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Stabilizing the Macroeconomy with Labor Market Policies

Author Oh Jong-seok and Hong Sungwook Date 2019.12.23 Page

This study argues that aggregate demand management policies alone (which have traditionally been used to stabilize economies) may not be effective in this crisis and argues that they should instead be implemented alongside labor market policies such as work sharing programs. The use of active labor market policies was critical during the global financial crisis of 2008. While the U.S. economy underwent a slow recovery despite the most aggressive fiscal and monetary policies pursued since the Great Depression, the German economy, by contrast, having implemented active labor market policies such as the Working Time Account, experienced a prompt recovery process.

To begin with, we focus on the cyclicality of the share of labor income, that is, the moving correlation between the GDP growth rate and the share of labor income, as a measure of stability in the labor market. If the labor income share exhibits counter-cyclical movement in the business cycle, we can interpret that the labor market is stable. On the other hand, if it shows a pro-cyclical movement, it implies that some stabilizing policy measures are required. We divided the entire period into three sub-periods: the pre-1997 East Asian economic crisis (period 1), the time between 1997 and the 2008 global financial crisis (period 2) and the post-2008 crisis (period 3). First, we found that in Korea, the share of labor income is mostly countercyclical, excepting a very short period between 1993 and 1997. Second, the share of labor income in the manufacturing sector was pro-cyclical in period 2 but exhibited counter-cyclical movement during other two sub-periods. Third, the share of labor income in the service sector exhibits procyclical movement in periods 1 and 2 and counter-cyclical movement in period 3. The counter-cyclicality of the labor income share in the overall economy seems to be led by the service sector, since the service sector’s moving correlation is located below that of the manufacturing sector.

Using industry-level data, we also conducted an empirical analysis on the cyclicality of wages and employment, which are the components of the measure of labor’s income share. First, we found that the employment in the overall economy is pro-cyclical for all three sub-periods. Manufacturing employment is pro-cyclical for periods 1 and 3; pro-cyclical employment in period 3 is especially noteworthy since it calls into question the view that Korean work sharing programs were allegedly successful in mitigating the impact of the global financial crisis on the labor market. In other words, it shows that work sharing was effective only in public institutions and at some large corporations, not in the manufacturing industry as a whole. Second, the coefficients for the cyclicality of wages is not significant, and the sign of the coefficients crossed positive and negative. This suggests that wage flexibility in Korea was not working properly.

We can categorize the work sharing program into two dimensions. As the objective, there are work sharing programs for either maintaining employment or creating employment. As an instrument, a firm can either adjust wages or adjust both working hours and wages. We exclude the employment-creating type of work sharing program from our discussion since it is aimed at long-term and structural issues and not on short-run business cycles on which this study focuses. The wage-adjustment/employment maintenance type can be seen in countries with a free market system and a flexible labor market. The best example of this type is the bargaining between U.S. automakers and the UAW in the early 1980s. In addition, a number of Korean companies that employed the Anglo Saxon flexible labor market since the 1997 economic crisis also exercised this type of work sharing program. On the other hand, the best example of simultaneous adjustment of wages and working hours and maintaining employment is the collective bargaining of Volkswagen, Germany, whose profitability deteriorated in the early 1990s.

The German case in particular draws to our attention the fact that Germany is a manufacturing-oriented country in which flexible working hours have been instituted across a considerable part of the manufacturing sector. Since Korea has a similar industrial structure, we can refer to the German experience in establishing a labor market policy during an economic crisis.

In this study we also address some of the issues with Korea’s work sharing programs during the global financial crisis. First, the work sharing program at that time was mainly implemented through an employment maintenance subsidy, which is similar to Germany’s short time work policy. However, the crucial parts of German stabilizing system were twofold: temporary reductions in regular working times and the utilization of the working time account, which constitutes a system based on trust between labor and management. This relationship, based on mutual trust, is still absent from Korean corporate culture.

Second, lacking in methods to actively adjust working hours, it was mainly bargaining concessions resulting in wage decreases that reduced the costs of firms during the downturn.

Third, although bargaining concessions were achieved through wage adjustment mainly at public firms and large corporations, under the structure of the dual labor market, employment was still unstable for irregular workers and subcontractors. In particular, the pro-cyclical movement of manufacturing employment even after the global financial crisis as found in our empirical analysis could imply that work-sharing policies at that time were adopted among a handful of companies rather than across a broad swath of the manufacturing industry.

We built a two-sector post-Keynesian model consisting of manufacturing and service (non-manufacturing) industries, taking into account the characteristics of the macro-economy and labor market in Korea. The directions for labor market policy suggested by the model are as follows. First, in an economic crisis, when the Keynesian stability condition is satisfied under a wage-led demand system, it is necessary to promote consumption by reducing the wage gap between the manufacturing and service sectors through either a minimum wage increase or various self-employment support policies. Second, when the Keynesian stability condition is met under a profit-led demand regime, it is possible to find a way to temporarily reduce the burden on firms by implementing a work sharing program centering on manufacturing. Lastly, if there is Harrodian instability in the economy, it is possible to actively consider the simultaneous adjustment of wages and working hours centered on manufacturing as well.