labor markets.
This paper, therefore, focuses on aggregate labor market adjustments, and the analysis is
conducted in a cross-country comparative framework. From the macroeconomic point of view,
“aggregate real wage flexibility determines the overall balance of supply and demand in the labor
market and is a key substitute for the adjustment roles of the nominal exchange rate and an
independent monetary policy.” (HM Treasury, 2003, p. 2) Since the difference between real and
nominal wage growth is given by inflation, real and nominal wage adjustment approach each
other in a low inflation environment.
In spite of the common argument that a fixed exchange rate regime requires higher wage
flexibility, theoretical frameworks and empirical evidence are both lacking. The same goes for
studies focusing on the labor market in transition/accession countries (e.g. Schiff et al., 2001).
This is the primary novel aspect of this project. Other novel aspects lie in constructing a
comparable quarterly data-set for the new member states over the past decade, performing time-
1 See Fidrmuc (2004) for recent evidence on labor migration in the Czech Republic, Hungary, Poland, and
Slovakia, in comparison with Italy, Spain, and Portugal. A detailed analysis of the Czech case is available in
Flek (2004). The reasons for the restrictions on migration within the EU are discussed in Boeri and Brucker
(2005). One explanation is that when the labor market is rigid, immigration may increase unemployment among
the native population.