Conceptualizing Sticky Wage Theory
The sticky wage theory proposes that employee salaries respond sluggishly to shifts in business performance or broader economic conditions. According to this theory, during times of rising unemployment, the wages of the remaining employed workers tend to stay constant or increase at a slower rate, rather than declining with lower labor demand. Specifically, wages are often termed as sticky-down, implying ease of upward movements yet resistance to downward adjustments.
The concept originates from the renowned economist John Maynard Keynes, who described this as the nominal rigidity of wages.
Key Insights
- Wage Resistance During Downturns: Sticky wage theory argues that employee pay defies reduction even amid adverse economic conditions.
- Cost-Cutting Alternatives: Workers oppose pay reductions, leading firms to cut costs by other means, such as layoffs, if profitability dips.
- Impact of Inflation: Due to wages being sticky-down, real wages decrease via inflationary pressures.
- Broader Implications: Besides wages, the phenomenon of stickiness extends to prices and tax levels, reflecting in various economic sectors.
Understanding Sticky Wage Dynamics: Moving Beyond Theory
Sticky pricing is a theoretical market condition where certain nominal prices, including wages, resist change. Although primarily referring to wages, stickiness can extend to market prices, referred to as price stickiness.
The aggregate price level, the average market prices, can become sticky due to asymmetry in pricing flexibility and rigidity. This asymmetry causes prices to respond readily to upward pressures but resist downward forces. Similarly, wages exhibit gradual upward movement preference, resisting downward adjustments, demonstrating the concept of wage stickiness.
The sticky wage theory enjoys considerable acceptance, particularly in macroeconomics. Yet, some neoclassical economists question its robust applicability. Proponents cite several stickiness factors like reluctance to accept pay cuts, union contracts, and employer image concerns against wage reductions.
Macro-economic Importance: In Keynesian and New Keynesian macroeconomics, wage stickiness holds significant relevance. Without it, wages would align more efficiently with the markets leading to constant economic equilibrium. However, stickiness results in static wages during disruptions, leading firms to reduce employment instead of wages. This explains stagnant market adjustments and delayed equilibrium.
Generally, unlike wages, the prices of goods adjust more flexibly in response to supply and demand changes.
Examining Sticky Wage Theory in Real-World Contexts
Sticky wage theory suggests an asymmetry favoring upward over downward wage adjustments. This upward trend in wages, often named creep or ratchet effect, substantiates wage stickiness. Economists warn this stickiness might merely signify an illusion, revealing real income declines in buying power due to inflation, identified as wage-push inflation.
Wage stickiness within one sector can incite similar trends across other sectors, driven by inter-industry competition and parity efforts.
Global Effects: On a broader scale, wage stickiness influences the global economy. For instance, the phenomenon termed overshooting in foreign exchange rates mitigates price stickiness, resulting in considerable rate volatility globally.
Sticky Wage Impact on Employment Rates
Employment rates often echo distortions prompted by sticky wages. During severe recessions like 2008’s Great Recession, wages didn’t drop easily. To manage costs, firms opted for layoffs over wage reductions. Post-recession, both wages and employment showed sluggish adjustments reflecting sticky-up and sticky-down wages respectively.
Employment Dynamics: Identifying recession cessation remains challenging. Businesses face high short-term costs hiring new employees versus offering minor wage increases. Consequently, post-recession employment becomes ‘sticky-up’ while retained employees might experience marginal wage increments.
