Readers' Submissions

Downward Nominal Wage Rigidity

  • Written by Professor
  • October 7th, 2014
  • 4 min read



This article follows up on two previous submissions which attempt to begin to answer one of the most vexing economic issues of our times, that is, why do bargirl prices remain the same when tourism drops during an economic downturn?

In the first abstract “Hotels, Bar Girls and Thai Economics” it was argued that bargirls need to deliver a certain specified amount home each month, and that in order to maintain this number prices cannot fall. In abstract 2 “The Economics of Bar Girl Pricing
a number of different variables were examined which all have a bearing on the final price.

This new abstract seeks to address 80-year economic theory that has recently been cited by Janet Yellen, Chair of the US Federal Reserve. In a speech last month in Jackson Hole, Wyoming, Yellen referred to “downward nominal wage rigidity”.

This concept was first articulated by John Maynard Keynes during the Great Depression of the 1930’s. Keynes was trying to understand how companies acted when faced with declining demand for their goods and services. At first, companies tried to forestall layoffs by reducing wages, but workers resisted. Thus, companies had no choice but to reduce costs via layoffs, thus contributing to the spiraling unemployment we are all familiar with during that time.

Keynes called the concept of workers refusing to drop their salary “wage stickiness”.

The concept of wage stickiness was dismissed in the 1970’s when a new school of economic theory called “Rational Expectations” emerged, claiming that workers would not accept layoffs instead of wage cuts. But in the 1990’s, an economist from Yale named Truman Bewley did field research in New England. He learned that pay cuts hurt morale, and low morale negatively affected production. This was further support for Keynes’ theory that to many workers layoffs are preferable to pay cuts.

At the same time, Yellen’s husband, a notable economist in his own right, co-wrote a paper claiming that in a downturn when businesses keep wages high, they are forced to keep prices high, which reduces demand thus supporting the need for layoffs.

Yellen’s recent speech cited new data that confirmed the concept of wage stickiness. Reviewing data from 1986-2012, two economists from the San Francisco Fed found that there were very few wage cuts in the most recent US recession, which is why unemployment has remained stubbornly high.

Bottom line, Keynes postulated, and economists since have accepted, the point that workers reject pay cuts. Like most of economic theory, this is obvious when one thinks about it.

Take yourself, good reader. You are paid a certain amount to do your current job. Let’s say tomorrow your boss comes to you and says, due to global economic conditions, he wants you to do the same job as you have been doing, but for 50% less pay.

Would you accept?

Some of you might, but many of you would not. Instead, you might take this as an opportunity to accept a new job somewhere else, go back to school, take time off to travel, or start your own company.

Now think of a bargirl. Like you, she also has a fixed minimum amount she needs to live on (including the money she needs to send home). When a recession hits and tourism drops, is she willing to reduce her wages? If she has always charged, for example, 2000 baht for short time, is she now willing to work for 1000 baht? The concept of downward nominal wage rigidity will tell us “No”. In fact, when faced with needing to reduce their fees, many service providers prefer to take up other work, or simply go home and do nothing. They wait for the recession to finish and then they come back. In fact, we see this every year in places like Phuket during low season, when the number of girls drastically drops, only to bounce back up when high season rolls around.

Let’s look at his numerically (all numbers here are purely made up for this case).

Let’s say on a given night in a bar area there are 1000 punters out drinking. Of these, let’s say 20% (or 200) are interested in further company for the night. Now let’s also assume there are 1000 ladies wishing to provide said company. So in M&A parlance, we have 200 willing buyers and 200 willing sellers who then agree to an average price of 2000 baht. But only 200 girls (20% of total supply) get to earn money.

Now the recession hits, tourism drops, and there are only 500 punters, of which the same 20% want to have further congress. If the supply of girls remains the same, then only 10% will earn wages, which is unacceptable for the remaining. As wage stickiness tells us they won’t reduce prices, this means that half the girls will have to go home. Of the remaining 500 girls, the same 20% will earn the same 2000 baht, and equilibrium will be restored.

Obviously, the real world is messier than hypothetical examples, and labor movements such as described above take a while to go into effect.

In the meantime, I’ve always felt it was not so important to worry about the costs of things when on holiday. If prices don’t go down, so what? In the end 500 baht here or there will make no difference to your wallet, but being stingy or generous will have a huge impact on your enjoyment.

Take care.

Professor