How are nominal wages sticky for the *unemployed*?

by on August 15, 2011 at 6:44 am in Economics, Uncategorized | Permalink

There are good arguments that wages are sticky for (many of) the employed.  Observed wage changes cluster in funny ways, indicating an unwillingness of the boss to change the nominal wage at all, and employers testify to morale problems from wage cuts (see Alan Blinder’s work).  In terms of the financial crisis, Keynesian theory explains the initial lay-offs fairly well, but it — at least the sticky nominal wage version — has a tougher time explaining unemployment persistence at such a high level.

Why don’t the unemployed lower their wages to find a job?  The more tragic you think unemployment is, the greater the puzzle here, and yet the people who stress the tragedy are often least likely to admit the positive puzzle (and vice versa).

There’s pretty clear evidence that, during the crisis, when the elderly wanted to work more, the elderly were able to work more.

I hear various arguments in response:

1. Falling wages can lead to a downward deflationary spiral, but a) these wage cuts would be for only a few percent of the workforce, b) let’s not confuse the wage rate with the total wage bill, and c) our Fed, however weak, is committed to stopping a downward deflationary spiral.

2. Maybe firms don’t have enough money to take on more workers, especially since the wages of the employed are fairly sticky.  Yet businesses are sitting on record-high levels of cash.  So while #2 may make sense in theory, it takes a lot more work to apply it to 2011.  I don’t see people even trying.

3. In a few unionized sectors, hiring lower-wage add-on workers may antagonize the incumbent workers.  Yet a) these sectors are not creating many jobs anyway, and b) in most modern sectors the real morale problem comes when you hire the newbies at higher wages, not lower wages.

4. Another claim is that it is hard for workers to signal that they are willing to work for twenty percent less, or whatever it takes.  How about applying for a job at a Washington non-profit?  Every time you do so you are signaling an ability to work for considerably less than what you are worth elsewhere.  Yet this labor market seems to hire as many people as its revenue stream can support and employers do not throw out all applications.  More generally, in down times the unemployed worker doesn’t need to signal much of anything.  The worker applies for a job.  The employer knows there are a number of workers competing for the job.  The employer makes a low-ball wage offer.  The worker accepts the offer.  End of story.

5. Often I get arguments which either refer back to nominal wage stickiness for the employed, or it is observed that lots of people are out of work so the nominal wage story must be true somehow.  Those responses are signs of a weak paradigm.  Another set of responses point to and then attack some excessively strong version of the nominal flexibility view, such as mocking the view that the Great Depression was a big voluntary holiday.  Another sign of a weak paradigm, don’t fall for it.

One simple view is that Keynesian economics holds true in the short run — it explains a lot of layoffs — but it doesn’t explain longer-run unemployment, precisely because wages are sticky only for a while.  That’s what most neo-Keynesian models imply and for the most part those are good (but not perfect) models.  What we’re seeing is a previously rejected form of Keynesianism, applied across increasingly long and increasingly implausible time frames — suddenly pretending to be the mainstream view.  It’s not and has not been for a long time.

In other words, Keynesianism is morphing into a theory of the long run.

Often when this topic comes up I feel I am playing a game of whack-a-mole.  Most of all, I am struck by how little attention people pay to their own sticky nominal wage hypotheses.  If that were the problem, and if unemployment were today’s biggest issue (a totally plausible claim), you might expect people to blog the microfoundations of nominal wage stickiness very, very often.  You might expect ethnography.  Micro-level data.  Lots of juicy anecdotes and journalistic features, not just on the unemployed but on the stickiness itself.  Perhaps some micro-level advice.  Dozens, no hundreds of blog posts on the all-important microfoundations of the #1 social problem of our time.

But no, there’s not much of those to be seen.  At some level it is understood, if only implicitly, that the sticky nominal wage theory is an embarrassment — when it comes to the unemployed across the longer run (but not the employed).  It doesn’t get too close a look.

What else?  Few people want to come out and utter the possibility: “They’re just too stupid and too stubborn to lower their wage demands.”  Mood affiliation reigns, and the prevailing mood is to express sympathy with the unemployed.  In fact that sentence is not my view, but it actually makes somewhat more sense than most of what is listed above.  A lot of people don’t like hypotheses which suggest the unemployed are not victims of the system, so it doesn’t get much of a hearing.

I think, by the way, that excess capacity theories are one of the most plausible attempts to explain continuing unemployment (you’ve already heart about PSST and ZMP, among others).  I’ll blog excess capacity more soon, but in the meantime note the hypothesis doesn’t rely on nominal wage stickiness.  The firm doesn’t want to produce any more output, so the worker’s wage demands don’t matter so much.  This will have real import for the analysis of monetary and fiscal policy, so the microfoundations really matter here.

In the meantime, beware of claims about sticky nominal wages among the unemployed.

Addendum: Arnold Kling comments.  And Brad DeLong responds but a) he cannot bring himself to tell us what makes wages sticky for the unemployed, and b) he simply misrepresents my point of view, plus he ignores #1.  Scott Sumner responds, but no need to fire the old workers to hire more and don’t reify NGDP!  Here is Matt Yglesias, the question is why the labor market adjustment isn’t quicker, unless you are assuming excess capacity.  As time passes, the gap should narrow, even for a given level of spending.  Kevin Drum seems to embrace excess capacity explanations.  Here is Karl Smith, and Ryan Avent, and Robert from Angry Bear.

Ted Craig August 15, 2011 at 7:21 am

Wages aren’t the problem. We could use another administrative assistant at our office and we could probably afford to pay the wages for one. What we can’t afford is the worker’s comp, the insurance, etc.

Mark August 15, 2011 at 12:52 pm

For us, it is worse. We were recently told by the “admin coordinator” for our group that the university pool of admins (including temp pool, a group that wants to do temp work to move into long term positions) is filled with very, very low quality people. She told us that she gets complaints, backed up with specific evidence, all the time from other faculty.

Here is an economic problem: if you told me that by *not* having an admin, I could put the $20-$30K into my lab (my portion of shared admin), I would volunteer to to their job in a minute, in addition to mine. As it stands, I do this anyway – our admin is always having a family problem or the roof leaked or the mean people aren’t responding to her emails or…

Conclusion: many, many employees out there totally suck.

Our admin experiences:
#1 – excellent until he committed suicide.
#2 – very good, except for the stealing money from accounts problem
#3 – nice person, doesn’t seem to realize that “work” means actually being at work and that we actually need to get things done. Can’t figure out that “I need it ordered today” means today, not sometime next week.

This is honestly the full set of our admins, I’m not skipping over people.

Free Spirit August 15, 2011 at 3:18 pm

I share Mark’s experience. My wife and I own a Veterinary hospital. We have gone through more than a dozen employees in what are two very simple positions, for many of the same reasons: endless family crisis, not taking the job seriously, failing drug tests (knowing days in advance that they are required for employment), etc.

The number of candidates we have rejected reach the dozens: the lady whose breast popped out of her indecent clothing during the interview, the lady who yelled constantly at her children when she dropped off her application, the person who told us that they didn’t really want the job and were only satisfying the unemployment agency’s requirement, the girl who wore pajamas to her interview, etc.

Do any of these people sound like greater than Zero Marginal Product workers? Do they even desire to be?

ezra abrams August 15, 2011 at 5:44 pm

neither you nor the previous poster, unhappy with admins, mentions salary.
Isn’t it sort of a tenet of conservative economists that you get what you pay for ?
clearly, you are not offereing enough salary to get good candidates; I realize you might have to downgrade from a bimmer to a lexus, but life is hard;

Free Spirit August 16, 2011 at 10:16 am

Nice try. Wages and benefits are competitive, and we never cut hours during the recession–we know our employees have mouths to feed and a roof to keep over their heads. Profits are zero or negative due to the general business turndown, and are just now improving. My wife has given up her salary for the past five years so that employees can be properly provided for. We don’t want to lose good employees for reasons within our control, and we have been successful in this strategy. The quality of candidates coming through our door, with an above-minimum wage compensation range advertised, is just pitiful. This is not the only reason for unemployment in the broad market, but I argue that it is a significant factor.

mulp August 15, 2011 at 9:24 pm

“Wages aren’t the problem. We could use another administrative assistant at our office and we could probably afford to pay the wages for one. What we can’t afford is the worker’s comp, the insurance, etc.”

Are you sure the problem isn’t the cost of the desk they would work at, the cost of the floor space they require, the cost of the parking place for their car, the cost of the electricity they need, the costs of the paper and pencils, the cost of the lump of coal needed to keep them from freezing to death in winter?

The cost of a worker is a lot more than their wage, from the stuff they need to do the job to the share of the cost to society employers impose that society imposes on employers.

If employers had totally safe workplaces and work practices so no worker was ever killed or injured, there would be no need for workers comp.

You seem to be in the camp of those who want deregulation and tort reform so employers can kill and harm workers, customers, and neighbors with pollution without cost to increase profits.

Free Spirit August 16, 2011 at 10:22 am

<>

This is nothing more than a leap down the slippery slope. No matter how safe one tries to make a workplace, accidents still happen. Whether the employee does not follow procedure (not necessarily out of ignorance–complexity is a big driving factor, as is whether the person is having a bad/off day), or the procedure does not anticipate a low-probability event, or the dog you are holding slips from your grasp and chomps you on the arm, the world is complicated enough that you cannot legislate accidents away. OSHA’s main benefit is that it requires businesses to prepare management and staff for the eventual bad outcomes, preventing what it can control, and mitigating what it can’t control.

Jason August 15, 2011 at 7:33 am

Ted is close I think.

Many (not nearly all) of the unemployed are so low skilled (31% national HS dropout rate) that they are, frankly, unemployable given the fixed costs of hiring. It’s more than wage – it’s supervision and mandated benefits as well. Someone has to take time out to figure out what a person with no skills can do to add value – and those that can figure that out are in such short supply that they can’t spare the time. As industries become more efficient, even service industries (think Blockbuster vs Netflix), no skill jobs are becoming increasingly rare.

Jobs aren’t some mythical concept. Have some skills, learn how to be useful, and you’ll find work. You may have to move, it may not be easy.

Steve the hyena August 15, 2011 at 1:46 pm

I seriously doubt that is the problem. I’m unemployed; I have a college degree, a decent resume and am under 30. Yet I remain unemployed.

Nate August 16, 2011 at 8:16 pm

Out of curiosity, what field is your degree in? And what fields have you been searching for work in? Are there a lot of open jobs in your field in the area you live?

sp6r=underrated August 15, 2011 at 3:04 pm

Oh please, this is beyond stupid and shows how quick some people are to jump to structural unemployment is the explanation. The unemployment rate for young college graduates is around 10%.

Noah August 16, 2011 at 9:51 am

The problem with these explanations is that they don’t explain why long term unemployment has increased during the recession.

Martin August 15, 2011 at 7:44 am

When the UK returned to the gold standard at the pre-war parity in the twenties, they suffered through grinding deflation for more than a decade. If this could’ve been prevented by not returning to the gold standard at pre-war parity then it stands to reason that monetary stimulus could also have fixed this at any moment in that period. I believe this is the role of monetary stimulus in NK-models?

If you argue that sticky wages cannot explain ‘long-term’ (~10 years) of unemployment then, it seems to me, that you also have to argue that UK’s unemployment during the 20′s was not due to returning to the gold standard at the pre-war parity.

I find Koo’s debt minimization to be plausible. Debts are in nominal prices, firms paying back debt still value their employee’s at their pre-crisis nominal wage, however they’re faced with a debt burden to pay down before any hiring (investment) can happen. And paying down is the more profitable decision than hiring new workers. Still sticky prices, but different prices.

TheophileEscargot August 15, 2011 at 8:07 am

Are you considering stickiness on the employer side? An employer might be reluctant to hire someone for 20% less than their last hire: they’d be worried about the quality of the worker. More importantly, it might make the hirer look like an idiot to his boss, for spending 20% more on the last guy. In a big organization, innovation is dangerous to your career: especially in a recession you don’t want to start doing something different and risk standing out.

Nemi August 15, 2011 at 5:44 pm

There is usually some substantial cost in hiring someone (training, potential rookie mistakes, social and organizational issues when the new work group tries to find each other etc.).

If you offer an unemployed 20 % lower salary than normal – surely (s)he will take it – but will (s)he almost instantly start to search for another job (at least after the training is complete and you expect to start making a profit from your new hire)? You bet (s)he will. Also, even if (s)he had a hard time to initially find a job, once your employed it is much easier.

Will August 15, 2011 at 8:18 am

Perhaps the problem is that the unemployed face a difficult gamble on a day-to-day basis. They don’t know for certain that their previous wage will never return and to take a lower paying job forces them to admit this downgrade in their life and increases the possibility that they may never get a higher paying job again. Afterall, they only need to get one good job to get them back to where they were. An analogous situation would be an actor whose popular sitcom just got cancelled. They get offered a lot of lower-paying and lower-status gigs after the cancellation, but to take these offers means diminishing their status for possibly forever so they keep gambling that a better opportunity will come along. Thus, they keep turning down offers until one day they are irrelevant. If this were actually the cause for why the wage rate does not fall faster and increase employment, a weird solution to this problem would be to punish the unemployed for continuing to not take work by some sort of garnishment of wages once they did get a job (but this would be completely politically unfeasible). Anyway, its just a thought.

Free Spirit August 15, 2011 at 3:29 pm

In fact, the employer that laid them off pays the penalty in the form of increased unemployment tax (AKA “insurance”). (Some states charge it to the employer. Others to the employee. Ultimately, is is a cost of employment.) The penalty in Virginia is in the form of an increased premium–a percent of the wage base. The percentage is based on how much was paid in benefits to laid off/fired employees, up to a maximum statutory rate.

The other problem with a candidate looking for a lower-qualified position is “flight risk”. Someone with a college degree is only going to flip hamburgers until a better-paying job comes along. If the employer has a choice of candidates, they’ll pick the lowest flight risk with acceptable qualifications. Two conclusions: 1) What’s the point of the college graduate looking at lower paying jobs, if the employer is biased against them? 2) Taking the lower-paying job might not cover the mortgage, and will certainly end unemployment benefits, which may be worth more (if based on pre-layoff earnings) than the job pays.

JonF August 15, 2011 at 5:20 pm

Two other problems with hiring someone who is grossly overqualified for a low-wage, low-skill job.
1. The person may have a bad attitude and do a poor job as a result.
2. The person may have serious bills and be tempted to dishonesty– and theft (both of cash and merchandise) from retail and service industry jobs is common and easy to pull off.

ezra abrams August 15, 2011 at 5:46 pm

GOOD POINT !!
when you go for an interview, one of the things your prospective employer asks you, is what sort of wage are you looking for…and they check your prev job (ok, I’m college educated, maybe this doesn’t hold for min wage)
so
ONCE YOU TAKE A LOW SALARY JOB, YOU ARE TRAPPED ON A LOW SALARY LADDER FOR LIFE
LET ME REPEAT THAT, BASED ON MY OWN EXPERIENCE
ONCE YOU TAKE A LOW SALARY JOB,……

Nate August 16, 2011 at 8:20 pm

Trapped there for life? No chance of advancement? No ability to switch fields or careers or companies or retrain and gain more skills or quit your job and freelance or start a business of your own? None at all? I’m very sorry for your negative situation, but I bet there are more opportunities out there than you realize. Take heart!

AndrewL August 15, 2011 at 8:22 am

This is an interesting article as it is like academics meets reality. It is true businesses are sitting on piles of money, but they are afraid to hire. Businesses aren’t just just cold economic machines that only make perfect economic decisions, businesses are made up of and run by people. People are still human, last time I checked. Human’s still care about the feelings of other humans and would be reluctant to hire and fire at every gyration of the market. If the business can see 10-15 years out, I think they would be more willing to invest that cash capital into more employees knowing they won’t be destroying peoples lives with quick hire and fires.

The uncertainty in the new rules that are coming down the pipe with Obamacare is forcing a lot of businesses to take the wait-and-see approach because seriously, no-one knows how it’s going to work.

Everyone thought they would have to comply with mandated insurance portion, until the DHHS began handing out waivers. If your competition got a waiver and you did not, then you are automatically at a huge competitive disadvantage and look like a complete sucker for not getting one.

I anticipate alot more of these kinds of issues cropping up as more and more parts of obamacare come into effect.

FYI August 15, 2011 at 9:22 am

I agree. I also have plenty of anecdotal evidence on the impact of Obamacare and the increase in regulation. I know it sounds like a Republican talking point but companies are really concerned about the extra fixed cost associated with this (and it is not like the fixed cost before that was light).

I know of a large company who is having great profits lately and sits on a mountain of cash that decided to cut the budget for a team in 20%. The explanation was simply that they need to save more because of uncertainty. Do you really think these people will hire anyone?

I am usually in favor of a divided government but I think we need either the Dem or Rep to win big in 2012 so we can have some clear direction for the country.

Floccina August 15, 2011 at 3:32 pm

So would you say that offering temp jobs be a good solution?

FYI August 15, 2011 at 3:44 pm

I think it already is… I don’t have any hard data on this but for IT I would say 90% of all ‘new hires’ are either vendors or trainees

mulp August 15, 2011 at 9:35 pm

So, I guess the reason hiring was so much worse than in the 90s from 2001 to 2007 (7 million in 7 years) was the 10% annual increase in health insurance premiums under Bushcare??

In 2007, the two biggest complaints from business on the employment front was uncontrolled health care benefit costs and a lack of qualified applicants.

Odd that those are the same two top complaints 4 years later.

Find one business owner during the Bush terms who didn’t complain about uncontrolled health care insurance cost increases….

Perhaps you are arguing that from 2001 onward, business owners were fearful of Obamacare having predicted Obama would be elected in 2008 on the basis of their complaints over the uncontrolled health care insurance costs increases??

Nate August 16, 2011 at 8:23 pm

If employers were previously complaining about uncontrolled healthcare cost increases prior to Obamacare, and now after it they’re complaining about uncontrolled healthcare cost increases as well as uncertainty due to Obamacare, then Obamacare didn’t actually solve the problem, did it?

foosion August 15, 2011 at 8:33 am

>>The firm doesn’t want to produce any more output, so the worker’s wage demands don’t matter so much>>

This seems the most likely explanation. There are currently approximately 5 job seekers for every job opening, while there are usually less than 2 job seekers per opening. It’s hard to see how wage demands are the problem.

If there are five people looking for work for every job available, how low a wage will clear the market?

Neal August 15, 2011 at 9:08 am

So … low wage-elasticity of job creation?

RZ0 August 15, 2011 at 8:36 am

I think Ted Craig confuses wages with total compensation. Companies have always looked at total compensation and most employers seem bright enough to know that a 20% cut in wages is equivalent to about a 12% cut in total compensation. Either way, you’re getting a deal.

As a 99er, my experience has been similar to what TheophileEscargo describes. I’d happily work for 40% less than what I made previously (it was a lot), but employers tend to think the offer is too good to be true, so reject it.

Also, others have documented the lack of mobility in the current job market, as people are tied to their homes, either by being underwater or by deluding themselves that the housing market will bounce back.

Age discrimination is open and obvious. Don’t bother to deny it, because I have lived it.

The “too stupid and stubborn” argument could fly both ways. Perhaps employers are the ones being stupid and stubborn. If one suggests someone is behaving irrationally, why wouldn’t it be the employer with a job and cash resources instead of the worker who lacks both?

If employers perceive a lack of future demand, they will not hire, no matter how much cash they are sitting on. Bloating your payroll is a waste of money.

And swapping out current employees for cheaper new employees rarely works. There are significant training costs, and when you are short-staffed, as many employers are, training is really difficult – there aren’t enough hours in the day.

When I used to hire, I assumed that about 15% of new hires would be a total waste of time, even after training. I think research puts the washout rate higher. As such, wages would have to fall around 30-40% for everyone before you’d start to see that kind of competition among workers make sense to the employers.

In the meantime, quality would fall off – even temporarily while you trained the newbies. So you’d worry about losing business to your competitor, who kept his staff intact.

And it’d be a really shitty thing to do to the good people who worked for you. Bosses think about that, too.

TheDarkestPassenger August 15, 2011 at 9:58 am

RZ0, thank you for sharing your unemployment experience and your previous workforce and management experience. You sound like one of my better former bosses. He warned me of age discrimination (I’m not there yet myself), but I hope you can find a company that’s not a complete a**hole about hiring someone who actually knows what the frack they are doing. And thank you for providing some business-realm perspective for how companies look at hiring new workers in a recession-oriented economy. It provides a richer set of issues to consider.

Ted Craig August 15, 2011 at 10:02 am

No, I’m not confusing wages and compensation at all. I’m saying that while wages may be flexible, fixed costs are static. A 12 percent decrease in compensation may not be enough to justify a hire, especially when you add in regulatory costs.

JonF August 15, 2011 at 11:42 am

Actually some mandated benefit costs do fall with lower wages. FICA taxes for example. And aren’t unemployment insurance premiums tied to some extent to wage levels?

JonF August 15, 2011 at 11:41 am

Re: Also, others have documented the lack of mobility in the current job market, as people are tied to their homes, either by being underwater or by deluding themselves that the housing market will bounce back.

I doubt that housing has much to do with it The current housing bust shows that people are perfectly willing to simply let a house go to forecloure if they can see some benefit to themselves in doing so. A more likely reason for decreased mobility is the two income couple: if one spoues is working (and perhaps working for good wages and benefits) moving to a new location for a new job for an unemployed spouse doesn’t much benefit a couple since they still end up with one of them out of work and looking for a job. Our office in Florida closed in 2008 and relocation to Baltimore was offered to everyone in my depatment; fewer than half took the deal. Housing was not an issue: four of the seven of us who moved had houses/condos which they then had to rent out when they left. Rather family connections and spouses were the main deterrent to moving. Of the three of us who had spouses/domestic partners and relocated, two had spouses who were already not working (one by choice; one unemployed not by choice); I was the only person with a significant other who had to quit a job to move with me– and that was a much lower earning job than mine.

Bernard Guerrero August 15, 2011 at 8:40 am

Martin,

“And paying down is the more profitable decision than hiring new workers. Still sticky prices, but different prices”?

Paying down what debt? Consumers have a ton of debt, corporate balance sheets are actually pretty clean. This can’t be it.

Martin August 15, 2011 at 9:13 am

http://research.stlouisfed.org/fredgraph.png?g=1Bp (2001-end)

Total credit market debt of the nonfinancial corporate sector expressed as a fraction of GDP.

http://research.stlouisfed.org/fredgraph.png?g=1Bq (1949-Now)

You’re right too, come to consider it, is the household sector restoring its balancesheet and therefore there is little demand.

http://research.stlouisfed.org/fredgraph.png?g=1Br

So current wages are above market-clearing, but by quite a bit if the household sector needs to repay its debts first.

Bernard Guerrero August 15, 2011 at 11:47 am

Martin, I’ll stick by my initial comment. The difference between the current level of corporate debt and that during recent boom periods is small, and the servicing cost smaller given prevailing rates. And then there’s the cash hoard that the exact same corporations are sitting on. There is no on-going effort to pay down corporate debt, and so no impact from that direction on hiring.

Martin August 15, 2011 at 3:38 pm

Bernard. % is of NGDP. if NGDP is decreasing and the debt burden is still getting smaller, then there is a lot of repaying going on.

D. F. Linton August 15, 2011 at 8:43 am

If you used the term “unusable capacity” instead of “excess capacity”, not only would you encompass Austrian school explanations, but you would also avoid the naive idea of totally homogeneous, perfectly substitutable capital goods.

Anita August 15, 2011 at 8:58 am

“The firm doesn’t want to produce any more output, so the worker’s wage demands don’t matter so much.”

This sounds like coordination failure. Firms would like to hire more people if demand is high but demand will only increase if all firms hire more people.

babar August 15, 2011 at 9:00 am

> And it’d be a really shitty thing to do to the good people who worked for you. Bosses think about that, too.

Even in non-union workplaces, the effect of bringing in a qualified employee at a significantly lower wage (news would get out) would be pretty bad.

RZ0 August 15, 2011 at 1:36 pm

I never had a problem with employees finding out what other employees made. In my experience, it was the HR department insisting that salaries get evened out every two or three years.
Typically, workers don’t tell each other what they make. I’ve always thought it interesting that people will detail their sex lives before they’ll talk about what they make.

sp6r=underrated August 15, 2011 at 3:07 pm

The problem with bringing someone in at a significant discount is that the lower paid worker knows he is earning below his peers. He will quickly look to jump ship.

David K August 15, 2011 at 5:04 pm

Agreed but that begs the question. Why can he jump ship? Why doesn’t the market in new hires descend to a higher-employment equilibrium at a lower wage across all firms?

I suppose however that one could argue that no one firm is willing to be the first to deviate on wages, for this reason, and therefore the old low-employment high-wage equilibrium is stuck as a sort of industry-wide coordination failure problem?

l.a.guy August 15, 2011 at 5:07 pm

It might depend on the circumstances. Doesn’t the UAW have two tiered wage structure under which new hires make considerably less than legacy workers? I wonder if GM is having trouble finding people to work at the lower wage jobs?

TGGP August 15, 2011 at 9:16 am

Just for a reminder, here’s a discontinuous graph that shows the impact of downwardly rigid nominal wages.

Silas Barta August 15, 2011 at 12:55 pm

I think it’s just being used as evidence _that_ wages are downwardly rigid, not evidence of their impact.

And I don’t think it works, either. It only refers to wages, not total compensation. Typically, yes, employers don’t cut wages, but they cut all kinds of other fringe benefits: reduce 401k matches, make you pay for more of your health insurance, reduce quality-of-workplace spending, tighten workrules, etc etc etc. Talk to most employees and they’ve gone through something like that since 2008.

Neal August 15, 2011 at 9:20 am

Unemployment insurance provides an effective floor. People on UI will overlook jobs whose wages are lower than the marginal UI withdrawal rate.

Also, what about temporary cash jobs? If we take those into account, are unemployment wages still so sticky? (Do the U* count cash jobs?)

JonF August 15, 2011 at 11:46 am

Ultimately there’s a “minimum wage” without or without unemployment benefits, the legal minimum wage etc. As with everything in the market, you cannot expect suppliers to supply goods below the cost of their production. That’s as true with labor as with, say, oil or computers. Workers require sufficient income to live on. Offer to pay people less than that and you will no more find people willing to work than you will find sellers willing to sell for less than it costs them to do so.

An Onyx Mousse August 15, 2011 at 9:25 am

Anecdotes: I some older men who were laid off of jobs in dying industries who have mostly maintained their standards of living via their wives careers. One now volunteers full time doing something he loves after giving up looking for work. Lots of the unemployed may have other options due to 2 income households – their non-work option is not as good as working at their previous wage but preferable to working long hours at a crappy job for low pay. I know people who have used unemployment time to care for aging parents, watching children or grandchildren, and working on the house. One of the consequences of having a society much wealthier than during the Great Depression is that most people aren’t starving and have a roof over their heads, so dropping out of the work force isn’t as bad. We were coming off of record high work force participation levels – we may never get back there again as people choose non- workforce forms of home production and cheap leisure consumption, while someone else in their family works.

Brian August 15, 2011 at 10:53 am

This is closest to my thinking. It doesn’t seem like anybody is talking about the human capital stocks of many of these workers. We can talk about sticky skill portfolios in much the same way as sticky wages. Why should a laid off factory worker be so quick to take a job as a Wal-Mart greeter at a fraction of his former wage just because the unemployment rate is high? Better to keep looking for work which matches your accumulated skills. The more experience, the more people are keen to stay in their old field. In some sense the two are related since wages are very much tied to skills, but we need to be clear about what causes what in terms of these long unemployment durations. If workers are rejecting jobs like the one they had before a layoff at a lower wage then we can say something about sticky wages or whatever else. If they’re simply turning down “McOpportunities” then it gets a bit more complicated.

E. Barandiaran August 15, 2011 at 9:45 am

Tyler, thanks for your excellent post. Once again unemployment is moving to the top of politicians’ agenda in the advanced economies. And again we hear a lot of nonsense. For example, a few days ago, Scott Sumner concluded his obituary of monetarism by saying: “Unemployment is the great tragedy of our time. History will judge the current schools of thought on how seriously they addressed this issue.” Claims about the sticky nominal wages among the unemployed are as wrong as claims about the effectiveness of monetary policy to control NGDP and ultimately to restore full employment.

Because of that new interest in unemployment, I’ve been surveying the field of labor economics to assess what we have learned in the past 25 years. Too ealry to have conclusions, but as you highlight in your post it seems that there has been little interest in doing research on the microfoundations of labor contracts. It seems that the developments in microeconomics in the past 40 years have been largely ignored by researchers in this field. (I may be wrong because my evidence is just what topics and approaches advanced textbooks are including). Any suggestion is welcome.

Jonathan August 15, 2011 at 11:01 am

Ignored by many, but not Ed Lazear. There is too much focus on initial salaries and on feckless methods of productivity assessment — or at least that’s my take.
Try http://faculty-gsb.stanford.edu/oyer/wp/handbook.pdf
and Personnel Economics in Practice, 2nd edition http://www.wiley.com/WileyCDA/WileyTitle/productCd-EHEP000821,descCd-OVERVIEW.html

E. Barandiaran August 16, 2011 at 6:45 am

Thanks for your references. I’ve been reading some of Lazear’s old papers and I expect soon to read the paper and the book you refer to.

Tom West August 15, 2011 at 9:47 am

Anecdotally, I am aware of two smaller firms that will not lower their wages for new workers (and these are high-skilled workers) simply because they believe that the workers know what they’re worth (probably true). While these workers would currently accept the job at the lower wage, the management is convinced that the workers would resent “being taken advantage of” and thus work less hard and more importantly, leave the firm when employment recovers, even if the firm then raises wages. People understand having to lay off employees when times are bad. But they won’t ever forgive you “profiting from misery”.

And having seen a one company that had such a two-tiered system, I think they’re right. It was poisonous for the work place.

Given the example of people being resentful enough about firms that raised prices during a crisis to put them out of business once the crisis ends, I think management is wise to be *very* wary of being seen as taking advantage of “desperate” workers.

Enrique August 15, 2011 at 11:02 am

Well I dunno. At my firm they sacked 6 or 7 and next week they gathered all of us and told us that our benefits were being cut and that everybody was getting a 5 to 30% pay cut. It has been over a year, nobody complained then, and I don’t remember anybody quitting.

Tom West August 15, 2011 at 12:11 pm

If the company is obviously in high distress, then people will accept a lot. You’re not ‘taking advantage of misery’, you’re miserable yourself :-).

It’s when the company can “obviously” afford to pay full wage (see, the current workers aren’t taking a cut), but “chooses” not to in order to increase their profit margin that will make people feel bitter and resentful.

Life is full of cases you are much better off not making an offer than making an offer that people will accept but resent.

Mark August 15, 2011 at 12:59 pm

I agree. When I last hired someone at a high salary, I realized that I could have easily offered them $10K less. I considered this, then I realized that it might create great resentment.

This isn’t that hard: I hired them at $83K (includes benefits). If I shaved 10K off her salary, then she would have cost me about $71K (includes benefits). That difference is not worth having a slightly pissed employee – I think the loss of productivity would have been larger (this is a “knowledge worker”).

Alex R August 15, 2011 at 10:28 am

Tom West gets at an important point: think of it as the “prosperity mary be just around the corner” problem. Firms don’t want to hire an employee, even if the price is right, if they think that the employee will leave in a year if the job market improves. (And employees are reluctant to set a low wage level for themselves if they could demand a higher wage in six months — though I suspect that this effect is smaller, since an extra six months of unemployment probably looks worse on a resume than six months at a lower wage than you think you’re worth.)

So from the employers perspective, hiring someone at a depressed wage only works of the economy neither improves (causing your new employee to take their training and leave) nor worsens (meaning you’d have to lay the employee off again). One could solve this problem by negotiating an employment contract specifying an automatic wage increase in the event that the firm’s business improves, but I suspect such contracts are rare…

Donnie August 15, 2011 at 10:33 am

Perhaps their expenses are sticky (mortgage, health insurance, fuel, food), and this causes their wages to be sticky.

MNL August 15, 2011 at 10:45 am

I agree with some of the points made above -

Lack of demand means you don’t need to hire, even at lower wages

Employers don’t want to hire someone who’s overqualified/taking a big pay cut out of fear they’ll leave once the economy improves

Also, you have to look at the *kinds* of jobs that have been growing. If you’re a displaced construction worker, assembly line worker, administrative assistant or classroom aide, how competitive are you going to be for a waiter/waitress job? And you’re definitely not qualified for an engineering job, or a CNC machinist job.

There are some examples of folks turning down jobs they see as too big a pay cut or not applying for McDonald’s jobs because UI is a better wage than that, but that certainly can’t explain the bulk of what’s happening, given how many people have completely exhausted their UI — and given the stats we know about the long-term unemployed who *do* get jobs, it doesn’t seem that they’re resisting pay cuts. See: http://www.bls.gov/news.release/disp.t07.htm

Paul N August 15, 2011 at 10:52 am

The large firm I work for can’t just hire people at low wages, even if the people are willing to take them (many are, especially new grads). There are pay bands for specific job types, and even if you start a new employee at the bottom of the pay band, they get bigger raises (and those that are above the median for the pay band get lower, or zero raises) because the goal of the HR policy is to equalize salary over time of all employees who do the same work.

Brian August 15, 2011 at 10:56 am

I’m curious about what determines the starting salary. Would you have these initial low earners flying past somebody hired at the median a few years down the road?

Donald Pretari August 15, 2011 at 10:58 am

” A lot of people don’t like hypotheses which suggest the unemployed are not victims of the system, so it doesn’t get much of a hearing.”

I suppose one reason I support a Guaranteed Income/Negative Income Tax like the ones proposed by Milton Friedman & Charles Murray is that I find the discussion about UI & Unemployment disconcerting. I think the reasons for what’s actually occurring are complicated & messy. Also, I’m not comfortable looking at gross numbers of employment and benefits to determine how useful cutting off benefits would be. For example, would we make life unnecessarily burdensome for lots of people in order to get a few people employed? Do we know?

I’d rather have this problem dealt in a cleaner fashion and be a more effective, and possibly more efficient and just, automatic stabilizer for the economy. By all means conduct the research, but I suspect it will lead to the conclusion that it’s complicated and messy.

Barry Ickes August 15, 2011 at 10:58 am

Suppose someone offered to work at your Econ Department for 30% less than the starting wage for an Assistant Professor? Would you hire him. Of course not. Suppose someone offered to work as a secretary in your department for 10% less that your current secretary. Would you fire your current secretary and hire the unemployed one? Of course not. What you are imagining is a lot harder to do in practice than you think it is. You could not even do that at McDonalds.

Andrew Edwards August 15, 2011 at 11:31 am

Institutional stasis like this is observable. Walk into the HR department of a major corporation if you want verification. Hiring someone at a rate other than their assigned pay grade carries real external costs.

Barry Ickes August 15, 2011 at 11:00 am

Your argument #2 makes no sense. You say that firms are sitting on piles of cash, so if only workers lowered their wages they would get hired. But if firms are sitting on piles of cash why don’t they hire them now? Because they are afraid that they cannot sell the output. What would it matter if the wage was lower. They could still not sell the output. Piles of cash do not appear only if the unemployed lower their wage demands a bit.

Enrique August 15, 2011 at 11:03 am

But if they had a tax cut on top of that pile of cahs… maybe then they will start hiring.

James Bang August 15, 2011 at 11:20 am

The costs of accepting a lower wage in the current period are often cumulative over the entire tenure of the job, not just limited to the current period.

Nick Bradley August 15, 2011 at 11:29 am

1. No discussion of the reservation wage for the low-skilled. Labor has a certain disutility to it, and the low-skilled seem to have an unusually high labor disutility, evidenced by their lack of educational attainment…and skill attainment. Unemployment insurance pushes this reservation wage up considerably, since you get about 2/3rds of your old salary under unemployment benefits — capped out at around $40,000 a year. So if you’re below that income earning level, you’re better off just hanging out at home for a while.

2. How much of unemployment is generated by second-income earning moms? Since they drop 1/2 of their income on daycare as it is, staying at home would actually increase take-home pay! Not to mention all the other savings of staying home, like lower food bills, a happier home life, less eating out, etc. My wife makes quite a bit more than $40k, but we still have to spend $20k a year on child care for your two young children regardless of how much she makes. Hypothetically, if she only made $40,000 a year, she would increase her pay by over 20%. After-tax (15% bracket, 5% for state), her take-home would jump from $10,375 (assuming $5,000 childcare tax deduction) to $17,400, a whopping take-home increase of 67%. That number goes to 80% if you live in a state that doesn’t tax unemployment benefits at the state level. ** I also have not included costs of going to work like gas and lunch and clothes.

JonF August 15, 2011 at 11:53 am

Re: you get about 2/3rds of your old salary under unemployment benefits

Actually no. The system was originally designed that way, but inflation has eroded the value of benefits considerably over the years. The average person collecting benefits only gets about 35% of his previous salary from the system.
For a real world (if a bit aged) example, in 2001 I was laid off from a 44K/yr job. My unemployment check was 300$ weekly– annualized that would $15,600, which is 35.4% of $44,000.

Nick Bradley August 15, 2011 at 12:26 pm

- It varies by your state’s max weekly benefit. I ran my state’s calculator (Colorado) to see what a person making $40k a year would get and it worked out to 60%. Florida was only 30% or something like that, but a minimum wage earner in Florida gets about 2/3rds.

JonF August 15, 2011 at 5:16 pm

A minimum wage earner maybe, because they are unlikely to run afoul of the maximum payment cap. Those caps were set many years ago, and in most states they have not (perhaps never) been adjusted for inflation. A few states have done so: apparently, Colorado is one from your citation, and from what I’ve heard Massachusetts and Maryland have bumped theirs up. I’ve collected UI in both Michigan and Ohio and the weekly payments there were capped at c. 300$. I’ve known someone who collected in Florida and only got $325 a week (despite having held a job making 55K/yr). Nationwide, as I posted, unemployed people, if they can collect at all (most in fact do not qualify for any benefits) will collect about 35% of their previous salary.

Andrew Edwards August 15, 2011 at 11:30 am

You need to consider the time series for the person.

If nominal wages are sticky, what is the NPV cost to me of accepting a job now at a (sticky) lower wage and thus being locked in at that lower wage even if wages rise in the future? What is the NPV of holding out for a higher wage for one year? two years? What is the breakeven point?

It’s easy to say that I should just switch jobs in the future, or re-negotiate, but do not forget to account for search costs, or the empirical fact that most people are terrible negotiators with huge status quo biases. People are often aware of these weaknesses and plan accordingly.

Also, Tyler, given the facts of persistent unemployment and lack of deflation, I think the burden of proof goes the other way. The world appears to feature sticky nominal wages for the unemployed. That needs explanation, regardless of whether the current explanations appear logical to you.

Jim August 15, 2011 at 11:50 am

>Yet businesses are sitting on record-high levels of cash.

Citation needed.

And to justify your use of the phrase “sitting on” you must show that cash balances are at a record-high, and have been that high for a long time.

In any event, if you a profitable business and significant cash in the bank, you probably go to bed every night thanking God, and wake up every morning wondering how Obama is going to take it from you that day. It’s not conducive to hiring and expanding. The uncertainty around the Obamacare disaster alone is enough to dissuade you from all but the most critical hires.

Free Spirit August 15, 2011 at 3:55 pm

I would also challenge the distribution of those piles of cash. Several well-known companies have mountains (tens of billions each) of cash. Small business like mine are getting closer to zero-balance every week that the slump continues. In my case, it is largely due to lowering prices to keep/build business, coupled with sticky wages for staff and rising supply costs. Kick in the roller-coaster of local tax rate equalization+hikes and you’ve got major financial pressure on small business.

J Ward August 30, 2011 at 2:22 pm

With all the talk of Obamacare and the crushing uncertainty, I can’t help but marvel that any business at all got dne under Reagan, who actually raised taxes, let alone under Nixon or Eisenhower. I think the “uncertainty” meme was pretty accurately analyzed here,

http://baselinescenario.com/2011/06/06/not-all-businessmen-are-smart-you-know/

but I think if you are really going on about that sort of thing, it nights be better discussed entirely under the tenets of behavioral economics. It is certainly, at least from a historical perspective (US or the entire western world, take your pick), just silly to assume that there is any baseline level of regulatory and taxation scheme which would assure “certainty” given that a totally captured, enslaved to big biz interests Dem admin such as Obama’s, is creating economy-crippling uncertainty.

As for unemployment, etc. I’d be surprised if corporations making record profits from squeezing large productivity increases out of much smaller workforces for the last 2 years would be even CONSIDERING hiring anyone when demand is pretty well flat. Doesn’t seem to require much more explanation, but I’m sure I’m missing a few nuances at least.

And one more point, most unemployment (nominally rather than anecdotally) is concentrated in the lowest education/skills and presumably wage brackets. How does one advertise to Applebees or a landscape contractor that one would be willing to work for less? Many of these jobs are up against the minimum wage and, as an earlier poster pointed out, there ain’t much lower to go in this country before a job is paying less than the worker’s cost of working (read surviving).

Good discussion.

Kevin Postlewaite August 15, 2011 at 12:08 pm

Perhaps wages are not sticky for any particular person hired but employers prefer to increase the quality of their hires rather than lower the wage they offer.

Rahul August 15, 2011 at 12:39 pm

A key point in the analysis (often ignored) has to be the HR department and the inefficiencies it induces. Maybe I am ranting, but it has been my experience that the HR department at most large corporates is a serious source of drag and impedes any sort of dynamic adjustment to external conditions. Any sort of wage tweaking would run foul of the reams of paperwork that HR needs you to fill before hiring.

I’ve seen so many cases of a manager finding the ideal person for a job (wage factored in) and then the HR department throwing the spanner in the works for all sorts of arcane reasons. A key problem is mis-aligned incentives. Often HR, in the long run, does not have a direct interest in getting the best candidate for the job.

Are there any analyses that study the HR-effect on the labor market structure? I’d love to hear anyone who really “likes” the HR personnel in their firm. To me, most HR is pretty evil.

JonF August 15, 2011 at 5:10 pm

I cant say I’ve ever seen an HR department blackball a hire that a manager decided to make. However HR does intervene at the front end by determining which resumes to forward to the hiring managers.

David K August 15, 2011 at 5:11 pm

Our company had pretty good HR, and fairly flexible. Then again, it was a 200 person firm with four HR people. Seems likely that HR is one of those bureaucracies that gets less and less efficient with firm size…

Matt August 15, 2011 at 12:43 pm

“What we’re seeing is a previously rejected form of Keynesianism, applied across increasingly long and increasingly implausible time frames — suddenly pretending to be the mainstream view. It’s not and has not been for a long time.”

Does this also apply to calls for a second public spending program (Keynesian stimulus) that would take place, if its advocates had their way, at least 5 years after the onset of the 2007-8 recession? My impression was that Keynesian stimulus as initially conceived was a very targeted, short term action taken as an economy was slipping into the trough of a 2-3 year “V” in the business cycle.

I wasn’t around during the 70s, did people continue to advocate for Keynesian style stimulus plans even after several years of stagnation had passed?

Sebastian H August 15, 2011 at 12:45 pm

There seem to be quite a few possibilities, and it may even be “all of them”

Here are the ones on my mind:

1. Discrimination against the unemployed: If you have a multi-month hole in your employment record, employers are very likely to choose someone who otherwise looks quite a bit less interesting but doesn’t have that hole. They suspect that there is something otherwise wrong with you that they couldn’t pick up. In the 90s and early 00s they were probably right. Now the bad luck factor could damage your ability to earn or get a good job for the rest of your life.

2. Stickiness of benefits and government mandates. In many companies the base benefit level (health care availability, vacation pay, etc.) is relatively uniform across the company and if it isn’t uniform it is relatively uniform by job title. Further there are government associated costs with hiring. As such, medium-level changes in the nominal wage aren’t enough to justify a new hire and drastic cuts within a job title are likely to cause inter-company problems (see discussion above).

3. A belief that we will be returning to the 90s job market soon. This is probably an irrational belief, but I suspect it is a widely held/hoped for one. In the 90s job market, this underemployed person you’re about to hire will be able to find a job at a much higher wage. This will cause them to leave your company and any training period will be wasted.

4.Unwillingness to radically raise the pay later. This is the flip side of #3. Many of the risk factors could be mitigated if a company was willing to try you out at a reduced salary and then bump it up very significantly if it turns out that the risk was worth it. But that is exceptionally rare, especially at mid-level jobs. Once they hire you in at a pay rate, you won’t ever be making as much as your peers who were hired at a higher pay rate because the company won’t have you catch up. This feeds directly into #3, but is held onto for other reasons.

JonF August 15, 2011 at 5:07 pm

All of the “adult”, non-temp jobs I’ve held except one I got a healthy raise of 7% or more after my first year. The one exception netted me a raise of 20% after my second year in connection with a promotion. I’m not sure how common this is, but I think you’ll find other people have had similar experiences. Salaries usually are low-balled when you are first hired (absent stellar credentials or rare skills) but if you work out you generally get a significant boost after the first year– but may stagnate afterward.

TallDave August 15, 2011 at 12:46 pm

Great points Tyler, thanks for sharing, and for the Kling link.

endorendil August 15, 2011 at 1:23 pm

“How about applying for a job at a Washington non-profit? ”
BS. Signalling that you are willing to take 20% more by taking 100% less is dumb, especially since the signal is more likely to be interpreted as just inability to get a paying job. Not to mention that is not feasible, unless mommy and daddy are paying your rent, groceries and so on. It is extremely hard to signal you’re willing to work for less. HR is hardwired (and correctly so) to assume that people are loathe to take pay cuts of any size, but that they will never stop looking for a better job if they have to take a double-digit one. Since there’s not a shortage of young bucks that don’t have sticky wages and memories of free catering, healthcare insurance and so on, there’s no need for HR to even consider this. They will fight departments that value experience and track record. That is, after all, their job….

Unemployment is not a signal. Not when it is so ill-defined. The US labor force has shrunk much more than unemployment has increased. Job quality for the employed has never matched world standards for the developed world, but it has decreased rapidly.

nb August 15, 2011 at 1:40 pm

Roger Farmer’s recent work on “Old Keynesian” microfoundations is relevant:
http://www.nber.org/papers/w17137

Troy Camplin August 15, 2011 at 1:42 pm

Lower wages aren’t demanded because of unemployment insurance. Why take a job that pays less than unemployment? Or pays less than unemployment + child care (if you have children under school age)? There is a lot of evidence that shows people stay on unemployment up through the last year of their unemployment, at which point they magically, suddenly find a job. What are the odds that they lowered their standards — including wage standards — when the reality of no money coming in is staring them square in the face.

This is aside from the entirely laughable claim that Keynsianism explains recessions.

Nick Bradley August 15, 2011 at 2:08 pm

I agree; I’m trying to find some data, but it seems like a lot of second income earners, i.e. moms, are unemployed — probably because unemployment + saved child care expenditures + saved work-related costs > wage. This point is driven home even harder because they are not the breadwinner and don’t need to get a benefits package.

JonF August 15, 2011 at 5:01 pm

If people have decided to exit the job market and become full-time homemakers while a spouse supports the family financially, I don’t see that that is a problem, or that such people can be called ” unemployed” (and in fact they aren’t counted as such).

Troy Camplin August 16, 2011 at 4:00 pm

You assume that they decided without much of that decision being made for them. If the person would prefer to have a job, but it’s not financially responsible to do so, how are they not unemployed? Some of us are full-time homemakers because of these conditions, but are still looking for a job. I’m certainly considered unemployed by that definition.

More than that, if you have a lot of people who are not working for these reasons, you have less money coming in and, thus, less disposable income — which is bound to affect the economy, don’t you think? I mean, I do believe that economic growth is driven by the creation of new things, but at the same time, new things can come on the market, but I wouldn’t be able to afford them with our family’s income.

Ryan August 15, 2011 at 2:56 pm

Wow. Great article and a bunch of great comments. Curiously, the rationale I have used as an employer for the last 20 years is not explicitly listed anywhere, although MNL does touch on part of it. Since I believe this rationale is widespread among my peers, will take a stab at first-ever comment on this blog…so here goes.

Workers cannot credibly signal their long-run willingness to work for lower pay. Tyler’s argument #4 discusses worker’s short-run willingness. However, that is of limited value to any employer who faces significant new-hire costs.

Building block #1: New hires in many occupations take quite a bit of time to become productive and generate marginal benefits that exceeds their cost. Therefore, one of the hiring criteria for an employer is to assess the candidate’s risk of an inordinately early departure from the job.

Building block #2: Most people have limited financial resources to weather a stint of unemployment. They need an almost uninterrupted income stream in order to pay monthly bills. Therefore, people are motivated to accept a job even if it is pays much less than what they feel they are “worth”. To put another way, the fact that someone accepts a job today that pays a low amount does not necessarily signal that they have changed their long-run view of what they are worth.

The real-world impact: When I see a candidate offering to take a job at a lot lower pay than what they were previously making, it is a red flag as far as expected duration of employment. Amass a bunch of red flags together, and you end up with the observed phenomenon of sticky nominal wages among the unemployed.

EricTitus August 15, 2011 at 3:07 pm

I recently reread Keynes on sticky wages, and his ideas about sticky wages don’t seem that different from your own. Existing workers are resistant to lowering nominal wages–a point on which you appear to agree–after all doing so is of no benefit to them unless they are in danger of losing their jobs. Unemployed workers are not hired do to issues with aggregate demand, not because they are making unreasonable wage demands. As a manager, I can tell you that a modest difference in salary would not make or break a hiring decision–you generally expect ROI on an employee to be far above their salary anyway, given costs of training, benefits, and space.
My company is generating a fair amount of cash and hiring. But we were slow to hire, not because we couldn’t afford more employees or they would not generate ROI, but because we were unsure about revenue streams due to being in a volatile industry that got hit hard in 2008, and it takes 3 months to train new employees. It didn’t matter what the unemployed were doing–we just weren’t hiring. Because every company that is experiencing strong but unpredictable demand can become “productive” by not hiring, but is order to enable growth beyond some upper limit of capacity you need to hire new people.

Jay Titus August 15, 2011 at 6:17 pm

I echo your comments and admire your last name.

Donald A. Coffin August 15, 2011 at 3:13 pm

I think one way to approach this is as a signaling problem. If the prevailing wage (which, incidentally, needs to be seen as including all the costs of employing an additional worker, not just the direct compensation of that worker) is currently $x, then offering to work for $(x – a) signals the employer that you, the applicant, do not believe that your productivity is worth $x. Which does not mean that the employer should accept that your productivity is worth at least $(x – a). I would suggest that such a signal reduces the probability of an employer accepting your offer to work.

Floccina August 15, 2011 at 3:13 pm

1. The questions is why are employers not offering jobs at lower wages. I would say that they do not see growth prospects.
2. Many people are working for lower wages in the un-taxed black market cash economy.
3. The following does not answer the question but rather adds to the mystery: Looking around I see that we have raised some bad workers and I am surprised that they have not been fired and replaced with better workers as unemployment has risen. Also I was just in NY city and the foreign born seem to work so much harder than USA born particularly at the lower wage jobs.

AJ August 15, 2011 at 3:15 pm

Even though I’m proposing it, I’m not sure that I’m completely satisfied with this argument, but it could be that the unemployed choose to remain unemployed because of unrealistic inflation expectations, i.e., they have not realized that as a result of the recession, firms’ inflationary expectations have adjusted and thus are offering lower wages. In the short run, workers still make labor decisions based on the status quo ante. Eventually, as the disconnect between firms and workers is resolved, we should revert back to natural rate of unemployment. One problem with this is something that was mentioned above: according to this argument, the elderly seem to have gotten the message about expected inflation and everyone else has not. Another issue is whether this recession will cause a change in the natural rate of unemployment, which may be higher than the pre-recession period.

Dave August 15, 2011 at 3:18 pm

There is also the simple pattern of employment growth following profit growth with a 12 month lag. A simple explanation is that businesses wait to be confident that profits have come back before hiring again. That picture may be muddled with the economic growth already faltering again, and businesses may not have the confidence typically felt after exiting a recession to continue a fast pace of hiring, and playing a wait-and-see strategy.

Geoffrey August 15, 2011 at 3:18 pm

Take a look at Truman Bewley “Why Wages Don’t Fall During A Recession”

http://cowles.econ.yale.edu/books/bewley/tfb_wages.htm

He actually went and talked to business managers to get their reasoning. He locates the stickiness in managers unwillingness to drop wages – largely an issue of morale. But it’s worth a read to get the whole picture.

o. nate August 15, 2011 at 3:22 pm

There are two possibilities for an unemployed person who is willing to accept a lower wage: find the same type of job but at a lower wage, or look for a different type of job that pays less. There are difficulties with both options. In the first option, the employer is reluctant to offer the same job at a lower wage because of the inequity issue – how could they justify paying significantly different wages for the same job? And they can’t lower the current workers’ salaries to make it even, for all the usual wage stickiness reasons. As for the second option, most workers are reluctant to switch fields, for lots of fairly obvious reasons.

Donald A. Coffin August 15, 2011 at 3:47 pm

There is, as it turns out, some actual research on this issue in the job search literature. The bottom lins 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”
http://ideas.repec.org/p/kie/kieliw/1095.html
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-Oursider 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, http://www.nber.org/papers/w6924 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.

Dan August 15, 2011 at 4:07 pm

How is excess capacity different from insufficient aggregate demand?

Floccina August 15, 2011 at 4:14 pm

Who normally does most of the hiring? Start ups? High growth companies?

Many people who could run the type of low tech low wage start ups would not like the huge hassles.

Free Spirit August 15, 2011 at 4:19 pm

One of the great ironies I noticed was the rush by Congress to increase depreciation expenses over shorter time frames. This means less tax now and more tax later, but there is another pernicious effect: increased mechanization. What happens as we increasingly mechanize our factories and other processes? We reduce long-term employment in those mechanized firms.

How much has mechanization influenced 1) the growth of the ZMP population (a structural labor pool issue), and 2) the length of unemployment (laid-off employees replaced by machines due to re-hiring or increasing long-term employment costs)?

Likewise, how much has rising regulatory employment costs (which are considerably sticky) altered the profitability/viability of businesses? Small business pay ~50% more per employee (http://archive.sba.gov/advo/research/rs264tot.pdf) in compliance costs, due to absence of scale advantages.

Similarly, small businesses seem more likely to reduce prices in a bid to stay busy (those fixed costs are a huge drag!) and keep the bills paid, and the benefit-cost ratio starts dropping with profits. If the owner can’t sell and wants his life back, he’ll close and take the jobs with him.

dirk August 15, 2011 at 4:57 pm

Question: does the AD side explanation disappear if one doesn’t buy the sticky wages narrative?

Michael Thaddeus August 15, 2011 at 5:29 pm

Isn’t there the problem that workers have certain fixed costs associated with working?
They need to travel to work, and both gas and public transport are expensive by historical standards.
Many also need child care, which can be very expensive.
So even in a world with no government intervention, working for less than a certain wage is not economically viable.

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