The current unemployment crisis in Europe strikingly demonstrates that the labor markets there are failing to deliver rising living standards, as they have for most of the postwar period. In addition to persistent high unemployment, real wage growth has stagnated across Europe. In the late 1960s and early 1970s, European wages rose by about 4 or 5 percent a year. In the decade from 1983, real wage growth throughout Europe averaged between 1 and 2 percent. Indeed, a general wage stagnation swept across most of the industrialized democracies. Real U.S. wage growth had always been slower than in Europe, and by the 1980s and 1990s, hourly wage rates in the United States were falling by almost 1 percent annually.

It is tempting to attribute the broad slowdown in wage growth to the power of market forces. In addition to the persistently high unemployment, wages were buffeted by inflationary shocks and a sustained slowdown in productivity growth. The European wage stagnation thus seems the likely by-product of hostile market forces. The market explanation is further supported by the sheer breadth of the wage slowdown. The United States, where wage setting is significantly more decentralized than in Europe, experienced very similar economic trends. The appearance of common economic conditions despite substantial variation in wage setting suggests that market forces have simply swamped the capacity of labor market institutions to protect wage standards.

We present an alternative account of the OECD wage slowdown that investigates the role of institutions and institutional change.