The paper uses a new German employer survey on wage setting practices to analyze incidence and sources of nominal wage rigidity in services vs. manufacturing. We observe that wage freezes are significantly more frequent and wage cuts less frequent in services. Reasons preventing wage cuts reported by employers suggest that fear of excess worker turnover could explain this distinct behavior.nominal wage rigidity, efficiency wages, manufacturing and services, Germany

Bonin, Holger

Radowski, Daniel

English

Research Papers in Economics

IZA DP No. 3923
Downward Nominal Wage Rigidity in Services:
Direct Evidence from a Firm Survey
Daniel Radowski
Holger Bonin
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Forschungsinstitut
zur Zukunft der Arbeit
Institute for the Study
of Labor
January 2009 
Downward Nominal 
Wage Rigidity in Services: 
Direct Evidence from a Firm Survey 
 
 
Daniel Radowski 
Deutsche Bundesbank  
 
Holger Bonin 
ZEW and IZA 
 
 
 
 
Discussion Paper No. 3923 
January 2009 
 
 
 
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January 2009 
 
 
 
 
 
 
 
ABSTRACT 
 
Downward Nominal Wage Rigidity in Services: 
Direct Evidence from a Firm Survey 
 
The paper uses a new German employer survey on wage setting practices to analyze 
incidence and sources of nominal wage rigidity in services vs. manufacturing. We observe 
that wage freezes are significantly more frequent and wage cuts less frequent in services. 
Reasons preventing wage cuts reported by employers suggest that fear of excess worker 
turnover could explain this distinct behavior. 
 
 
JEL Classification:  J31 
  
Keywords:  nominal wage rigidity, efficiency wages, manufacturing and services, Germany 
 
 
Corresponding author: 
 
Daniel Radowski  
Deutsche Bundesbank 
Research Department 
P.O. Box 100602 
D-60006 Frankfurt am Main 
Germany 
E-mail: daniel.radowski@bundesbank.de       
 
                
 1. Introduction 
The paper analyses the incidence and sources of downward nominal wage rigidity using direct 
evidence from a survey among German employers on wage setting behavior. It adds to the 
literature on downward wage rigidity based on firm level surveys (Campbell and Kamlani 
(1997), Bewley (1999), Agell and Bennmarker (2007)), by focusing on sector differences. In 
contrast to Franz und Pfeiffer (2006) our data does not only cover the reasons of wage rigidity 
but also the incidence at the firm. Our findings suggest that wage cuts are significantly less 
frequent in services than in manufacturing, and that fear of higher worker turnover could 
explain the difference between sectors. 
 
2. Data 
We employ the recent Wage and Price Setting Survey of Deutsche Bundesbank, conducted in 
October 2007. The survey was carried out in written form among the firms participating in the 
monthly  ifo Business Cycle Survey. The respondents are CEOs, controllers or personnel 
managers. 
Beyond basic firm characteristics, the survey directly asks about the incidence of wage 
freezes and wage cuts, as follows: “Over the past five years, has the base wage of some 
employees in your firm ever been frozen (cut) instead of being increased?” By linking the 
incidence of wage freezes (cuts) to the standard of a wage increase, positive answers imply a 
higher degree of wage flexibility. This concept differs from that common in micro 
econometric studies which treats wage freezes as an alternative to wage cuts and thus indicate 
wage rigidity. 
As the survey refers to direct remuneration excluding bonuses, earnings flexibility is probably 
larger than measured (base) wage flexibility. Due to the five year time span covered, annual 
rates of wage freezes or cuts will be smaller than the reported rates. 
The survey also asked for reasons preventing wage cuts: “Even in times of bad economic 
conditions or high unemployment firms tend to rarely cut their employees’ wages, although 
this could help firms to survive in the market and help to save jobs. Which reasons prevent 
you from cutting base wages?” Seven reasons for downward wage rigidity are listed, namely 
efficiency wages, labor regulation, collective agreements, loss of reputation, excessive worker 
  1turnover, implicit wage smoothing and improved outside options for workers. Firms are asked 
to mark the three most important reasons. 
Sampling in the survey is done “by purpose”, i.e., is not fully representative but still designed 
to yield a balanced picture of manufacturing and services. Services covered include both high-
skilled labor (like IT) and low-skilled labor intensive services (like hotels/restaurants). Larger 
and older firms are overrepresented in the sample. 
The survey covers 661 services firms and 1,149 manufacturing firms. Firms report for product 
groups, which in most cases coincide with plants. Most firms are single plant firms. In firms 
with several plants, the survey refers to the largest product group. 
Descriptive statistics reveal the expected sectoral differences. Firms in services are 
significantly smaller and younger. The labor cost share, approximating labor intensity, is 
larger in services (43%) than in manufacturing (32%). The labor cost gap also reflects a 
markedly higher share of less educated, blue collar workers in manufacturing. Manufacturing 
firms are more often covered by collective agreements (43%) than services firms (38%). Part-
time and fixed-term work is more frequent in services. Firms in services perceive labor 
markets more often as tight (26%) than the ones in manufacturing (17%). Worker turnover 
rates are much higher in services (31%) than in manufacturing (13%). 
 
3. Incidence and Sources of Wage Rigidity 
According to our survey, nominal wage cuts are rather rare. Only 13% of firms in services 
and 16% of firms in manufacturing have ever cut their wages over a five year span. Wage 
freezes instead of wage increases are quite common. 57% of firms in services and 46% of 
firms in manufacturing report zero wage changes. Thus wages appear markedly more flexible 
in services than in manufacturing. 
To test whether sector differences are statistically significant after controlling for specific firm 
characteristics, we run binary probit models, see Table 1. 
Firms in a favorable state of business, indicated by growing employment, are less inclined to 
freeze wages. Wages freezes are significantly less common in firms covered by collective 
agreement and larger firms. They are more prevalent in firms with a higher labor cost share 
and firms facing strong price competition. Labor intensive firms tend to have a higher wage 
  2bill and thus incentives to adjust at the labor cost margin are relatively large. Firms in strong 
price competition have more difficulties to adjust at the price margin and may therefore prefer 
the labor cost margin. There is no apparent correlation between the incidence of wage freezes 
and worker turnover, the total of hiring and separation rates. The propensity to wage freezes is 
also unrelated to firms’ reported difficulties to hire workers. 
Sector-specific firm characteristics, like the lower rate of unionization, contribute little to 
explaining the higher incidence of wage freezes in services. At the mean, the propensity to 
freeze wages is 9.2 percentage points higher than in manufacturing, while the unconditional 
sector gap amounts to 11 percentage points. Inclusion of the significant services dummy does 
not markedly alter the impact of the firm characteristics affecting wage freezes, comparing 
models (1) and (2). 
Turning to wage cuts, we find little systematic correlation with firm characteristics. Given our 
sample size and the scarcity of the event, lack of statistical significance at conventional levels 
is not too surprising. If judged by the point estimates, variables that drive wage freezes 
(employment growth, collective bargaining agreement, price competition) seem to drive wage 
cuts in the same direction, though the impact on wage cuts is smaller. The rather large point 
estimate may indicate that a higher turnover rate yields fewer wage cuts. 
After controlling for sector-specific firm characteristics, wage cuts are significantly less 
common (by 6.4 percentage points) in services than in manufacturing. Given that wage 
freezes are more common at the same time, a suggestive interpretation would be that firms in 
services resort to wage freezes as they have difficulties to implement wage cuts. This leads to 
the question whether there are special reasons preventing wage cuts in services. 
 
3.2 Reasons Preventing Wage Cuts 
According to our survey, five out of the seven reasons preventing nominal wage cuts appear 
equally important in services and manufacturing. In line with the literature, loss of labor 
efficiency, mentioned by three in four services and manufacturing firms, is the primary 
concern. Three in five firms (60%) mention labor regulation. Loss of reputation (24%), 
implicit wage smoothing (16-18%) and improved outside options (6-8%) are also mentioned 
at very similar rates in the two sectors, and do not seem too relevant. 
  3Substantial sector differences emerge regarding two sources of wage rigidity – collective 
bargaining preventing wage cuts (33% of firms in services, 45% in manufacturing), and fear 
of increasing quits and excess worker turnover (32% services, 19% manufacturing). The first 
observation would fit higher unionization rates in manufacturing, the second higher labor 
intensity, higher general worker turnover, higher share of white collar workers, and the 
perception of a tighter labor market in services. 
In Table 2, we consider the role of sector-specific firm characteristics driving the sector-
specific responses. Models (1) and (2) substantiate that the higher incidence of the collective 
bargaining argument among manufacturing firms mostly reflects that collective agreements 
are more frequent here. Besides, larger firms in manufacturing contribute to the raw sector 
gap. The impact of these two variables is strong enough to render the sector differential 
insignificant.  
Regarding the excess turnover argument, empirical findings are generally consistent with our 
expectations. First, the higher the share of white collar workers, the more relevant is the 
worker turnover argument. Better qualified workers have more outside options, and the costs 
of replacing more productive workers associated with hiring and training tend to be higher. 
Second, firms that grow in employment are markedly more aware of excess worker turnover 
associated with wage cuts. They need to keep quit rates low to facilitate the growth process. 
Third, the turnover argument is significantly less relevant in East Germany where there are 
fewer outside options for workers due to high levels of unemployment compared to West 
Germany. Perceived hiring difficulties, however, do not seem to foster fear of excess worker 
turnover. 
The negative correlation of collective agreements on the incidence of the worker turnover 
argument may reflect that unionized firms are low turnover firms. First, quitting from such a 
firm is less attractive given the risk to move to a non-unionized firm. Second, unionized firms 
are a non-random sample of firms. High turnover firms have incentives to leave the collective 
bargaining system to facilitate labor adjustment. Thus, the collective agreement variable may 
cover some of the variation in worker turnover at individual firm level. This might contribute 
to explain why, somewhat surprisingly, the individual worker turnover rate is uncorrelated 
with firms mentioning the worker turnover argument. 
Sector-specific firm characteristics do not explain the higher prevalence of the worker 
turnover argument among services firms. The sector gap conditional on characteristics is even 
  4wider than the raw gap, partly because of the larger firm sizes in manufacturing. As we 
control for individual firm level worker turnover, a suggestive explanation for the significant 
disparity might be the large difference in overall worker turnover rates by sector. 
 
4. Conclusions 
Our survey results confirm previous micro econometric evidence suggesting that wage freezes 
are quite common in Germany, whereas wage cuts seldom occur. Wage cuts are even rarer in 
services than in manufacturing. The difference is not due to peculiar firm characteristics, but 
fear of excess worker turnover could explain the result. Services firms mention this argument 
much more often, even if one controls for relevant firm characteristics. A suggestive 
interpretation of this behavior is that it reflects high actual turnover rates in services. In our 
data, they are more than twice as high as in manufacturing. 
 
References 
Agell, J. and H. Bennmarker, 2007, Wage Incentives and Wage Rigidity: A Representative 
View from Within, Labour Economics 14, 347-369. 
Bewley, T.F., 1999, Why Do Wages Not Fall During a Recession?, Harvard University Press. 
Campbell, C.M. and K.S. Kamlani, 1997, The Reason for Wage Rigidity: Evidence from a 
Survey of Firms, Quarterly Journal of Economics 112(3), 759-789. 
Franz, W. and F. Pfeiffer, 2006, Reasons for Wage Rigidity in Germany, LABOUR - Review 
of Labour Economics and Industrial Relations 20(2), 255-284. 
  5Table 1: Probit Estimates on Wage Freezes and Wage Cuts 
    Incidence of Wage Freezes  Incidence of Wage Cuts 
  Firm  Characteristics  (1) (2) (3) (4) 
  log Number of Employees  -0.047***  -0.040**  0.011  0.007   
  Employment Growth Rate  -0.412**  -0.413**  -0.205  -0.203   
 Worker  Turnover  Rate  0.043  0.032  -0.161*  -0.127   
 Firm  Age  0.001  0.001  0.000  0.000   
  Labor Cost Share  0.003***  0.003***  0.000  0.000   
  Share of Blue Collar Workers  0.020  0.063  -0.025  -0.057   
 Hiring  Difficulties  0.036  0.036  0.048  0.048   
 Collective  Agreement  -0.200***  -0.207***  -0.043  -0.040   
 East  German  -0.014  -0.002  -0.062***  -0.068  ** 
 Export  Share  -0.001**  -0.001  -0.000  -0.000   
  Strong Price Competition  0.097***  0.099***  0.044*  0.045  * 
 Service  Sector  NO  0.092*  NO   -0.064 * 
 Observations  832  832  837  837   
 Pseudo  R
2 0.077 0.081 0.032 0.037   
Notes: Marginal effects. *** denotes significance at the 1% level, ** at 5%, * at 10%. 
  6Table 2: Probit Estimates on Reasons Preventing Wage Cuts 
  Collective  Bargaining  Agreement Excess  Worker  Turnover 
  Firm  Characteristics  (1) (2) (3) (4) 
  log Number of Employees  0.094***  0.093***  0.025*  0.036  *** 
  Employment Growth Rate  -0.294  -0.295  0.284*  0.285  * 
 Worker  Turnover  Rate  0.066  0.069  0.015  0.002   
 Firm  Age  0.001  0.001  -0.001*  -0.000   
  Labor Cost Share  -0.001  -0.001  0.001  0.000   
  Share of Blue Collar Workers  0.071  0.065  -0.252***  -0.185  *** 
 Hiring  Difficulties  -0.102*  -0.103*  0.010  0.015   
 Collective  Agreement  0.600***  0.601***  -0.157***  -0.165  *** 
 East  German  -0.036  -0.036  -0.090**  -0.076  ** 
 Export  Share  -0.000  -0.000  -0.000  0.000   
  Strong Price Competition  0.024  0.023  0.001  0.001   
 Service  Sector  NO  -0.014  NO  0.147  *** 
 Observations  792  792  792  792   
 Pseudo  R
2 0.380 0.380 0.095 0.101   
Notes: Marginal effects. *** denotes significance at the 1% level, ** at 5%, * at 10%. 
 
  7

Downward Nominal Wage Rigidity in Services: Direct Evidence from a Firm Survey

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