WAGE ADJUSTMENT: Labor Markets and Exchange Rates

Posted by Kathryn Schwartz on August 22, 2014

All else equal, optimal adjustments to labor demand in response to exchange rates movements are increasing in the industry export orientation and import competition. These effects are more ambiguously related to an industry’s use of imported inputs because domestic and imported inputs may be either substitutes or complements in the production function.

The theory presented in Section II also tracks how other industry features should systematically affect the level and mix of industry wage versus employment adjustment, if these features are correlated with labor demand and supply elasticities or the costs of employment adjustment to shocks. 6 Among these features are the mix of skilled and less-skilled workers and the industry unionization rates, which may influence the cost of adjusting the labor force. In addition, industry structure should matter: more “competitive” industries (i.e. those with lower price-over-cost markups) are expected to have more responsive labor demand than more oligopolistic industries.

The remainder of the paper, Sections III and IV, describes the data and provides the results from the empirical estimation of the effects of exchange rates on industry wages, employment, and overtime activity in the United States. Section V concludes.

Labor Markets and Exchange Rates

We present a simple dynamic model of labor market equilibrium, wherein within each year some combination of employment and wage adjustments equilibrate labor markets in response to shocks. Exchange rate shocks influence labor demand by affecting the marginal revenue product of through changes in its domestic and foreign sales and the cost of imported inputs into the production process.

The elasticity of marginal revenue product with respect to exchange rates depends on industry pass-through elasticities, i.e. the price elasticities with respect to exchange rates in both domestic and foreign markets. Theoretically, these coefficients should be sensitive to industry trade orientation and to industry competitive structure (for example, see Dornbusch 1987, Marston 1990, and Bodnar, Dumas and Marston 1998).

Industry structure matters because producer profitability and labor demand will be most affected by exchange rates in industries where producers have little ability to counter shocks by exerting price-setting abilities. The trade orientation of the industry also matters, since greater export orientation increases labor demand sensitivity and the positive stimuli from a dollar depreciation. More intensive imported input use can either increase or reduce labor demand sensitivity, depending on the assumed structure of production activity and product demand. Other industry characteristics, including those that alter an industry’s costs of adjusting it’s workforce, will change the timing of wage versus employment response, and the degree of short-term reliance on overtime work efforts. fast cash payday loans

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