Relative Prices, Real Wages, and Macroeconomic Policies: Some Evidence from Manufacturing in Japan and the United Kingdom

Research paper by Leslie Lipschitz, Susan M. Schadler

Indexed on: 01 Jun '84Published on: 01 Jun '84Published in: Staff papers - International Monetary Fund. International Monetary Fund


Countries differed in their adjustment to the commodity price shocks of the 1970s. In some countries there was little wage adjustment, so that the brunt of the terms-of-trade loss was borne by profits; in others greater wage adjustment allowed the term-of-trade loss to be distributed more evenly between labor and capital. The extent of wage adjustment is important to the current unemployment problem and to the debate on the efficacy of demand management. Where there has been little wage adjustment, poor output and employment performance is likely to be due to ("classical") excessive wage costs rather than simply to a ("cyclical") deficiency of demand. This paper uses an econometric model to separate the cyclical and classical influences on manufacturing output and employment. It compares results for Japan and the United Kingdom, countries chosen because of significant differences between their labor markets. The comparison indicates that labor cost developments depressed output and employment growth in the United Kingdom during the last decade; in Japan, however, labor cost developments exerted a small positive influence on manufacturing output and employment during the same period. Two measures of "warranted" changes in real wages are constructed from the estimated model. The first indicates wage movements consistent with fixed factor shares in value added, and the second, wage movements that would equilibrate labor supply and demand. The gap between actual and warranted wages provides an indication of the adequacy of wage adjustment and, in turn, of the sustain-ability of an output and employment response to an expansion of demand. During the last decade, and especially since the second oil price increase, the wage gap widened considerably more rapidly in the United Kingdom than in Japan. The wage gap estimates underscore the dangers of too rapid an expansion of demand, particularly in the United Kingdom.