The effects of Korean wage hikes on Korean trade structures with the U.S. and Japan.

• Author: Liew, Chong Kiew

Input-Output Model," 1979 Proceedings of the Business and Economic Statistics Section. Washington D.C.: American Statistical Association, 1979, pp. 236-41.

8. ----- and ----- . "The Multicountry Industrial Linkage Model," Unpublished paper, Division of Economics, The University of Oklahoma, 1987.

9. ----- and -----, "Measuring the Development Impact of A Transportation System." Journal of Regional Science, Volume 25, May, 1985, 241-58.

10. ----- and -----, "Measuring the Effect of Cost Variation on Industrial Outputs." Journal of Regional Science, Volume 28, November 1988, 563-78.

    1. Introduction

       During the last two decades, Korea has experienced a rapid economic growth. This growth is primarily the results of two factors; (1) Korean outward development strategy, and (2) a high quality labor force working at a relatively low wage rate. Until 1985, Korean labor market conditions were conducive to the outward development strategy.

       Before 1985, Korean workers were unable to negotiate their wage with employers through the usual channels of labor unions. As a substitute for labor unions, many Korean firms utilized worker-employer councils, which were a variant of unions. These councils gave a nominal capability of intermediating labor disputes and of accomplishing collective agreements between workers and employers. However, in many firms the leaders of these councils were nominated by employers. Indeed, these workers did not have any meaningful channel to negotiate their wages with employers.

       Prior to 1985, wages in most small and mid-sized firms were determined by wage regulations which were set up by employers beforehand. In large firms such as conglomerates, the government issued guidelines for the percentile increase of each industrial wage with respect to macro-economic circumstances. Since the increase was typically determined at a much lower rate than the actual productivity growth, most large firms had no reason to deviate from these government guidelines. Furthermore, the National Security Special Law has been in force since 1972. This law specifically prohibited any collective action and collective wage bargaining.

       With the recent political liberalization in 1985, including the correction of the National Security Special Law and various labor acts, Korean workers started demanding higher wages and insisting on the abolition of improper labor practices. Korean workers claimed their wages had been unfairly diminished by economic policy in comparison with their actual productivity.

       This political liberalization was so abrupt that both workers and employers were ill-prepared for collective wage bargaining. There are several reasons(1) why massive labor disputes were protracted for such a long time. Both employers and workers stubbornly held to their strict positions in wage bargaining. Many employers stubbornly resisted the existence of the union itself. Some employers even announced publicly that firms would be shut down if workers formed any union or made any labor dispute. These employers' behavior mainly came from the absence of any past experience of collective bargaining. On the other hand, workers' wages had been suppressed at a low rate for past two decades. Once politically liberalized, the workers demanded much higher wages all at once. This approach was not acceptable to most employers, especially in such a short period. Second, both parties had such imperfect information about the other parties that they often failed to convey the true position of their strategic schedules to the other parties in negotiation. This imperfect information about the other parties were mainly due to the inexperience in wage bargaining.

       The purpose of this paper is to trace the effects of wage hikes on Korean imports and exports with the United States and Japan. These two countries are the most important trade partners for Korea. This paper investigates the industrial effects of the rising wage rates on prices, outputs, and trade structures of Korea, Japan, and the United States.

       In order to answer these questions, we construct a Multi-country Industrial Linkage (MIL) model of Korea, Japan, and the United States. The MIL model is an applied general equilibrium model which fully captures the profit maximizing behavior of industries and the utility maximizing behavior of consumers. The MIL model has an explicit linkage between the profit maximizing capital stocks and the demands for investment goods. It adopts CES production frontiers to describe the production technology of each industry in the country.

       The MIL model is an extension of conventional input-output models [13], Leontief and Strout [6], Polenske [16], Miller and Blair [12], Richardson [15], Hewing and Jenson [3], and Rietveld [14] by permitting the model to capture the output effects of cost variations under the framework of multicountry input-output transactions which explicitly identify the origin and destination of each commodity as well as their final usages. There are many general equilibrium models which trace the output effects of cost variations such as Jorgenson [4], Shoven and Whalley [17] and Srinivasan and Whalley [18]. The import and export items are usually aggregated across all trading countries in order to report the effects of various trends on trade patterns. In these general equilibrium approaches, input-output coefficients were rarely reported. Hence, the trade flows of each commodity between countries could not be described nor the input transactions in industry and country detail could be identified. The MIL model enables us to identify the import and export of each product from its origin and destination to its final usages in the consuming country.

       Following the introduction, section II describes the theoretical background of the MIL model. Section III presents a CES version of MIL model, and section IV provides a labor simulation model to trace the structural effects on Korean imports and exports with the United States and Japan. After a brief description of data used in this study, section V summarizes the empirical findings of the labor simulation. We could not gather the elasticity of substitution between inputs for Japan and Korean industries. Hence, the unitary elasticities of substitution for all industries (Cobb-Douglas function) are used for the empirical pan under the assumption that the industrial structures of Japan and Korea are similar to those of the United States.(2) Section VI offers brief concluding remarks.

    2. The Theoretical Background of the Model

       The Multicountry Industrial Linkage (MIL) model refers to a computable general equilibrium model which satisfies the following six conditions; (1) Producer Equilibrium Conditions, (2) Household Equilibrium Conditions, (3) Linkage between Investment and Capital Stocks, (4) Balancing Conditions, (5) Trade Flow Conditions, and (6) Resource Constraints. The model captures the profit maximizing behavior of firms and the utility maximizing behavior of households with given supply of resources in the regions. The model assumes that households interact with business firms by supplying primary inputs for firms to earn income which is used to spend for consumption.

       Producer Equilibrium Conditions

       It is assumed that the production technology of the region is described by a homogenous production frontier (i.e., a constant return to scale production technology). With given production frontiers (equation (1)) describing the production technology of the country, the profit maximizing input demands are defined by equations (2) and (3):

       Production Frontiers

       [Mathematical Expression Omitted]

       where

       [Mathematical Expression Omitted] = the amount of product i produced in country s and delivered to industry j in country r;

       [Mathematical Expression Omitted] = the amount of primary input k employed by industry j in country r;

       [Mathematical Expression Omitted] = the amount of product j produced by industry j in country r.

       Profit Maximizing Input-Equations

       Intermediate Inputs

       [Mathematical Expression Omitted]

       Primary Inputs

       [Mathematical Expression Omitted]

       where [Mathematical Expression Omitted], [Mathematical Expression Omitted], and [Mathematical Expression Omitted] are the producer price of [Mathematical Expression Omitted], the primary input price of [Mathematical Expression Omitted], and the purchase price of [Mathematical Expression Omitted] respectively.

       Household Equilibrium Conditions

       It is assumed that the household sector in region r has an Indirect Utility Function (equation (4)), from which a utility maximizing consumer demand equation (5) is derived by using Roy's Identity. The consumer budget is a constant fraction of the gross national products (i.e., the sum of values added as shown in equation (6)).

       Indirect Utility Function

       [Mathematical Expression Omitted]

       Consumer Demand Equation

       [Mathematical Expression Omitted]

       Consumption Budget

       [Mathematical Expression Omitted]

       Linkage Between Capital Stock and Investment

       The gross investment in the region [Mathematical Expression Omitted] is the sum of net investment and replacement investment. The net investment is a change in profit maximizing capital stock ([K.sup.r] - [K.sup.r](-1)) and the replacement investment is assumed to be a constant fraction of beginning capital stock in region r ([[Theta].sup.r][K.sup.r](-1)). Let the second primary input ([Mathematical Expression Omitted]) be capital stock. Then, [Mathematical Expression Omitted]. We further assume that the growth rate of capital stock is constant: i.e.,

       [K.sup.r] - [K.sup.r](-1)/[K.sup.r](-1) = [n.sup.r]. (7)

       Then, the gross investment in the region r has the following relation.

       Gross Investment

       [Mathematical Expression Omitted]

       Note that [Phi][prime] = ([n.sup.r] + [[Theta].sup.r])/(1 + [n.sup.r]).

       We further assume that the firms have the following indirect utility function and purchase their investment goods so as to maximize their utilities. By using Roy's...