Wage flexibility in a high unemployment regime: spatial heterogeneity and the size of local labour markets

Author(s): Dieter von Fintel

Stellenbosch Working Paper Series No. WP09/2016

Whereas some previous microeconometric evidence suggests that wage setters in South Africa are highly responsive to external local labour market circumstances, this is not corroborated by macroeconomic studies. This question is interrogated again, with particular attention to methodological issues in wage curve estimation. The latter is a robust negative relationship between individuals’ wages and local unemployment rates, found in most countries, except where bargaining is highly centralized. Adding time variation to the micro data allows controls for spatial heterogeneity to be introduced, leading to the conclusion that wages are really inflexible in the short-run. Rather, the trade-off between wages and local unemployment that previous work has found represents a long-run spatial pattern. This finding is robust to instrumentation for reverse causality and the measurement error that is associated with choosing incorrect labour market demarcations. Additionally, this paper disputes the notion that very small geographic regions are appropriate to define “local” labour markets. Specifically, former magisterial districts appear to be smaller than the functional regions for which wage setters take labour market information into account. District councils tend to offer the most appropriate definitions. This concurs with the fact that collective bargaining councils “galvanise” smaller areas into larger wage setting regions, encompassing multiple magisterial districts. The role of bargaining councils is further investigated, with wage curve elasticities tending to be significantly negative for wage setters that work in the small firm, non-unionised sector. This points to the fact that the short-run inflexibility that is found overall is driven by sub-samples of larger firms with high concentrations of unionised workers. This section of the labour market appears to be insulated from the pressures of high unemployment in the short run.

JEL Classification:
J31; J51; C21

South Africa; labour market flexibility; unemployment; wage curve; spatial lags; regional heterogeneity; local labour markets