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Cyclical Wage Movements in Emerging Markets Compared to Developed Economies: A Contractual Approach

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  • Nan Li

    () (Stanford University)

Abstract

This paper documents that, at the aggregate level, (i) real wages are positively correlated with output and, on average, lag output by about one quarter in emerging markets, while there are no systematic patterns in developed economies, (ii) real wage volatility (relative to output volatility) is about twice as high in emerging markets compared with developed economies, and (iii) real wage volatility, as a ratio of output volatility, decreases with the level of financial development across countries. I then present a model of contractual arrangements between workers and employers in a small open economy that helps explain this contrast in cyclical wage movements between emerging markets and developed economies. Only employers have access to financial and capital markets in the model, but they need to borrow working capital to pay for labor costs before production is carried out. The idea is that countercyclical interest rates and less developed financial markets in emerging markets make it less optimal for employers to provide workers with relatively stable wages, leading to more volatile and procyclical wages. This is further demonstrated by calibrating the model using data from Mexico and the U.S. to represent emerging and developed economies respectively.

Suggested Citation

  • Nan Li, 2007. "Cyclical Wage Movements in Emerging Markets Compared to Developed Economies: A Contractual Approach," Discussion Papers 06-026, Stanford Institute for Economic Policy Research.
  • Handle: RePEc:sip:dpaper:06-026
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    File URL: http://www-siepr.stanford.edu/repec/sip/06-026.pdf
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    More about this item

    Keywords

    real wage; output; developing countries; emerging markets; volatility;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials

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