The Relationship between Real Wages and Output: Evidence from Pakistan

Afia Malik, Ather Maqsood Ahmed


Information on wage levels is essential in evaluating the
living standards and conditions of work and life of the workers. Since
nominal wage fails to explain the purchasing power of employees, real
wage is considered as a major indicator of employees purchasing power
and can be used as proxy for their level of income. Any fluctuations in
the real wage rate have a significant impact on poverty and the
distribution of income. When used in relation with other economic
variables, for instance employment or output they are valuable
indicators in the analysis of business cycles. There has been a long
debate regarding the relationship between real wages and the employment
(output). Despite the apparent simplicity, the relationship between real
wages and output has remained deceptive both theoretically and
empirically. Keynes (1936) viewed cyclical movements in employment along
a stable labour demand schedule thus indicating counter cyclical real
wages. His deduction is in line with sticky wages and sticky
expectations, which augments models like Phillips curve. In these models
real wages behaved as counter-cyclical as nominal wages are slow to
adjust during recession (decrease in aggregate demand and associated
slowdown in price growth). Stickiness of wages or expectations shifts
the labour supply over the business cycles [Abraham and Haltiwanger
(1995)]. Barro (1990) and Christiano and Eichenbaum (1992) have
associated these labour supply shifts with intertemporal labour-leisure
substitution. This in response to temporary changes in real interest
rates (fiscal policy shocks) could yield counter-cyclical real wages.
However, Long and Plosser (1983) and Kydland and Prescott (1982) while
studying the real business cycle models highlight on the technology
shocks which leads to pro-cyclical real wages.

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