An Open Economy Model of Wages and Employment with an Application to Korea

Abstract

Money wages have two aspects: increase in the money wage rate raises money costs, and money incomes and aggregate demand as well. The Classical analysis assumes that the money wage rate affects nothing but factor costs, with aggregate demand constant. It follows that employment varies inversely with wages. Keynes (1936, pp. 257-260) declares this proposition an ignoratio elenchi, and insists that changes in money wages must be analyzed through their effects on the components of aggregate demand. In a closed economy, therefore, most economists argue that the net effect of the rise in the money wage rate is generally to reduce employment via the Keynes effect.' The negative relationship between wages and employment is often inferred from Neoclassical two-sector models such as Hicks (1937) and Meade (1937),2 or from Post Keynesian models such as Weintraub (1978, 1981), Kregel (1988), and Darity (1989).3 The relationship between changes in money wages and employment in open economy is a different question where a distinction can be made between export and domestic sectors. The Classical presumption regarding wage changes on employment in the export sector may be relevant if the demand for exports is determined almost independently