Sticky wage transmission mechanisms

by on July 1, 2010 at 6:56 am in Current Affairs, Economics | Permalink

The most obvious way in which sticky wages impede employment is by keeping the cost of hiring workers above the equilibrium wage. The standard story explains that sticky wages increase unemployment. The standard story, however, is not the only and perhaps not the most important transmission mechanism.

Wages are the largest component of costs thus sticky wages keep costs high and profits low.  The point is obvious once stated but it has implications for how we look at sticky wages.  Tyler, for example, writes:

[Consider] illegal immigrant Mexican construction workers, a group which lost jobs in large numbers following the crash. Are they — who often came from $1 a day environments — also supposed to have sticky wages? They are out of work in massive numbers.

The focus here is on the unemployed workers with the argument implicit that it's the stickiness of their wages which counts (which makes sense given the standard story).  But suppose that the problem is that firms can't get capital to expand–perhaps because the banking system is not working well–then what matters for firm expansion is free cash flow.  But sticky wages keep firm costs high, reducing free cash flow and inhibiting expansion. In this argument, the stickiness that matters is the sticky wages of the employed workers.

A story which focuses on employed workers has several advantages.  First, the wages of employed workers are clearly more sticky than the wages of unemployed workers–in fact, if you are employed real wages are up slightly. Moreover, since more than 90% of workers are employed this type of argument has leverage.  

If there are fixed costs, new firms do not arise instantly so infra-marginal sticky wages can be important for a number of "balance-sheet" reasons in addition but related to the free cash flow story such as debt constraints or various coordination and risk reasons.  

1 Floccina July 1, 2010 at 8:34 am

Sounds like a good reason to try a SS and Medicare tax holiday for employers and employees.

2 Bill July 1, 2010 at 8:46 am

The stickiest wages I know are those of tenured faculty.

Unstick their wages and let a thousand students bloom.

3 Bill July 1, 2010 at 9:19 am

@Andrew, Just not buying a new one this year. No need to compete for conspicuous consumption. Don’t want to stand out in this environment. My wife wants me to put in some new heated marble flooring in the bathroom, but I am waiting to see what kind of high income tax cut you are going to give me next year to do it.

4 ila July 1, 2010 at 9:26 am

To my mind, employed workers and unemployed workers compete as suppliers in the same market for labor. Segmenting markets for labor between those who are currently employed and those who are currently not doesn’t strike this amateur as being very useful. If you could pay less for someone who is as equally productive because the wages of such an unemployed person aren’t stuck, then wouldn’t it do to hire the unemployed person and lay off one who is currently employed? This then produces another unemployed person whose price now becomes unstuck as well. Repeat as needed until the price falls to equilibrium.

I’m not saying wages aren’t sticky or that AD isn’t needed to spur investment. But I don’t think employment status is a great determinant of wage stickiness.

5 Ken Klarich July 1, 2010 at 9:32 am

I am puzzled by notion that sticky wages are holding back firms ability to expand when the issue is one of excess capacity/lack of demand. Most firms have no need to expand. Secondly, productivity has been rising faster than wages. It seems to me that labor per unit of output is getting cheaper.

6 baconisgood July 1, 2010 at 10:20 am

Are real wages actually increasing or are wages flat and those losing their jobs are disproportionately on the low pay end of the scale?

7 bbartlog July 1, 2010 at 12:19 pm

‘I’m 49 yrs old, and I don’t remember this level of churn in the 70’s and 80’s.’

Yes, this is one of the distortions introduced by low interest rates. A lot more money can be borrowed to start marginal ventures when carrying debt is cheap.

8 Bill July 1, 2010 at 1:46 pm

Hey Adam:

1. Re stickiness of wages and inflation: if there is inflation, and wages are sticky going up, real wages in effect decline.
2. Re stickiness in the price of goods–or pricing transaction costs (ie, the costs of instituting pricing changes)–see the previously referenced research and also research cited within the paper. To the extent that price changes are not frictionless, that is, there is a cost in making pricing adjustments to clear a market, then the market will have a mismatch with pricing and aggregate production.
3. If there is a mismatch and slow adjustment, then production drops dramatically–and the stimulus picks up the short term slack–until the market adjusts without overshooting in fear or panic.
4. Corporate taxes, corporate schmaxes. Show me how, if, as you believe, or why corporations will increase production and investment, and increase supply–all in the face of a drop off in aggregate demand. The only place that this would work is if we gave a tax credit for exports (forbidden by WTO (see export trading company tax holiday)), assuming we could export our way out by buggering our trading partners (before they did the same to us). Having watched a Fortune 500 company reduce its taxes through some pretty fancy tax work, all I saw was that the management gave themselves raises for the fine job they did reducing the corporate tax bill. They could have given a bigger dividend–but increase production??? And, they certainly wouldn’t do it today.

9 John Parker July 1, 2010 at 3:41 pm

I’ve been reading here for some time now, and when the discussion gets into the meat of macro econ I get totally lost pretty quickly. Can anyone recommend a good macroeconomics text for someone who has taken introductory micro and macroeconomics in college?

Thanks and sorry for the OT question.

10 indianajim July 1, 2010 at 11:03 pm

John Parker

I’d recommend you read Roger Garrison’s book: Time and Money. It is not a text, but it will set you on a path that will allow you to clear the rubble that remains in your head from any typical undergrad macro class.

11 ionides July 1, 2010 at 11:39 pm

Could some explain the difference between nominal and real inflation? I have never encountered this distinction before. Or, come to think of it, maybe this turns on the defintion of inflation. If it means a rise in the price level, I don’t see it; but if it means an expansion of the money supply, then it makes sense.

12 Adam July 2, 2010 at 12:05 am

Bill,

Duly noted on corporate taxes. But…if, aside from the corporate governance issues you mentioned (pay raises), the management of American companies cannot be trusted to invest in human / physical capital by an increase to the bottom line provided by a permanent tax cut, isn’t the problem of unemployment more attributable to a flawed system, and not the economic recession?

My young, innocent mind wants to blame continued high unemployment on stickiness of the employed, as the original post suggests we should, because it makes a lot of short-term sense. It defies all social and cultural norms to decrease an employee’s salary (for white-collar workers, and God knows how hard it is to actually fire people), and unions defend against wage reductions on the labor side. So management either bites the bullet and fires you or you are kept at a higher cost than your current real worth to a presumably cash-strapped company.

13 Chris July 2, 2010 at 5:43 am

As a person who looks at, ahem, sticky wage models, I find it hard to believe that sticky wages are allocational. Lots of people would take a nominal wage cut of a few percent if it meant that they’d hold onto their jobs (if it’s framed this way), and this is exactly what we would expect in a well-functioning bargaining environment. Recent work also seems to show that the wages of new hires (which are allocational) aren’t all that sticky, but this isn’t quite so settled.

I guess that what matters more isn’t a matter of stupid worker-firm pairs who refuse to bargain reasonably, but the equilibrium effects of this stickiness. What a contracting friction like this this does is to make nominal and real expenditures sluggish, so nominal shocks don’t show up everywhere in the economy at once. This is just a guess.

14 Thomas DeMeo July 2, 2010 at 10:43 am

Rob- “Entrepreneurs ‘need’ some stickiness.” No, that’s bullshit.

That’s not a particularly good argument.

15 mbt shoes August 5, 2010 at 5:04 am

We should be talking about the Kalecki profits equation instead. You know, government spending determines the level of corporate profits.

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