Tuesday, May 18, 2010

More on Wages

Yesterday I wrote a post about wages and wage rigidity, covering David Henderson's view that it's the cure for what ails us, reviewing some New Keynesian thoughts on why that's all well and good to say but you can't just wish upon a star and make wages fall - they often don't. I also reviewed some more traditional Keynesian insights (which are quite different from the New Keynesian points) from Roger Farmer, Keynes himself, and me. I have a couple more things to share.

First, Tom at Cobb Dug Less responded to the post. He wrote:

"I think we do see rigidities in the labor market wrt real wages. Let me suggest this is a problem with the makeup of the labor supply due to skill mismatches, immigration policies, shifts in the composition of firm birth and death, and other structural elements. I guess what I am saying is that the wage-supply-demand model is not very generalizable and this appears as wage rigidity when in fact it is much more a case of substitutability of labor inputs and the labor demand curve changing slope rather than shifts out or in."

I confess I'm having a little trouble understanding this point and I'm hoping Tom can explain in more detail. Some of these points seem to be getting at the idea of a monopsonistic labor market, where the fact that labor isn't perfectly substituitable results in firms facing upward sloping labor supply curves, rather than flat labor supply curves. That can have all sorts of effects - lower wages and lower employment than a competitive labor market, as well as some unusual labor market policy impacts (the most famous being a minimum wage that raises employment). But I don't see how it impacts wage rigidity. I might be misinterpreting the point, though.

Bryan Caplan also had a post recently on wages. He made this very bad point:

"Is labor market rigidity a market failure? I'm afraid so. But strangely enough, this market failure is largely caused by anti-market bias! The main reason workers hate wage cuts is that they imagine that wage-cutting employers are satanically "unfair." If workers saw wage cuts for what they are - a full-employment mechanism - they'd sing a different tune."

No, no, no. The main reason why they hate wage cuts is because they prefer higher wages to lower wages, they know that the employer prefers full-time workers to part-time workers, and they're willing to take a gamble that when adjustment occurs on the extensive level (cutting jobs) rather than the intensive level (cutting hours) that they're going to be spared. They also hate wage cuts because they have a labor contract with their employer and they (rightly) see wage cuts as a breach of contract, however well justified. You don't have to think your employer is satanic or not understand or trust markets to resist wage cuts. This is a prisoner's dilemma writ large. People know that layoffs won't be avoided by their own wage cut - you need lots of wage cuts for that to happen. Of course they're going to continue to resist - there is no benefit to them as an individual to take a cut. They'd rather free ride off of someone else's wage cut or layoff. Pursuing your own self-interest isn't thinking that the boss is satanic or that markets are bad.

Scott Sumner responds to Caplan and Henderson on wages here. He has a few interesting points, including that he prefers to use PPI to deflate nominal wages, rather than the CPI. He also makes this very interesting point: "Real wages are not reliably pro- or countercyclical. They tend to be more countercyclical if the downturn is caused by demand-side factors", which is precisely my point about the 1920-21 depression vs. the Great Depression or the 1981-82 recession vs. today. Henderson and others try to pretend that all downturns are created equal. They're NOT. Demand driven downturns operate very differently from others, and they are much more pernicious. Keynes wrote an article about this in the 40s that I should dig up. He made a guess in the General Theory about the cyclical behavior of wages. Later empirical work suggested he was half-right on it, so he wrote an article responding and explaining possible reasons for the empirical finding. I believe it was this finding that demand-driven recessions have counter-cyclical wage behavior. Anyway, this is precisely the reason why wages didn't budge for the current downturn in the David Leonhardt post I linked to yesterday:

If you can't read it, the top line is real production worker wages over the course of the current recession, and the bottom two are real production worker wages over the course of the 1980-82 and 1973-75 recession. In the earlier two, wages fall and the market recovers. In the current recession they rise and then stay flat. Why? Because we're dealing with a different kind of downturn.

Finally, Cafe Hayek had a typically apoplectic screed on Paul Krugman recently, but in the comment section MikeMcK made a very good point about things that Krugman has been saying recently on wages. He wrote:

"On the blog today he's saying "WAGES IN THE PERIPHERY NEED TO FALL 20-30 PERCENT RELATIVE TO GERMANY." [all-caps his] mere months after repeatedly saying for weeks that wages and employment have no relation ("...the belief that lower wages would raise overall employment rests on a fallacy of composition. In reality, reducing wages would at best do nothing for employment; more likely it would actually be contractionary.")

Maybe I'm too micro, or just too dumb, to reconcile those too statements, but I like to believe it's because Paul has descended into the realm of pure hackery. It is, for lack of a better term, adorable that anyone listens to him."

Of course MikeMcK is getting a little melodramatic at the end there too. Here's what I think Krugman means. I think Krugman is simply making the David Henderson point that wages are too high and they need to be X% lower in order for them not to be too high anymore. However, there are effective demand implications of lowering wages that can actually make it contractionary. Inflation is the solution most people turn to first - but Krugman's whole concern with Greece is that it can't inflate its way out because it is tied to the euro. The other option is that the government can boost effective demand, but there is no way Greece's creditors will let that happen (nor should they). So I don't really think these two points are contradictory - one is about what they should/need to do, and one is about what they can do. But I may be interpreting that wrong. Open economy macro is not my strong suit by any means.

Oh well - another morning I didn't spend revising my 1920-21 depression paper... it'll happen eventually I suppose.

UPDATE: This is the Keynes article I mentioned (from 1939, actually). It should be ungated. I'm very interested and want to reread this now. He notes the fact that when nominal wages are rising, real wages seem to rise too, and that one nominal wages are falling, real wages sometimes rise and sometimes fall. My immediate reaction is "well I bet real wages only fall when its not a demand-driven downturn", but I shouldn't get ahead of myself. Nevertheless - that is the theoretical insight that I would bring to this empirical observation.

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