Labor market rigidities and ramifications of the Asian financial crisis: what can we learn from Hong Kong's experience?

Cheng, Chak Hung Jack

Labor market rigidities and ramifications of the Asian financial crisis: what can we learn from Hong Kong's experience? Public Deposited

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March 21, 2019

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Cheng, Chak Hung Jack
- Affiliation: College of Arts and Sciences, Department of Economics

Abstract

The economic downfall experienced by Hong Kong during the Asian financial crisis is bewildering since Hong Kong did not undergo large currency devaluations as did other affected Asian economies. The purpose of this dissertation is to ascertain whether the large impact of the Asian crisis on the Hong Kong economy can be attributed to labor market frictions. In the first part of this dissertation, I develop and estimate a dynamic stochastic general equilibrium model with sticky wages based on the work by Cheng and Salemi . The chief findings of this analysis are that nominal wages in Hong Kong are very sticky and the significant rise in unemployment after the crisis can be predominantly ascribed to wage setting frictions. However, wage rigidities are not responsible for the large decline in output. The rationale behind this result is that labor compensations account for a rather small share of total production costs in Hong Kong. Hence, changes in wage costs have only a limited effect on prices and output. In the second part of this work, I estimate a standard search-matching model. I find that a standard search model cannot explain the data as well as the sticky wage model. In particular, volatility of wages implied by the search model is much higher than that in the data. Finally, in the last portion of this work, I add wage stickiness to the standard search model to further determine the role of wage rigidity in explaining the Hong Kong data. I find that incorporating wage rigidity into the search model can improve the model's ability to explain the volatility of nominal wages. Also, by conducting counterfactual experiments on the sticky wage search model, I confirm that wage rigidity significantly amplifed the impact of the Asian financial crisis on the Hong Kong economy.

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