Academic journal article Seoul Journal of Economics

A Study of Downward Nominal Wage Rigidity in Korea

Academic journal article Seoul Journal of Economics

A Study of Downward Nominal Wage Rigidity in Korea

Article excerpt

(ProQuest: ... denotes formulae omitted.)

I. Introduction

After the Global Financial Crisis in 2008, many countries experienced a sudden increase in unemployment as they suffered from economic recession. Even after several years of financial crisis, unemployment has not returned to its previous level; instead, high unemployment rates have persisted. This phenomenon is somewhat puzzling. One may expect a high unemployment rate to lead to lower wages (the price of labor). In such a situation, unemployment can be alleviated through wage cuts. In reality, however, this adjustment rarely happens. Schmitt-Grohe? and Uribe (2013) confirm that countries in the Eurozone have failed to adjust wages (measured as nominal hourly wages), which has resulted in widespread unemployment. The phenomenon by which the (nominal) wage is resistant to change is called the downward nominal wage rigidity (DNWR).1

Downward nominal wage rigidity can be particularly costly in a low inflation environment, a situation that many countries have faced in recent years.2 For example, when inflation is high, firms can adjust their labor costs by paying relatively lower real wages without cutting nominal wages. They can offset increases in labor costs with high inflation, resulting in the real increases in labor cost to be well below the nominal figures. On the contrary, avoiding large labor costs in a low inflation environment is more difficult for firms because they cannot reduce their real labor costs without actual wage cuts. Therefore, the unemployment rate may rise because the only way for a firm to cut labor costs is through adjustments in employment. Thus, the existence of DNWR may be an important force to account for the high unemployment rate during low inflation. Examining the existence or degree of DNWR may provide some insights into how the labor market responds flexibly to a sudden (exogenous) negative shock or to changing economic conditions.

A large volume of existing literature has examined micro data on the distribution of individual wage increases. In addition, many scholars have attempted to explain the sustained high unemployment rates in U.S. and Europe since the Great Recession by investigating the existence of nominal or real wage rigidity. Several studies suggest that nominal wage rigidity may have contributed to the persistence of high unemployment since the recent crisis. Similar studies have unveiled specific factors responsible for the high unemployment rates in Japan during its Lost Decade when concerns on deflation were high. Nevertheless, research on nominal wage rigidity in Korea has been scant. Thus, our paper attempts to provide certain evidence of nominal wage rigidity in Korea by using micro and macro data. In the past, the lack of proper individual wage data hindered researchers from examining this issue. However, household income panel data has become available since 1999, enabling us to document evidence based on existing literature and provide our own to support the existence of nominal wage rigidity in Korea.

Related Literature

Several strands of the literature have studied nominal wage rigidity; hence, before proceeding with our study, we present several strands closely linked to the concerns of this paper.

One strand of the literature assesses the extent of wage rigidity based on micro data by analyzing the distribution of wage growth (McLaughlin 1994, 1999, 2000; Kuroda and Yamamoto 2003; Lebow et al. 2003). A number of papers have attempted to determine whether the degree of wage rigidity is related to inflation rate. Daly et al. (2012) illustrate that real wage growth in the U.S. did not decrease with low inflation during the recent recession after the 2008 crisis. They document that the proportion of workers whose wages were frozen (equivalently, not changed) is relatively large, supporting the existence of nominal wage rigidity in the U.S. Akerlof et al. (1996) also argue that adjusting labor costs is difficult for firms during low inflation, which leads to labor market distortions. …

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