Labor market rigidity refers to conditions where the market mechanism does not work in the labor market. Wages do not necessarily respond to changes in labor demand and supply.
For example, during a recession, labor demand falls because businesses cut their production. However, a fall in demand does not necessarily encourage wages to go down because there is rigidity.
Factors affecting labor market rigidity
Several factors cause the labor market rigidity, including:
- Minimum wages
- Job security
- Unemployment benefits
- Labor taxes
- Lack of supply-demand information on the labor
Sometimes, specialization also produces stiffness. With specialization, workers only focus on one specific skill. When new technology disrupts their industry, unemployed people find it challenging to find work because of the incompatibility of their expertise with demand.
The rigidity of the labor market leads to a higher unemployment rate. To explain, let’s take the case of unemployment benefits.
Unemployment benefits do provide income for the unemployed and maintain their spending levels. However, when it is high enough, it disincentivizes the unemployed to find work immediately. They may reject some jobs because the salary offer is not higher than their salary before being unemployed.
However, the rigidity might reduce fluctuations in the unemployment rate in the short run. That’s because workers and companies in rigid markets will find it more challenging to adjust to rapidly changing economic conditions, especially around the turning points of the business cycle.