Sticky Wages (Wage Stickiness)

Sticky wages (or wage stickiness) refer to the inability of wages to adjust flexibly, particularly downward, in response to changes in market conditions. This phenomenon is observed as wages tending to remain fixed despite fluctuations in labor market supply and demand. The concept plays a crucial role in explaining unemployment and macroeconomic imbalances.

According to neoclassical economic theory, wages and prices are flexible; markets self-correct, for example by lowering wages in the presence of unemployment. In contrast, New Keynesian economics argues that both nominal and real wages are sticky and therefore markets cannot automatically reach equilibrium.

Historical Development

The concept of sticky wages came to the forefront in the context of economic stagnation following the 1929 Great Depression, when neoclassical theories proved inadequate in explaining the observed economic conditions. The persistence of wages despite widespread unemployment led to questioning the theoretical assumption of wage flexibility. John Maynard Keynes argued that nominal wages are evaluated by workers not in absolute terms but in relative terms, leading to resistance against downward adjustments. Keynes’s views were later reinterpreted in the 1980s by New Keynesian economists who provided microeconomic foundations for these ideas.

Nominal Wage Stickiness

Within the New Keynesian framework, nominal wage stickiness refers to the failure of wages to adjust quickly in response to economic shocks. The main reasons for this are:

1. Staggered Wage Contracts: According to models developed by Fischer (1977), Taylor (1980), and Caplin & Spulber (1987), wage contracts cover specific periods, and not all firms renew their contracts simultaneously. This leads to delays in wage adjustments.
2. Menu Costs: Applied to the labor market, Mankiw’s (1985) theory of price stickiness suggests that wage changes occur infrequently due to administrative, bargaining, and evaluation costs.
3. Employer-Employee Trust Issues: The difficulty of observing future commitments by either party encourages wage stability. For instance, failing to raise wages despite increased worker productivity, or the risk of reduced performance following a wage increase, creates mutual trust problems.
4. Unemployment Insurance: Unemployment insurance provides workers with income security, strengthening their bargaining power and raising reservation wages, thereby preventing wages from falling below a certain level.

Real Wage Stickiness

Real wage stickiness refers to the tendency of wages to remain constant despite inflation or other real variables. This phenomenon is explained by several theoretical models:

1. Implicit Contract Theory: Developed by economists such as Baily and Azariadis, this theory posits that workers’ aversion to risk and limited access to capital markets incentivize firms to offer stable real wages.
2. Efficiency Wage Theory: Economists such as Akerlof, Yellen, and Stiglitz argue that worker productivity is a function of the wage paid. Therefore, reducing wages may negatively affect productivity, leading firms to prefer paying wages above market levels. Submodels include the Food Model, the Shirking Model, the Worker Turnover Model, the Adverse Selection Model, Sociological Models, and the Union Threat Model.
3. Insiders-Outsiders Theory: Developed by Lindbeck and Snower, this theory argues that current employees (insiders) use their bargaining power to prevent wage cuts. Firms avoid replacing existing workers with lower-wage new hires due to the costs of hiring and training.