The impact of wage share on domestic demand in the European Union

Abstract The wage share has been falling in most countries and regions for more than three decades. A decrease in the wage share is said to have a negative effect on private consumption expenditure because the propensity to consume out of labour income is higher than that out of capital income. There is contradictory evidence about the impact of wage decreases on investment expenditures. A decrease in wage share has a positive impact on investment because of the increase in profits and a negative impact because of the decrease in demand. If the total effect is positive, then the domestic demand regime is deemed to be profit-led; otherwise, it is considered to be wage-led. The aim of this research is to assess the impact of wage share changes on domestic demand (consumption and investment) in the groups of countries in the European Union (EU), distinguished by their constituent countries’ levels of openness to international trade. Our results are based on a panel of 28 EU countries over the period 1995–2014. For the EU, the average demand regime is found to be wage-led as both consumption and investment are negatively affected by the wage share decline.