The paper analyses the impacts of two types of counter-factual real wage cuts on the key demand components, output and employment in Finland over the past few years.
A freeze of contract wages at the 2010 level would have improved significantly employment in Finland by 2016. A cautious assessment is that the loss of jobs would have been at most around half of the true one. If the freeze of the contract wages had been complemented by a negative wage drift as in Germany, the employment impact would have been even greater. At least 2/3 of the job losses would have been avoided.
The decline of real wages would have implied smaller consumption. The loss would not have been great, however. Private consumption per head would have remained greater than that in Sweden throughout the period.
The results lend support to the attempts to conclude an agreement between the labour market partners on improving cost competitiveness, to modify wage formation to better take into account cost competitiveness requirements and a greater role for company and establishment level agreements. However, the results also suggest that the positive effects on growth and employment take time.
On the other hand, the wage adjustment alternatives examined would not have taken output back to the pre-crisis level. This suggests that insufficient cost competitiveness has not been the only reason for the slow recovery of the Finnish economy.