Primary Factor Substitution In Manufacturing And The Real Wage Explosions

In this paper an attempt is made to estimate the demand for labour in Australian manufacturing from time series data spanning 1962-63 through 1985-86. Over this study period two major wage shocks occurred; the first in 1973-74 and the second in 1981-82. The effects of these two events on the elasticity of primary factor substitution in manufacturing are estimated here. Surprisingly a substantial fall in the substitution elasticity was recorded across the sample period. Of related interest are the movements in the capital intensity of the technology over the study period; contrary to expectations, these movements seem to indicate a strong fall in the capital intensity of the technology. When allowance is made for possible disequilibrium at the height of the wages shocks, however, the latter result is overturned. With these frictions modelled there is still an implied fall in the elasticity of substitution but it is much smaller and, contrary to the earlier results, the expected deepening of the capital in the aftermath of the wages shocks was confirmed. The results show increased rigidity in the primary factor input mix in Manufacturing over the sample period, with the implication that, on average, firms became less able to reconfigure their capital/labour ratio in response to factor price shocks, and hence less able to contain costs in the face of such shocks.