CDEP-CGEG Working Paper No. 2

Nominal Wage Rigidity in Village Labor Markets

Supreet Kaur

Abstract
This paper tests for downward nominal wage rigidity in markets for casual daily agricultural labor in a developing country context. I examine wage and employment responses to rainfall shocks—which shift labor demand—in 500 Indian districts from 1956-2008. First, there is asymmetric wage adjustment: nominal wages rise in response to positive shocks but do not fall during droughts. Second, after transitory positive shocks have dissipated, nominal wages do not return to previous levels—they remain high in future years. Third, inflation moderates these effects: when inflation is higher, real wages are more likely to fall during droughts and after transitory positive shocks. Fourth, wage distortions generate employment distortions: employment is lower in the year after a transitory positive shock than if the positive shock had not occurred; landless laborers experience a 6% employment reduction. Fifth, consistent with misallocation of labor across farms, households with smaller landholdings increase labor supply to their own farms when they are rationed out of the external labor market. These findings indicate that wage rigidity lowers employment levels and increases employment volatility—in a setting with few institutional constraints. Data from a new survey I conducted in two Indian states suggests that agricultural workers and employers: view nominal wage cuts as unfair; are considerably less likely to regard real wage cuts as unfair if they are achieved through inflation rather than nominal cuts; and believe that nominal wage cuts cause effort reductions.

Coverage: “Could this be the best paper on nominal wage rigidity?,” Marginal Revolution, December 15, 2011

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