During the past decade, subdued wage growth and a faulty Phillips curve have puzzled economists. This column proposes an explanation: involuntary temporary workers have exerted significant competitive pressure on permanent workers, slowing overall wage growth. Using data from 30 European countries over the period 2004 to 2017, the authors incorporate temporary employment into the standard wage Phillips curve. Their findings reveal a competition effect that is comparable in magnitude to that of the unemployment rate, particularly in countries with weak wage-setting institutions.
Labour markets in Europe have come through the Covid-19 crisis with flying colours. Unemployment rates have fallen to levels not seen for many years, and wage growth has picked up. The wage Phillips curve – occasionally questioned over the past decade – appears intact. But is this the full picture?
Our answer: not necessarily. Involuntary temporary employment has become equally influential as unemployment in driving aggregate wage growth across European economies. Ignoring this factor risks overlooking key labour market dynamics. In early downturns, like the one we are currently witnessing, unemployment tends to rise, driven largely by layoffs among temporary workers. Focusing solely on the unemployment rate may lead to confusion about apparently sustained wage growth, as the decline in temporary employment can have a counterbalancing effect.
Figure 1
a) Involuntary temporary employment in European countries, 2017
b) Labour market dualisation in Europe
Second-tier or competitor?
Let us begin by examining our perception of temporary employment. We know that temporary jobs have a lasting impact on individual career trajectories (Boeri 2011, Jahn et al. 2012). A long debate has shed evidence on whether temporary employment serves as a stepping stone into permanent jobs (Holzer et al. 2007) or a dead end (Ziegler and Van der Klaauw 2019, Malherbet et al. 2017, Koustas and Asai 2022). However, the extent of temporary employment also has macroeconomic consequences. Our research (Lehner et al. 2024) shows that it influences aggregate wage growth, as temporary workers exert a dampening effect on the wage growth of permanent workers. Historically, much of the debate centred around the insider–outsider model (Lindbeck and Snower 1988) when considering the impact of temporary labour on the wages of permanent workers. According to this framework, permanent workers (insiders) are shielded from competition by temporary workers (outsiders) in part due to strong union protection. Permanent workers may even benefit from the presence of fixed-term workers, who absorb market fluctuations and are typically paid less. This arrangement has the potential to increase the rent component of wage payments to permanent workers.
In line with a growing body of research (Bellani and Bosio 2021), we contrast this framework with the competition model. Involuntary temporary workers, by definition, seek permanent positions. As such, like unemployed job seekers, they pose a competitive threat to permanent workers. Considering that wage-setting in the labour market is often conceptualised through the wage Phillips curve – wherein wage growth is inversely related to unemployment – this competition may have important implications for wage dynamics. We introduce this mechanism as the competition effect.
In our study, we demonstrate a clear competition effect of involuntary fixed-term workers across Europe. Using data from 30 European countries over the period 2004–2017, we incorporate involuntary temporary employment into the standard wage Phillips curve. By relying on individual-level data, we are able to account for the changing composition of employment. This enables us, first, to rule out the possibility that our results are driven by employment composition effects (e.g. an increasing number of low-earning temporary workers), and second, to isolate the pure effects on the wage growth of permanent workers.
For the first time, we are able to demonstrate that the share of involuntary temporary workers exerts a strong negative impact on the wage growth of permanent workers, thereby dampening overall wage growth. The economic significance of this effect is comparable to that of the unemployment rate, indicating that temporary employment has a substantial macroeconomic impact.
The role of institutions in mitigating the competition effect
However, robust and inclusive wage bargaining institutions can mitigate these macroeconomic consequences. Notably, the effect we observed is shaped largely by the institutional structure of labour markets, specifically the cross-country dimension of our sample. The more inclusive the wage-setting processes (i.e. the higher the collective bargaining coverage), the greater the coordination of the wage bargaining system. The higher the trade union membership density, the weaker the competition effect and, consequently, the lesser the impact on wage growth.
Figure 2 Trade union density
Note: Annual average, 2003-2018.
Source: OECD/ICTWSS.
For instance, in countries with weaker wage-bargaining institutions and high temporary employment – such as Spain (Malherbet 2017), Portugal (Martins 2022), or Poland – the wage growth of permanent workers slows as the share of involuntary fixed-term workers increases. This, in turn, dampens overall wage growth. In contrast, countries with stronger wage-setting institutions, as in the Nordic countries and Austria, face no competition effect. Nonetheless, across Europe, the competition effect remains the dominant force.
Conclusion
Economists traditionally view unemployed workers as substitutes for employed workers – in football terminology, this compares to the players ‘on the bench’. The more players there are on the bench, the greater the competitive pressure within a team, hence the lower the pressure for wage demands. If wage demands become too high, an unemployed worker could easily substitute. However, our study reveals that in many European countries, temporary workers should no longer be regarded as players on the field; rather, they have joined unemployed workers on the substitutes’ bench for permanent workers. This shift fundamentally alters labour market dynamics. Involuntary temporary work increasingly shapes wage trends across Europe, and our study provides clear empirical evidence of this phenomenon, demonstrating that the competition effect – driven by the presence of involuntary temporary workers – has an economic significance for wage growth comparable to that of the unemployment rate.
Furthermore, we’ve found clear evidence that temporary employment helps explain the weakening relationship between wage growth and unemployment following the global financial crisis (Sarchi et al. 2019). Fluctuations in temporary work should be monitored closely to improve our expectations of wage dynamics and inform macroeconomic policymaking.
Source : VOXeu
