Nominal Wage Rigidity in Village Labor Markets

Investigators: Supreet Kaur.

This project empirically tests for downward nominal wage rigidity in markets for casual daily agricultural labor in a developing-country context. In contrast to the approach generally taken in the labor literature, Kaur tests for rigidity by directly testing whether wages adjust to labor demand shocks. A major benefit of this empirical approach is that it enables tests for whether rigidity leads to employment distortions — direct evidence for which is lacking in the literature on rigidity. Specifically, she examines wage and employment responses to rainfall shocks in 500 Indian districts from 1956-2008.

Three results point to downward nominal rigidity.  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.

Wage distortions generate employment distortions, creating boom and bust cycles: 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. In addition, 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 Kaur 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.

Published as "Nominal Wage Rigidity in Village Labor MarketsAmerican Economic Review, Vol 109 No 10, October 2019.

This project is affiliated with CDEP’s Human Capital Initiative.