Wage determination in local labour markets: theory and evidence for the wage curve in New Zealand

Abstract

Blanchflower and Oswald (1994) claimed that a stable inverse relationship exists between the wages paid to workers and the local unemployment rate. Using microeconomic data from a range of countries they found an unemployment elasticity of pay of around -0.1. The aim of this study is to test for the presence of a similar "wage curve" in New Zealand, while maintaining a closer link with theory. A dynamic efficiency wage model based on Phelps (1994) is used to produce an upward-sloping locus of steady-state wage and employment rate outcomes. Points along this locus are identified by local labour market shocks. In addition, interregional equilibrium ensures that regions satisfy a so-called Harris-Todaro condition, which is consistent with zero net internal migration, and entails a negative relationship between wages and employment rates. Using a synthetic microeconomic sample of over 20,000 observations from the 1986, 1991 and 1996 New Zealand Censuses of Population and Dwellings, some support is then found for both this specification of the earnings equation and that of Blanchflower and Oswald. However, while the former is found to be robust to controls for the possible presence of simultaneity bias, due to the endogeneity of unemployment and other regressors, Blanchflower and Oswald's specification is not. As predicted, the coefficient on the employment rate is positive, while the gross in-migration rate has a positive effect on wages. Separate gender regressions reveal that males, but not females, exhibit a positive employment elasticity of pay. Evidence for other subgroups of workers is also broadly consistent with the prediction of the model that wages will be more sensitive to local labour market conditions the less geographically mobile workers are or the less elastic their labour supply. Finally, a further analysis of the labour market outcomes of different groups suggests that hours worked are relatively invariant to differences in economic conditions. Nonetheless, the hours of groups with inelastic wage curves tend to be more responsive to variation in the employment rate. This is consistent with the theory of unpaid labour hoarding among workers with higher levels of human capital.