From the comments, on nominal wage stickiness

by on August 18, 2011 at 7:32 am in Economics | Permalink

MR commentator Donald A. Coffin posts on the wage stickiness issue:

There is, as it turns out, some actual research on this issue in the job search literature. The bottom line is that reservation wages appear to fall relatively quickly with duration of unemployment. One common conclusion is that wage stickiness comes from the behavior of *employers.* Some citations:

“Reservation Wages, Offer Wages, and Unemployment Duration–Some New Empirical Evidence” The authors conclude that offer wages fall faster than do reservation wages (not that reservations wages do not fall).

“The Relationship Between Unemployment Spells and Reservation Wages as a Test of Search Theory,” by Stephen R. G. Jones, QJE, V. 104, N. 4, 1988. “…the main finding is that reservation wages play a significant role in the determination of duration.”

“Short-Run Equilibrium Dynamics of Unemployment, Vacancies, and Real Wages,” by C. A. Pissarides, AER, V. 75, N. 4, 1985.

“Efficiency Wage Models and Unemployment,: by J. L. Yellen, AER, V. 72, N2., 1984. The stickiness of wages is attributed to the reluctance of *employers* to reduce wages.

“Unemployment, Wage-Setting, and Insider-Outsider Relationships,” by A. Lindbeck, AER V. 76, N. 2, 1986. The stickiness of wages is again attributed to the reluctance of *employers* to reduce wages.

“Wage Dynamics: Reconciling Theory and Evidence,” by O. Blanchard and L. Katz, 1999. “In this paper, we ask whether one can reconcile the empirical evidence with theoretical wage relations. We reach three main conclusions. First, we derive the condition under which the two can indeed be reconciled. We show the constraints that such a condition imposes on the determinants of workers’ reservation wages as well as the relative importance of workers’ outside options as opposed to match specific productivity in wage determination. Second, in the light of this condition, we reinterpret the presence of an “error correction” term in macroeconomic wage relations for most European economies but not in the United States. Third, we show that whether this condition holds or not has important implications for the effects of a number of variables — from real interest rates to oil prices to payroll taxes — on the natural rate of unemployment.”

“An Empirical Test Job-Search Model, with a Test of the Constant Reservation-Wage Hypothesis,” N. Keifer and G. Neumann, JPE, V. 87, N. 1m 1979. “Reservation wages are found to decline significantly with duration.”

“An Econometric Analysis of Reservation Wages,” by T. Lancaster and A. Chesher, Econometrica, V. 51, N. 6, 1983. Their table A-IV clearly shows reservation wages falling with duration of unemployment, from 21.28 pounds per week for durations less than 13 weeks to 17,74 pounds per week for durations exceeding 52 weeks,

I could go on, but go to Google Scholar and search on “reservation wages and duration of unemployment” if you want more.

If the employers don’t want you at the high wage, and don’t want you at the low wage, what might your perceived MP be, temporarily or not?  Keep in mind, firms are flush with cash.

Realist Theorist August 18, 2011 at 8:14 am

The government should end the recent payroll-tax cut. Instead, they should raise the “personal” visible component on paychecks to reflect the total amount that they take from employees and employers; and, they should reduce the employer’s component to zero. Employers can readjust the nominal base-pay of employees to put them back to exactly how they were before.

Given enough political cover from rhetoric advocating belt-tightening and the need to be globally competitive, some companies may use that as a way to reduce their wage bill.

Even if nothing changes, at least we will end up with more visibility in taxation, as employees see the numbers on their paychecks.

Bill August 18, 2011 at 9:36 am

And, what would happen is what has happened in China: with no social security, and greater economic uncertainty because there is no social insurance, people would reduce current consumption and oversave.

How about, instead, we reduce the investment tax credit and accelerated depreciation, which subsidize worker displacement with equipment.

Floccina August 18, 2011 at 10:00 am

But an important skill of a politicians is to hide costs and make benefits visible to everyone. We need a better scheme one that gives cover to the politicians. The median voter does not know that he pays the employer’s part of the SS tax.

Bill August 18, 2011 at 5:20 pm

The median voter, under Realists proposal, would not get the employer SS contribution because, as Realist says, he will pocket it to reduce the wage rate.

Rahul August 18, 2011 at 8:51 am

Anecdotally, something doesn’t seem right. Most unemployed people I know are having a problem just getting an interview. Or maybe just get an initial screening interview.

The wage stickiness hypothesis should mean people getting to the wage negotiation stage and then not agreeing on a number. Hardly seems to be what is happening.

Alex Godofsky August 18, 2011 at 10:23 am

Not at all. If the employer knows what wage he’ll offer, and knows that he won’t want to actually offer a job at that wage, there won’t be an interview.

Finch August 18, 2011 at 10:27 am

I don’t understand your comment. Could you clarify?

Tom West August 18, 2011 at 11:01 am

Currently, that job used to be worth $80K wages. In the current climate, factoring uncertainty, I am only willing to offer $50K. Unfortunately, for $50K, I’m going to get a discontent worker who will move on as soon as things improve, as well as create a two-tier work force with all the resentment that engenders.

So, it’s not worth hiring at $50K, and it’s not worth hiring at $80K.

Finch August 18, 2011 at 11:02 am

Thanks, I appreciate it.

Finch August 18, 2011 at 10:30 am

I find it really funny that there are apparently no HR employees commenting on MR to say “this is how we do it.”

Can someone please walk down the hall and ask one of them?

kvm August 18, 2011 at 11:26 am

From my own perspective at admittedly small company and sample size:

1. We had an employee leave voluntarily and the bosses have not decided to hire someone to take his place for a few reasons. The first is that our industry is in decline or flat and so it is better to work the current salaried employees harder to make up for that. The second is that long term they expect this work to go away. Why hire when it doesn’t make sense long term?

2. We are interviewing someone with an MBA for a job that someone with a few years of college could do. Why the HR department scheduled this interview I don’t know. Maybe she was the most qualified candidate but they weren’t thinking long term about it. The people who actually do the hiring will probably see from the same perspective as a few others have pointed out already: once the economy picks up, that employee is gone. Again, why hire when it doesn’t make long term sense?

John August 18, 2011 at 9:19 am

Since wage policies are set with consideration of other factors besides MP I’m not sure we should care what the perceived MP is in all cases. Apparently in certain conditions it’s something of a residual value unrelated to the prevailing wages.

allan August 18, 2011 at 9:24 am

“wage stickiness issue”

Workers don’t want to take lower wages. Why? They want to feed their families.

“Price stickiness issue” Capitalists don’t want to lower their prices, except for the prices they pay for labor. Why? They want to keep profits as high as possible.

Jim Clay August 18, 2011 at 9:29 am

I’ve never been unemployed, but I have seen hints of employers being reluctant to offer you a lower wage than what you are making. I’ve always figured that it was because they assume that the employee’s morale would be bad, leading to low productivity and perhaps even spreading the grumpiness to other employees. Also, the fact that one is employed clearly makes one more employable, so it is likely that after a short time in the job the employee will get a job somewhere else.

Tyler Cowen August 18, 2011 at 9:32 am


Bill August 18, 2011 at 10:40 am

I don’t know if it is ZMP. You have a two sided matching problem: the employee, who has had past experience working at a higher wage, regards his true price as the last price he received prior to the offer he just accepted, so he is viewed by the employer as more likely to leave later when the economy turns around, if indeed his true wage price is above what the employer offers him. On the buyers side, the employer realizes this is an out of equilibrium situation, and that if he attracts new employees with higher reservation prices–or reduces his own employees prices below their prior wage price–he will risk losing them when the economy turns around.

You can think of this in terms of how people behave: how many people do you know who hold on to a stock until it reaches the price they purchased it for; how many people do you know who set a high price for their house based on a boom period, or who, when they do not adjust the value of their house to the current market price, add a new addition, believing that they will recover the “investment”.

What interested me in the literature that was selected was in the 70′s and 80′s, well before we had much of an understanding of behavioural economics and the irrationality of economic actors.

Bill August 18, 2011 at 11:55 am

By the way, the irrationality of economic actors or the behavioural approach would argue for inflation as the mechanism to equilibrium since employees would be fixated on nominal wages and not real wages. Maybe we did that in the early 70′s, calling it stagflation.

Andrew' August 18, 2011 at 9:36 am

Why does cash matter? Employees are an ongoing expense. Cash is for capital and acquisitions, right?. Cash is to take the place of the revolving credit market that was shown to be broken.

Rick Schaut August 18, 2011 at 9:45 am

Doesn’t it make more sense to think of this in terms of the marginal _revenue_ product of a prospective employee? Are there not conditions under which the marginal _revenue_ product of a prospective employee is zero regardless of the actual productivity of the prospective employee?

Barry Ickes August 18, 2011 at 10:02 am

You mean your perceived Marginal Revenue Product. You can produce output but the firm cannot sell it because there is no demand. They are flush with cash (your words) but they cannot sell what you produce. That is GT Keynesianism of the 1936-7 variety.

Andrew' August 18, 2011 at 11:17 am

Right. I haven’t figured out how ZMP contradicts GTK, or if it is meant to. The question is if nominal demand were goosed, would that create real demand.

Paul McMahon August 18, 2011 at 10:41 am

On that awash with cash comment …

First, that data concerns major corporations, not small employers. Moreover, a considerable amount of it appears to be parked overseas to avoid the high US Corporate taxes, and so wouldn’t be available for wages even so.

Bill August 18, 2011 at 10:47 am

The comment: “Keep in mind, firms are flush with cash.” is irrelevant to the argument if there is a shortage of aggregate demand, without even considering that wage costs in many industries is small fraction of total costs, much less that even a 5% reduction in total wage costs would not impact total costs.

Ask yourself this question: how many times have you heard an overpaid executive say that his exhorbitant salary is small relative to the total sales of the company.

Bill August 18, 2011 at 10:52 am

Is the ZMP employee perhaps the overpaid CEO? You can certainly understand why the Business Roundtable has opposed efforts to deny shareholders the right to vote on executive compensation.

Bill August 18, 2011 at 11:51 am

change: to deny to to grant Thinking double negatives again. sorry.

Dale August 18, 2011 at 10:57 am

I suggest that wages are generally flexible, within the constraints imposed by institutional factors (such as unions, public sector distortions, minimum wages, etc.). Take higher education for example. Tenure has distorted the system so that nominal wages are sticky – but only around 1/3 of the faculty in higher education are in the tenure system. The immense growth of low paid adjuncts is where the wage flexibility shows up. In other sectors, I believe the circumstances vary. In some, adverse selection may prevent employers from offering lower wages (they might attract the less efficient part of the labor pool). Further, lower wages for new hires pressures the wages of the other employees – this is the type of distortion that results from institutional factors. Firms may want to maximize profits in theory, but the reality is that the people making the decisions in these firms have fairly weak incentives to do so – and the actual owners have imperfect information and weak incentives as well.

So, I am not surprised that actual labor market conditions make wage flexibility opaque at best. Still i don’t buy the wage rigidity argument – it is too simplistic and unrealistic. A better theory is that, in the fact of unemployment, nominal wages will fall in the closest manner that is feasible within institutional constraints. Even where there are minimum wages, employment conditions may deteriorate to make the minimum wage close to the market clearing wage.

This leaves the big mystery – when there is 10% unemployment in the US economy, are wages market clearing? Could deficient AD be the problem (with insufficiently flexible wages)? I’ll let you true macroeconomists ponder this – all I want to contribute is that it is silly to argue about whether or not wages are rigid without considering the institutional factors that govern actual employment conditions and compensation.

Brendan August 18, 2011 at 12:41 pm

What does ‘reservation wage’ mean?

Sid the sidious August 18, 2011 at 3:51 pm

The wage at which at person is indifferent between working and not working. The theory is that things like unemployment benefits, charity, and minimum wage; raise it.

k August 18, 2011 at 12:44 pm

Didn’t Akerlof write something about this recently? Using an idea that reducing wages falls outside the perceived norm of society…

fmb August 18, 2011 at 12:46 pm

I’ve been pondering 2 ways in which quasi-rent issues might be important:

1. When a worker takes a job, they need to trust that their employer won’t quickly reduce their wage to their reservation price. Firms care about being credible as not squeezing quasi-rents and fear that offering lower wages, even to new employees, will undermine that credibility.

2. Firms also invest sunk costs into new employee relationships. Potential employees who are most productive working in a cyclical industry during a boom may not be able to credibly commit to stay at a counter-cyclical firm at a lower wage when we emerge from recession. The clearing price might be a 5 year contract at 85% of previous pay, but it’s hard to bind employees that way, which might mean that their “spot” wage should be shockingly low (where various fixed limits may bind).

Bill August 18, 2011 at 2:56 pm

Good point, particularly if you consider wages over the business cycle.

This also supports the observation that firms invest more in soft relationship feel good programs to reinforce attachment during an upswing without raising pay and employees remain attached even though they might be able to go elsewhere during the period when wages elsewhere are rising.

mmoten August 19, 2011 at 2:49 am

OK, your opinion is really new, most of the time it could be like what you said because the company is stupid.
what kind of thing can be better than a person raised by our own company…they can be high-employed, but they can also be very productive.

Mike in Shenzhen August 19, 2011 at 3:38 am

I don’t understand why this is evidence for ZMP rather than low aggregate demand. It seems to me that marginal product could be positive, but marginal revenue product is zero because we have oversupply relative to demand, and sticky prices rather than wages.

Can someone please explain to me why I’m wrong?

Bill August 19, 2011 at 9:35 am

You’re not.

TallDave August 19, 2011 at 7:59 am

That research squares nicely with my experience.

Paul B August 19, 2011 at 10:07 am

I’m intrigued by how contracts could come into play here. I’ve never had to sign one myself, but my friend, who is an engineer, has had to sign them, promising he would work for a company for 18-24 months or something in that range in exchange for moving costs being paid for, etc. When he elected to leave that company, before the contract had expired, he had to repay them the moving costs.

If the issue is that a firm is unwilling to pay an $80k worker $50k for fear that that worker will leave as soon as things get better, why not try and use a contract or something similar (with penalties) to lock in the low price for a few years?

Bill August 19, 2011 at 12:44 pm

Think about productivity and the difficulty of monitoring performance.

Let’s say you have a contract with a singer to sing, and the singer wants you to break the contract or have you let you out of it.

How many off key moments do you think you will get.

Better to have something like pension vesting or a bonus payment at the end.

Donald A. Coffin August 20, 2011 at 12:59 pm

Tyler comments: “f the employers don’t want you at the high wage, and don’t want you at the low wage, what might your perceived MP be, temporarily or not?”

My response would be that we do not know what the employer would want to do at the lower wage; that wage is never in play in the process. While the market for college faculty members does, in fact, involve some bargaining over wages (and other terms of employment), in most markets, the employer makes an offer and the applicant says yes or no. (And, in the job search literature, the evidence suggests that the answer is almost always “Yes.”) *There is no bargaining over wages.* And, therefore, if the offer wage is sticky downward, we have *no evidence* about hypothetical employer behavior at a lower wage. So what this tells us about the (perceived) value of marginal product of job applicants is, precisely, nothing.

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