Unemployment Hysteresis, Wage Determination, and Labor Market Flexibility: The Case of Belgium


WP/94/150-EA
Unemployment Hysteresis, Wage Determination, and Labor Market Flexibility:
The Case of Belgium by Reza Moghadam and Caroline Van Rijckeghem

This paper examines the potential contribution of unemployment
hysteresis theories to the understanding of the Belgian labor market. It
gives an overview of the Belgian labor market, reviewing the indexation
system and the wage bargaining process. It estimates models of wage
determination using aggregate data (1970-90) and firm-level panel data
(312 manufacturing firms during 1978-84).

The time-series results suggest that there is strong persistence in
unemployment and that it occurs primarily because the long-term unemployed
cease to exert downward pressure on wages. The results also show that the
suspension of indexation during 1982-86 had a significant and negative long-
run impact on real wages. Furthermore, the two-yearly bargaining round and
the indexation system induce long lags in wage determination.

The panel results provide evidence of insider power in wage
determination but also indicate that the industry-wide and national
unemployment rates continue to play a role in wage determination. However,
as with the time-series results, this impact diminishes when the proportion
of long-term unemployed increases.

The policy implications are threefold. First, the finding that the
long-term unemployed exert no downward impact on wages points to the
usefulness of tightening up the benefit system in order to encourage the
unemployed to seek jobs, and of providing targeted training and employment
opportunities. Second, insider power in wage determination needs to be
reduced to help employment generation by, for example, reducing hiring and
firing costs or removing entry barriers to new firms. Third, insider power
suggests the need for flexibility in applying indexation during a recession
to prevent layoffs that, given an insider wage setting, would become
irreversible. Recent initiatives, including the introduction of a
competitiveness norm for indexation and labor market programs aimed at the
long-term unemployed and the young, such as the plan d'accompagnement and
the plan d'embauche des jeunes, are consistent with these policy
implications.