In many developed countries, real wage growth has lagged behind labour productivity growth in recent decades. This column uses data from Japan and Korea to study the relationship between labour productivity growth, real wage growth, and labour's terms of trade, defined as the ratio of the consumer price index to the GDP deflator. It shows that the main reason for the real wage-labour productivity growth gap is a large decline in labour's terms of trade. Raising real wages in the future will require policies to support the business environment and develop high value-added sectors.
In recent decades, real wage growth has lagged behind labour productivity growth in many advanced countries. Several studies suggest that this growth gap is driven by the fall in the labour income share (Dabla-Norris et al. 2015, ILO 2018). Some countries like Korea and Japan raised the minimum wage in response to these findings. However, in this column we find that most of the observed gap between the real wage and labour productivity growth originates from differences in prices indices. Thus, when wage growth and labour productivity growth are compared in nominal terms, most of the observed gap disappears for many countries. Usually, the nominal wage is deflated by the consumer price index (CPI), whereas nominal GDP is deflated by the GDP deflator to obtain the real terms. Therefore, the widening real wage-labour productivity growth gap in real terms is influenced by the changes in the CPI-GDP deflator differential. As shown in Figure 1, the changes in labour's terms of trade – the CPI–GDP deflator differential – and the real wage-labour productivity growth gap are positively correlated with a correlation coefficient of 0.664. Widening real wage-labour productivity gaps have been witnessed in the past and in several studies in the related literature such as Bosworth and Perry (1994), Feldstein (2008), and Pessoa and Van Reenen (2013), which provided a similar explanation for the observed gap.
In Chun et al. (2021), we provide a decomposition to identify the factors behind the observed gap between the real wage and labour productivity growth for Japan and Korea. One limitation of the study is the difference in availability of the detailed data sets necessary to decompose the wage-productivity gaps in the respective countries. Labour productivity growth (NI0) for Japan is GDP growth per labour hour adjusted for changes in capital depreciation rate and net indirect tax rate. Labour productivity growth (NI2) for Korea is GDP growth per worker adjusted for changes in capital depreciation rate, net indirect tax rate, and changes in the proportion of the self-employed sector. The decompositions of the gaps for Japan and Korea are presented respectively in Panel A and Panel B of Table 1.
In Japan and Korea, labour productivity has increased by 22.8% and 46.7%, respectively, over the past 20 years, but real wages have increased by only 2.6% and 27.2%, respectively. In both countries, the increases in real wages are much smaller than the increases in labour productivity. The main reason for the stagnation in the real wages is the large decline in labour's terms of trade in both countries which fell by 14.2% and 15.5%, respectively. In countries that import primary commodities such as crude oil and agricultural products and export electronic products, automobiles, and machinery, labour's terms of trade are more likely to deteriorate according to the fall in the relative price of export products through technological progress. The decline in labour's terms of trade may also be attributed to the fact that products of the same quality as those produced domestically are produced in large quantities overseas through foreign direct investment (FDI). It is notable that the declines in the labour income share explain a relatively small portion of the stagnation of real wages in both countries.
For countries like Japan and Korea to raise real wages, they need to improve the business environment and support policies to develop new high value-added sectors with sustained relative prices so that labour's terms of trade do not deteriorate, rather than artificially raising the minimum wage to target the labour income share.
Authors' Note: The main research on which this column is based first appeared as a Discussion Paper of the Research Institute of Economy, Trade and Industry (RIETI) of Japan.
This article first appeared on www.VoxEU.org on September 6, 2021. Reproduced with permission.