CDEP-CGEG Working Paper No. 15

Nominal Wage Rigidity in Village Labor Markets

Surpreet Kaur


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 600 Indian districts from 1956-2009. 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, creating boom and bust cycles: employment is 9% lower in the year after a transitory positive shock than if the positive shock had not occurred. Fifth, consistent with the misallocation of labor across farms, households with small landholdings increase labor supply to their own farms when they are rationed out of the external labor market. The wage and employment results are not consistent with other trasmission mechanisms, such as migration or capital accumulation. These findings suggest 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; and believe that nominal wage cuts cause effort reductions.

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