Larry Kotlikoff on wages and sarcasm

He wrote:

Some prices and wages are set too high, thereby damping demand for output and for the workers needed to produce it. This is the standard sticky wage and price explanation for our economic malaise offered by Keynesian economists such as Paul Krugman and James Galbraith. I think there are fewer markets suffering from this problem than Krugman and Galbraith do, but there are enough such markets to make the case for government intervention. Indeed, the president should put these economists in charge of identifying the markets suffering from this problem and helping their participants set market-clearing prices and wages.

Via Mark Thoma, Jamie Galbraith objects to his cited role, and Paul Krugman piles on.  Three points:

1. Call me strange, but I read Kotlikoff as being sarcastic in this passage, especially in the last sentence, objecting to the pretense of knowledge which he sees as embedded in some extreme forms of Keynesian doctrine.  To respond to this criticism with a straight yet outraged face is to miss the joke and arguably at the same time to validate it.  Kotlikoff is not actually suggesting that Krugman and Galbraith rule a new wage and price commission (surely that proposal and its specificity is the giveaway, no?), or implying that Krugman and Galbraith see price flexibility as the answer to our macroeconomic problems.  He may, though, be wondering why they do not, which brings us to:

2. The “New Old Keynesians” repeat the Great Depression point that lowering wages will be destabilizing.  During the Great Depression, there was a large negative nominal shock, nominal wage reductions for a broad swathe of the employed labor force in response, and a downward spiral of wages and prices, at least for a while.  Fair enough, and one can model that coherently.  Today we are talking about trying to lower reservation wages for 2-4 percent of the wage force, namely some of the currently and non-naturally unemployed.  That is with a central bank which has set a fairly credible floor on nominal values.  To criticize these targeted (potential) wage cuts by citing the Great Depression, or relevant models thereof, is a non sequitur.  In fact it’s hard to find a good argument against such proposed targeted cuts; the best response is to cite excess capacity and claims the cuts won’t work but then they won’t lead to harm either.

3. Kotlikoff’s subsequent explanation of his stickiness point is on the mark and is not contested: “One example [of a stickiness] is the market for construction workers. A 1931 law called the Davis-Bacon Act effectively requires contractors using federal money to pay union wages. If the act were suspended or repealed, federal spending on much-needed infrastructure projects could create a lot more jobs. ”

4/5 of Kotlikoff’s piece is good.  I don’t like his idea of “…assembling in one room the CEOs of the largest 1,000 U.S. companies and getting them to collectively pledge to double their U.S. investment over the next three years.”  Does everyone have to double?  Relative to what benchmark?  What about the companies which are losing money or going under?  What happens if a company breaks its pledge?  Are they allowed to fly their private planes to the meeting?  Do those with the biggest pledges get to sit next to the President?  And so on.  In the longer run, I don’t think it helps to politicize investment decisions.


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