Labor Productivity, Real Wages, and Employment: Evidence from a Panel of OECD Economies Over 1960-2019

Abstract

This study investigates the relationship between labor productivity (LP), average real wage (RW), and employment (EMP), estimating the short run and long run effects of each variable on the others. The main goal of the paper is to test competing theories of growth and income distribution empirically. Standard theory predicts that real wages should increase following increases in labor productivity. Alternative theories and efficiency wage theories suggest that it is the distribution that causes changes in labor productivity. Theory delivers ambiguous predictions regarding the ultimate effects on employment, which can be either negative if factor substitution prevails or positive if higher wages and higher output per worker generate additional aggregate demand and, therefore, employment. I study a panel of 25 OECD economies over 1960-2019, using several approaches: 1) ECM, DOLS, FMOLS, and ARDL regressions with exogenous and endogenous variables, and 2) a VECM exercise where the system is assumed entirely endogenous as a robustness check. My main findings are the following: First, there exists a long run relationship between these three variables when LP and RW are considered dependent variables. Second, EMP cannot be explained statistically by LP and RW in the long run, showing that it is weakly exogenous. Third, regarding the relationship between LP and RW, I find a positive two-way causality in both the long and short run. Fourth, concerning the LP-EMP nexus, in the long run, the results show a negative association from EMP to LP in most specifications and are statistically significant only for the single-equations. Fifth, there is a positive effect running from EMP to RW in most specifications and are statistically significant only in the single-equation cases. Sixth, both LP positively affects EMP, and RW negatively impacts EMP in the short run.

Keywords: Labor Productivity, Real Wages, Employment, OECD