Wage Rigidity refers to the resistance of wages to adjust in response to changes in the labor market. This concept encompasses both nominal wage stickiness (where wages are slow to change in monetary terms) and real wage stickiness (where wages are slow to change when adjusted for inflation).
Nominal Wage Stickiness
Nominal wage stickiness occurs when wages in monetary terms do not adjust easily to changes in economic conditions. For example, despite a decrease in demand for labor, employers might be reluctant to lower wages due to contractual agreements, employee morale, or institutional norms.
Example of Nominal Wage Stickiness
During a recession, even as the demand for goods and services decreases, employers may resist reducing nominal wages because doing so can demoralize employees and lead to higher turnover rates.
Real Wage Stickiness
Real wage stickiness happens when wages are slow to adjust for changes in the purchasing power of money, often due to inflation or deflation. Even if nominal wages remain the same, if inflation rises, the real wages (purchasing power) of employees decrease.
Example of Real Wage Stickiness
If inflation rates suddenly rise but nominal wages remain unchanged, employees’ real income falls because their money has reduced purchasing power. However, employers may still resist adjusting wages to match inflation rates.
Types of Wage Rigidity
Downward Wage Rigidity
This occurs when wages are resistant to moving downward, even in response to economic downturns or decreased demand for labor. Common reasons include labor contracts, minimum wage laws, and concerns about employee motivation.
Upward Wage Rigidity
Upward wage rigidity is less commonly discussed but occurs when wages don’t increase rapidly in response to higher demand for labor. This may be due to preset wage structures, bureaucratic delay, or long-term contracts.
Causes and Implications
Causes of Wage Rigidity
- Legal and Institutional Factors: Minimum wage laws, labor unions, and long-term contracts.
- Psychological Factors: The adverse impact on employee morale and productivity.
- Economic Factors: Transaction costs related to renegotiating wages and contracts.
Economic Implications
Wage rigidity can lead to several economic inefficiencies, such as:
- Unemployment: During economic downturns, downward wage rigidity can result in higher unemployment rates as firms cannot reduce wages to retain or hire more employees.
- Reduced Flexibility: It reduces the labor market’s overall adaptability to changing economic conditions.
- Inflation and Deflation: Real wage rigidity can complicate the economy’s response to inflation or deflation.
Historical Context
During the Great Depression, significant wage rigidity contributed to persistent high unemployment rates. John Maynard Keynes drew attention to this in his seminal work, “The General Theory of Employment, Interest, and Money,” emphasizing how inflexible wages could hinder economic recovery.
Comparisons and Related Terms
- Price Stickiness: Similar to wage rigidity but involves the inflexibility of prices for goods and services.
- Labor Market Equilibrium: State where labor supply equals labor demand; wage rigidity can cause prolonged disequilibrium.
- Phillips Curve: Illustrates the inverse relationship between unemployment and inflation, influenced by wage rigidity.
FAQs on Wage Rigidity
What is the difference between wage rigidity and price stickiness?
Wage rigidity refers to the inflexibility of wages in the labor market, while price stickiness pertains to the slow adjustment of prices for goods and services in the market.
How does wage rigidity affect unemployment?
Wage rigidity, especially downward wage rigidity, can lead to higher unemployment during economic downturns by preventing wages from adjusting downward to maintain employment levels.
Are there policies to reduce wage rigidity?
Policies aimed at reducing wage rigidity include promoting more flexible wage negotiation processes, reducing the influence of minimum wage laws, and encouraging wage contracts that adapt to economic conditions.
References
- Keynes, J. М. (1936). The General Theory of Employment, Interest, and Money.
- Bewley, T. F. (1999). Why Wages Don’t Fall During a Recession. Harvard University Press.
- Akerlof, G. A., & Yellen, J. L. (1990). The Fair Wage-Effort Hypothesis and Unemployment. The Quarterly Journal of Economics, 105(2), 255-283.
Summary
Wage rigidity is a significant economic concept that explores the resistance of wages to adjust in response to varying labor market conditions. By understanding both nominal and real wage stickiness, policymakers and economists can better address issues like unemployment and inflation, striving for a more flexible and responsive labor market.
