Economics and the mid-life crisis have much in common: Both dwell on foregone opportunities

C'est la vie; c'est la guerre; c'est la pomme de terre . . . . . . . . . . . . . email: jpalmer at uwo dot ca

. . . . . . . . . . .Richard Posner should be awarded the next Nobel Prize in Economics . . . . . . . . . . . .

Monday, April 04, 2005

Sticky Wages and Labour Shortages

The NY Times (registration req'd) reports that there are shortages in factory labour in many of the manufacturing regions of China. The intensely neo-classical economist in me wants to shriek out:

There's no such thing as a shortage! What is perceived as a shortage would disappear if wage rates rose.
The empiricist in me recognizes that there are, nevertheless, reports of serious labour shortages, not only in manufacturing in China, but also in the trades in Australia [and let's not forget those substitute teachers in Denver].

In each instance, wages are below the market-clearing wage rate. In the case of substitute teachers in Denver, the problem is easy to understand -- wages are set administratively and the recent wage reduction was made without reference to market conditions.

In the most recent example - manufacturing in China - wage rates are slowly rising. Factories that used to pay as little as $50/month are now finding it more difficult to attract workers because other employers are offering as much as $150/month. Demand for manufacturered goods from China has raised the derived demand for Chinese labour.

No one thinks China is running out of workers. But young migrant workers coveted by factories are gaining bargaining power and many are choosing to leave the low pay and often miserable conditions in Guangdong. In a nondemocratic China, it is the equivalent of "voting with their feet."

Rising wage rates in China will, in turn, alter comparative advantages in Asia (see Anomaly UK for more on this result; also see the New Economist for too-brief comments on the competition for labour in developing areas):

It's not the end of the great China manufacturing story," said Jonathan Anderson, the chief Asia-Pacific economist for UBS. "But you're no longer going to be talking about China having labor so radically cheap that it will capture all the investment flows. This is an opening for Vietnam, it's an opening for India and Cambodia."

These slow responses to sticky wages tell us a something about macroeconomic models that assume rational expectations with instantaneous adjustment and full information -- they are not likely to be very useful for short-run analysis of these situations.
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