Background:

We study how aggregate employment adjusted in the Chilean economy to the so called Asian Crisis. We test different hypotheses used in the public debate, although not formally tested, that try to explain the sluggish recovery of employment after the crisis.

Methods:

We specify and estimate a vector autoregressive model with time series for the quarterly period 1995.1-2007.4 and apply the Johansen method to identify cointegration vectors.

Results:

We estimate one cointegration vector that represents the labor demand function. We perform hypothesis testing on this function: zero degree homogeneity in prices; unitary product demand elasticity; structural break in the labor demand function intercept; change in the long run product demand elasticity between sub-periods; existence of adjustment costs.

Conclusions:

The income elasticity of demand was unstable after the crisis, although not in the sense suggested by the previous debate. The more decisive factor in the slow recovery was the prevailing labor costs of adjustment in the Chilean economy.