Sticky wages are part of the macro labor market story, but not at the center

by on September 8, 2017 at 12:37 am in Economics, Uncategorized | Permalink

I can recommend to you this new survey by Lars Ljungqvist and Thomas J. Sargent, just published in the American Economic Review.  The serious work on unemployment these days is using models of matching markets, and varying returns to finding matches during tough times, including recessions.  That is how to think about the job creation process for unemployed workers, who do not currently have a nominal wage to even be sticky.  Here is their abstract:

To generate big responses of unemployment to productivity changes, researchers have reconfigured matching models in various ways: by elevating the utility of leisure, by making wages sticky, by assuming alternating-offer wage bargaining, by introducing costly acquisition of credit, by assuming fixed matching costs, or by positing government-mandated unemployment compensation and layoff costs. All of these redesigned matching models increase responses of unemployment to movements in productivity by diminishing the fundamental surplus fraction, an upper bound on the fraction of a job’s output that the invisible hand can allocate to vacancy creation. Business cycles and welfare state dynamics of an entire class of reconfigured matching models all operate through this common channel.

As you will see in the paper, sticky or constant wages still can play a significant role in these accounts, but they are one part of a broader story. This is useful from the concluding remarks:

The fundamental surplus fraction is the single intermediate channel through which economic forces generating a high elasticity of market tightness with respect to productivity must operate. Differences in the fundamental surplus explain why unemployment responds sensitively to movements in productivity in some matching models but not in others. The role of the fundamental surplus in generating that response sensitivity transcends diverse matching models having very different outcomes along other dimensions that include the elasticity of wages with respect to productivity, and whether outside values affect bargaining outcomes.
For any model with a matching function, to arrive at the fundamental surplus, take the output of a job, then deduct the sum of the value of leisure, the annuitized values of layoff costs and training costs and a worker’s ability to exploit a firm’s cost of delay under alternating-offer wage bargaining, and any other items that must be set aside. The fundamental surplus is an upper bound on what the invisible hand could allocate to vacancy creation. If that fundamental surplus constitutes a small fraction of a job’s output, it means that a given change in productivity translates into a much larger percentage change in the fundamental surplus. Because such large movements in the amount of resources that could potentially be used for vacancy creation cannot be offset by the invisible hand, significant variations in market tightness ensue, causing large movements in unemployment.

One very simple way to put the point is that unemployment is not always such an easy problem to fix and labor markets are not always so easy to steer. This is a far cry from the simple Phillips curve talk I see so often in the financial press.

Here are ungated copies.

1 Larry Siegel September 8, 2017 at 12:54 am

Unemployed workers have a package of government benefits that are sticky – *very* sticky. Many people would rather have Medicaid or heavily subsidized Obamacare than the chancy insurance you get with low-paid jobs. And health care is not the only benefit.

2 Bill September 8, 2017 at 8:01 am

Yeah, Larry, you too can have income of less than $12k annually (not including rent, food and clothing, transportation and medical care) and get those benefits. You can even get $40 a week in food stamps.

Go for it.

3 Harun September 8, 2017 at 11:42 am

Its not attractive to you, therefore its not attractive to anyone.

You’re probably also astounded that Judge Judy makes so much money. Who watches that show!

4 Bill September 8, 2017 at 1:35 pm

Evidently, it must be attractive to you as I hit upon your preference for this level of income, which, understandably means that you object to having your standard of living be defamed.

I am so sorry.

On the other hand, if it is not attractive to you, and it is not attractive to me, maybe you should think about what that means.

5 Borjigid September 8, 2017 at 8:29 am

Sticky wages seeks to explain cyclical unemployment. The people you are referring to would not be relevant to that discussion.

6 Ricardo September 8, 2017 at 10:27 am

The trend since the 1990s has been to structure benefits so that they give greater incentives to stay in the labor force. Obamacare subsidies only gradually phase out as one’s income rises and the same holds true for the Earned Income Tax Credit.

Also, if we consider unemployment as a matching problem, it isn’t always a bad thing. We want people to find jobs where their skills will be made the most of instead of settling for the first offer that comes along. Unemployment benefits and a basic safety net help give people the breathing room they need to be a little less desperate when they are on the job market.

7 JonFraz September 8, 2017 at 2:52 pm

Low paid jobs generally do not come with any insurance chancy or otherwise.

8 Tom P September 8, 2017 at 1:27 am

Is it surprising that models in which recessions are driven by productivity shocks have little role for nominal rigidities?

Isn’t this just saying that “sticky wages don’t matter if we live in an RBC world”?

9 Ray Lopez September 8, 2017 at 2:00 am

That’s a good point, if that’s what the model assumes. Remember, this is a modeler talking about a model that may not exist in real life. This sentence is odd: ” Because such large movements in the amount of resources that could potentially be used for vacancy creation cannot be offset by the invisible hand,” – and why is that? In theory, given enough time, didn’t Ken Arrow prove that markets clear? (Time to Google this): https://en.wikipedia.org/wiki/Fundamental_theorems_of_welfare_economics – yes I am right. Given enough time, all monopolies dissolve so Arrow’s First Theorem holds. Or that’s what free marketeers like FedEx’s Smith and others will have you believe.

10 Brian Donohue September 8, 2017 at 9:16 am

I still think sticky wages (and related Fed policy) were a pretty big part of the story.

Between July and December of 2008, CPI-U fell by 4.4%, far and away the largest drop seen since the post-WWII era. I think a Fed meeting from the second half of 2008 was peppered with worries about inflation. Thanks Ben.

The echo? Between July 2008 and July 2009, 7 million fewer people were employed (total peak to trough was 8.7 million.) In one year, the American economy decided it needed 7 million fewer workers. Huh?

In the 8-1/2 years since December 2008, CPI-U has risen by just 1.8% per year, well below average inflation for most of the previous 75 years (and consistently below the Fed’s own 2% PCE target).

Paralleling this, the recovery in employment has been dragged out compared to previous recoveries. The Reagan and Clinton recoveries saw job gains snap back- 5 million jobs gained in 1984, 4 million in 1995.

The current employment recovery barely broached 3 million new jobs in a year, and that wasn’t until 2014.

Employment growth has since slowed, but the economy is still adding 2 million jobs per year, which is faster than the net organic growth in job seekers, so we are continuing to see some people “coming back”. If I’m not mistaken, both you and Sumner were pretty early on your calls that whoever was gonna come back was already back, and I think you were wrong.

11 Brian Donohue September 8, 2017 at 9:23 am

That 7 million jobs lost in one year is completely off the charts. Nothing close to it. Since WWII, there hasn’t been another one year period with even as many as 2.5 million jobs lost.

And it’s not like the Dubya employment recovery preceding the crash was overly robust.

12 Ray Lopez September 8, 2017 at 10:16 am

Cool story bro. But it’s got nothing to do with the post, which is about something else, a model, except for the fact it talks about ‘sticky wages’.

13 rayward September 8, 2017 at 11:58 am

The shift in the American economy from manufacturing to services magnifies the effect of the factors identified in this study. For example, manufacturing requires labor of varying skills. In a recession, production is cut and so are the jobs of the least productive workers, but wages for the most productive workers must be sticky in order to retain them. That’s not necessarily a bad thing, because when the economy recovers from the recession the manufacturer will be leaner and more efficient, likely resulting in greater profitability if not higher wages for the remaining workers. On the other hand, the new service jobs are mostly low-skilled, which makes workers interchangeable and wages low. I know, America still has a large manufacturing sector, but the world’s manufacturing output has increased many times over since 1980 while jobs in the sector here have been stagnant. And I know that many of the service jobs are highly skilled and high paying, but they are the exception. But I am optimistic. I have confidence that tech and manufacturing will come together, to the great benefit of American manufacturing and American jobs. https://www.nytimes.com/2016/08/28/technology/ge-the-124-year-old-software-start-up.html

14 msgkings September 8, 2017 at 12:03 pm

American manufacturing yes, our output will keep rising and rising, as we manufacture more today than we ever have in history. Jobs, maybe not so much. rayward, it’s a tech story, it simply takes fewer and fewer humans to make more and more stuff. This trend is irreversible. It’s almost exactly what happened to jobs as people left the farms (tech made it easier for fewer and fewer people to make the food) for the factories. Now the factories are emptying out for the services.

15 rayward September 8, 2017 at 1:01 pm

I know, America still has a large manufacturing sector, but the world’s manufacturing output has increased many times over since 1980 while jobs in the sector here have been stagnant.

16 msgkings September 8, 2017 at 1:05 pm

Oh man, you can’t even read. I just wrote that manufacturing jobs have been stagnant, and gave a simple reason why. Which is also why your last sentence in the 11:58AM post is misguided. Tech and manufacturing will continue to be “to the great benefit of American manufacturing” but not “American jobs”. Capisce?

17 rayward September 8, 2017 at 1:08 pm

Compare China’s GDP in 1980 with China’s GDP today. The shift in manufacturing output (and manufacturing employment) from the U.S. to China is on a scale even readers of this blog cannot deny.

18 msgkings September 8, 2017 at 1:28 pm

The economic rise of China is one of the greatest and most rapid improvements in human welfare in history, and the definitive proof that capitalism is superior to communism. The US has done pretty well since 1980 too. Everyone wins! But rayward is still sad.

19 rayward September 8, 2017 at 5:09 pm

YAAI. ” But I am optimistic. I have confidence that tech and manufacturing will come together, to the great benefit of American manufacturing and American jobs. https://www.nytimes.com/2016/08/28/technology/ge-the-124-year-old-software-start-up.html

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23 Merijn Knibbe September 8, 2017 at 12:37 pm

Is this another way to state that the ‘invisible hand’ could not cure Great Depression unemployment?

24 Matthew Waters September 8, 2017 at 3:08 pm

I’m having trouble figuring out the abstract and the excerpt. It doesn’t say how much sticky wages are or are not emphasized compared to other factors.

But at least for the 2008-09 surge in unemployment, those other factors sound like something from Mars. Actual businesses saw big losses in revenues corresponding to declines in NGDP. Actual managers make ends meet by cutting hours or headcount rather than cutting wages. If not sticky wages, then how did these other factors like “alternating-offer wage bargaining” suddenly surge in September 2008?

Sure, across most of post-war America and other economies, the Phillips curve had little value. But I have to think, based on the 2008 cycle, an adjusted Phillips curve would be highly predictive of unemployment:

1. Change the predictor to NGDP rather than inflation.
2. Have it be asymmetric, corresponding to when individual market wages may see a zero-bound. A declining industry may hit negative nominal wages at, say, 2% NGDP growth.

IMO, such a modified curve would work well with, say, real wage stickiness based on unionization and duration of unemployment benefits. Real wage stickiness was a big deal in 70’s stagflation. The “marginal benefit of leisure” stuff sounds like something that only exists in economics papers, to be honest.

25 mulp September 9, 2017 at 1:31 am

When wages go down, consumer spending increase raising gdp growth, according to free lunch economics.

The problem with slow growth and slack labor markets is high wages depress consumer spending!

26 mulp September 9, 2017 at 1:28 am

I suppose Tyler citing a Slate article on airline pilots is out of the question.

It seems airline pilots do not suffer from sticky wages as they have been falling steadily for 35 years.

http://www.slate.com/articles/business/metropolis/2017/09/how_we_ruined_airline_jobs.html

“The degenerating passenger and pilot experiences aren’t separate phenomena but in fact are intimately related, both resulting from policy choices that have propelled a decadeslong, ongoing makeover of the national air-transit system. The difference, perhaps, is that we are more conscious that we, the passengers, are getting a raw deal.

“So are aviation workers, but there is more to the pilot shortage than just pay. Industry representatives are pushing Congress to address the rising cost of pilot training, which can exceed $100,000 after requirements became more stringent in response to a 2009 crash. Competition for pilots has also gone global, causing many young pilots to leave the U.S. to chase more exotic opportunities with Emirates and other Middle Eastern carriers. And there are class-conscious obstacles to recruitment—flying has become less glamorous.

“But at the regional airlines where the effects of the pilot shortage are most acute, even management seems to have finally acknowledged that pay matters, as evidenced by their recent efforts to raise starting salaries that paid first-year pilots as little as $15,000 to $20,000. And although many jobs have gotten worse in the past few decades, pilot wage stagnation distinguishes itself in several respects.

“First, airline jobs appear to be caught in a steeper free fall. Before President Carter and a Democratic Congress deregulated the airlines in 1978, few industries paid higher wages. In the 1990s, a number of studies reviewed deregulation’s impact on airline wages, attributing decreases in the range of 10 to 20 percent for pilots, … According to a Government Accountability Office analysis, pilots’ median weekly earnings fell another 9.5 percent from 2000 through 2012—lower wage growth than 74 percent of the other professions included in the GAO’s review.

“Regional airlines are having the hardest time hiring pilots. These companies, where most pilots now begin their careers, operate almost half of all domestic flights on behalf of major carriers like Delta, United, and American. David Dao was actually kicked off a United flight that was operated by Republic Airways. Though the employees on the plane wore United uniforms, their paycheck came from Republic.”

“Though Congress intended for the Airline Deregulation Act of 1978 to promote competition, the four largest airlines now find themselves in control of 80 percent of the market. When the reform passed, five airlines controlled 70 percent of the market. This has helped awaken political interest in consumer rights, but less attention has been paid to how airlines could wield market power to depress wages.”

So much for deregulation delivering more competition and better quality services….

And declining wages has not solved any problems in the airline industry.

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