Wage centralization and the political economy of budget deficits

Abstract

This paper studies the relationship between wage centralization and budget deficits. Using a panel of 18 major OECD countries from 1980 to 2014, I find strong evidence that wage centralization is associated with lower budget deficits in the panel of industrialized economies. The autoregressive distributed lag (ARDL) model shows that this negative link is mostly in the long run and not in the short run. The empirical results suggest that this negative association cannot be explained by either wage coordination at national level or by formal/informal cooperation among industry-level unions. Instead, the paper introduces a political economy model that can be viewed as one potential explanation for the empirical results. The model argues that wage centralization interacts with the political economy of budget deficits, leading to a lower level of deficit bias. The suggested mechanism is based on sectoral wage inter-dependency that emerges from centralization of wage bargaining.