In this paper we study the determination of real wages in Israel for the long and short run during 1968-98. This period serves as a uniquely rich macro-economic
laboratory as the Israeli economy went from hyper-inflation to low inflation,
liberalilzation of the economy, decline of the powerful national trade union,
massive immigration, influx of foreign workers and finally a high-tech led
economic growth. We employ a simple Neo-Classical framework in which
long run real wages are determined according to labor productivity. This
allows for a clear dichotomy between the long run and short-run. The long
run is estimated using co-integration techniques whereas the short-run
real-wage dynamic equations are linked to the long-run relationship via an
error-correction term. The results of our study relate to important debates in
the macroeconomic analysis of labor markets: Despite many competing
theories based on market imperfections and complex institutions, we provide
empirical support to the Blanchard and Katz (1997) approach and can not
refute the simple neo-classical framework and find that in the long-run real
wages are co-integrated with unit elasticity with labor productivity. In the
short run we find, on the one hand, rising importance of market forces and
evidence of nominal contracting with rational expectations such that real
wages are affected only by unexpected inflation. On the other hand,
unemployment benefits have increasingly produced real wages rigidities.
These rigidities may in fact outweigh the short-term effect of the Histadrut -
the national trade union.
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