Real wages differ markedly across countries: the typical worker in Australia is paid much more than the typical worker in Bolivia, for example. Suppose that we compare two countries, and we find that real wages are higher in one country (country A) than in the other (country B). This tells us that the marginal product of labor is higher in country A than in country B. There are two basic reasons why this might be true:
- Hours worked are fewer in country A than in country B.
- Other inputs are larger in country A than in country B.
***Figure 5.7 "Why Real Wages May Be Different in Different Countries" illustrates these possibilities. Part (a) compares two countries that are identical except that less labor is supplied to the market in country A. In country A, the real wage is higher, and the equilibrium number of hours is lower. In part (b), the two countries have identical labor supplies, but one or more of the other inputs (physical capital, human capital, knowledge, social infrastructure, or natural resources) is higher in country A. This means that the labor demand curve in country A is further to the right, so the real wage is higher, and the equilibrium number of hours is also higher.
The real wage is an indicator of societal welfare because it tells us about the living standards of the typical worker. From the perspective of workers, increases in other inputs—such as capital stock or an economy’s human capital—are desirable because they increase the marginal product of labor and hence the real wage.
Thus, when the World Bank helps to fund education in Niger, it is helping to increase GDP by increasing the amount of human capital in the production function. Furthermore, this increased GDP will appear in the form of higher wages and living standards in the economy. Conversely, if a food processing company decides to close a factory in England, capital stock in England decreases, and output and real wages decrease.
KEY TAKEAWAY
The quantity of labor in the aggregate production function is determined in the labor market.
All else being the same, labor will migrate to the place with the highest real wage.
Differences in real wages across economies reflect differences in the marginal product of labor due to differences in the number of hours worked, technology, and capital stocks.
***
Checking Your Understanding
To determine the patterns of labor migration, should we look at nominal or real wages? Should we look at wages before or after taxes?
Building on ***Figure 5.7 "Why Real Wages May Be Different in Different Countries", suppose that country A had fewer workers than country B but more capital. Would the real wage be higher or lower in country A than country B?
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