There are nominal rigidities in Indian villages too

Supreet Kaur has a new NBER paper on this:

This paper tests for downward nominal wage rigidity in markets for casual daily agricultural labor in a developing country context. I examine transitory shifts in labor demand, generated by rainfall shocks, in 600 Indian districts from 1956-2009. First, there is asymmetric adjustment: nominal wages rise in response to positive shocks but do not fall during droughts. Second, transitory positive shocks generate ratcheting: after they have dissipated, nominal wages do not adjust back down. Third, inflation moderates these effects, enabling downward real wage adjustments both during droughts and after positive shocks. Fourth, wage distortions generate employment distortions, creating boom and bust cycles: employment is 9% lower in the year after a transitory positive shock than if the positive shock had not occurred. Fifth, consistent with the misallocation of labor across farms, households with small landholdings increase labor supply to their own farms when they are rationed out of the external labor market. The results are not consistent with other transmission mechanisms, such as migration or capital accumulation. These findings indicate the presence of rigidities in a setting with few institutional constraints. Survey evidence suggests that workers and employers believe that nominal wage cuts are unfair and lead to effort reductions.

There are ungated versions here.  I am often puzzled, by the way, that we do not spend much more time studying nominal rigidities, which are the source of rather considerable deadweight losses.   We do not find nominal rigidities everywhere.  Salespeople working on commission often have flexible wages, as do (some) people working in high-trust, high morale organizations.  What exactly accounts for these differences and how much can they be replicated?  What are their psychological costs?  Are there personality types which can deal with nominal flexibility of wages and types who cannot?  How frequent is one type relative to the other?  How do the psychological costs of a wage cut compare to the psychological costs of suffering losses when running your own business?  Questions such as these should be much higher on the list of research priorities.

Comments

But why should wages/incomes be flexible when debt is not?

Clearly any economist arguing for wages falling rapidly in response to shock must likewise argue that debt principle balances be reduced just as rapidly.

If you are arguing that wages fall rapidly but not debt principle balances, then you are arguing for a debt-less economy - no income can be used as debt collateral because the income is not stable. Bankers require wages to be rigid for banking to function.

Mulp writes:

> Clearly any economist arguing for wages falling rapidly in response to
> shock must likewise argue that debt principle balances be reduced
> just as rapidly.

Mulp, you have not spent enough time with the Austrians, who will happily argue that we ought to let wages fall while preserving nominal debts. They have a moral argument that debtor and creditor entered the contract with eyes open, so the contracts should be enforced. They have an economic "argument" that markets are always optimal; therefore, in a depression, debtor ruin and a Fischer debt-deflation spiral is optimal. (I obviously do not agree with them.)

But this whole question you raise (what to do with debts if wages fall) is based on the assumption that wages can fall. Downward nominal wage rigidity is a fact, so the question of what to do with debts in a falling-wage environment is counterfactual. I run a team of over 400 software engineers, and I can tell you how often we go to someone and say, "great year! You met all your goals and delivered high-quality work. In return, we're only cutting your salary 3%!" Answer: never. This just does not happen. When companies in my industry (software) have to cut costs, they lay people off. They do not reduce nominal pay under any circumstances. It's quite literally unheard of. I get so frustrated. Why do we have to debate the existence of downward nominal wage rigidity?

-Ken

Kenneth Duda
Menlo Park, CA

So you lay people off, during a recession. They either are on unemployment or accept another job at 75% of former wages. All you are doing is concentrating the salary cut. Same result, but you now don't need to see it every day.

I personally think layoffs are a better way, you get rid off the least effective people, but I doubt that concerns you.

As anybody who has run a business outside of a large corporation (where there is always fat) knows, as I have, there are no sticky wages, and, if they exist, they are small and transient and do not transmit depression.

Source: "If wages possess some degree of nominal rigidity, then falling output prices will raise real wages and lower labor demand. Downward stickiness of wages (or of other input costs) will also lower profitability, poten-tially reducing investment. This channel is stressed by Eichengreen and Sachs (see in particular their 1986 paper) and has also been emphasized by Newell and Symons (1988). The reliance on nominal wage stickiness to explain the real effects of the deflation is consistent with the Keynesian tradition, but is nevertheless some-what troubling in this context. ... The case for nominal wage stickiness as a transmission mechanism [for worldwide depression during the Great Depression] thus seems, at this point, somewhat mixed." - The Gold Standard, Deflation, and Financial Crisis in the Great Depression: An International Comparison Chapter Author: Ben Benanke, Harold James, http://www.nber.org/chapters/c11482

You can count on Ray to say dumb sh*t

The overall wages, from all employers to all employees, are already flexible. If there has been a shock, there is less wealth to go around, and that is going to lead to less pay overall. (Other things being equal.) The question is whether this flexibility comes only from layoffs or from a mix of different sized reductions for different people.

From the point of view of lending, the difference is between seeing a borrower as having, say, a 5% chance of a catastrophic, total loss of income versus seeing them as having only a 1% chance of that, but also a 1% chance of a 10% pay cut, and a 1% chance of a 20% pay cut, ... In either case the flexibility is part of the lending decision.

But why should wages/incomes be flexible when debt is not?

1. Debt can be avoided or at least kept well below ones ability to pay back.
2. If for example you have a flexible interest rate your payments will tend to fall in a bad economy and so some flexibility in debt is available.
3. You may be able to insure against falling income.

And that house I bought from you 10 years ago, I want 20k off.
Difference is that debt was already incurred. Salary is in the future.

Tyler, could you comment on the implications of downward nominal wage rigidity on optimal monetary policy? Would it be interesting to come up with a model to test if overall welfare is improved by raising inflation targets during periods of slack demand or high unemployment, compared with a fixed 2% inflation target or ceiling? Would it be interesting to test the impact of NGDP targeting on overall welfare compared with inflation targeting? Or should we stick with the neoclassical assumption that all unemployment is voluntary, because naturally, after a high-demand growing season where there is upward wage pressure, the next season the workers are all tired out and so they are choosing leisure over working for the market-clearing wage? (Sigh)

-Ken

Kenneth Duda
Menlo Park, CA

How's this for a radical idea - instead of fixating on price inflation, how's about targeting WAGE inflation (which was the whole point of the original version of the Phillips curve, anyway) - since it's wage stickiness that matters.

Just as for variable investment income with stocks having a higher return than bonds one would expect variable labor income to have a risk premium so it is cost effective for employers not to drop wages in most occupations rather than pay higher average wages.

I get the impression that in recent times more compensation has been coming from discretionary bonuses linked to business performance, certainly in managerial and professional areas; see http://www.washingtonpost.com/blogs/on-leadership/wp/2014/08/27/bonuses-are-making-up-a-bigger-and-bigger-percentage-of-companies-payrolls/

As Tyler says bonuses seem to give the managers of the firm an easy way to cut compensation in hard times, since bonuses are by definition not firm. So should we not see less unemployment in the recent downturn than in the past? Maybe this is part of the reason for the UK's recent employment success, which is hitting new highs despite overall compensation falling in real turn. The UK has an usually large financial sector, where bonuses are more prevalent, so perhaps this is more obvious there than in other countries.

Two cents on the psychology of it all.

Flexible wages are psychologically possible when:
1) The award is clearly aligned with metrics you control (e.g. sales people)
2) In a very high trust environment (where you trust that wages will increase with company performance as well)

From a psych standpoint, the major shortfall we see in the American economy is a lack of trust. I know I don't trust any corporation to take my interests into account. In fact, it's their goal to pay me as little as possible. By assenting to lower flexible wages, most corporations would take that as a sign that the wages do not have to increase, even when performance rebounds.

Beyond that, most employees do not have clear metrics of success that they control.

We also see significant wage flexibility in management positions around bonuses -- discretionary and performance based. However, there is pretty wide ranging agreement that bonuses do not result in higher motivation or better long term outcomes -- and may stifle creativity.
https://www.youtube.com/watch?v=u6XAPnuFjJc
https://hbr.org/1993/09/why-incentive-plans-cannot-work

From a psych standpoint, the major shortfall we see in the American economy is a lack of trust. I know I don’t trust any corporation to take my interests into account. In fact, it’s their goal to pay me as little as possible. By assenting to lower flexible wages, most corporations would take that as a sign that the wages do not have to increase, even when performance rebounds.

But why do you not believe that they see that if they do not pay you enough, you will be compelled to leave at their loss? You either do not trust them to know what is in their own best interest and see value in keeping you or you fear that you really are overpaid and so will take the bigger loss on separation.

Salespeople working on commission often have flexible wages, as do (some) people working in high-trust, high morale organizations.
In 2008 I saw few stories about "open books management" that said employees in organizations that used open books management preferred lower pay to layoffs. This indicates to me that layoffs are due secrecy and a lack of trust. There seems to be little down side to openness yet it seems under practiced.

In terms of psychology, well, we all know that salespeople are slimy assholes, right? I exaggerate for effect, but I have definitely noticed a common element through 85%+ of all salespeople I have interacted with (as a customer or potential customer, as a coworker, and in purely social environments), which is this grating sense of self-regard, of intense competitiveness, and of being "always on." This despite the fact that salespeople tend to be friendly, charming types (or at least, successful ones do).

I believe -- without, I admit, formal evidence -- that this is a psychological type that is okay with commission-based compensation, and which is reinforced by such compensation. Commission-based compensation is really insecure! I would never be comfortable with commission-based compensation.

Look at this from the game theory perspective: When people are paid a salary, and another job is available somewhere else, it never pays to be the first to do salary cuts.

Anything that is detrimental to employee retention, like a salary cut across the board, will make a company lose their most valuable people first, because they have an easier time finding another job. So lowering your retention rate is lowering your overall skill pool pretty drastically. Add to that secondary effects, like how good people will enjoy their work less when other good people leave, and anything that loses good people can be very damaging to an organization. And those people that leave will go to competitors, which now are offering comparatively better wages.

We see that problem in industry all the time, especially in middle management positions. An entire 'caste' of people that are promoted past their competency will never leave willingly, and they block the way of promotions on organizations that are not growing. The first HR person you hired becomes the head of HR by default. First programmer is the CIO.

Instead, we se companies just lay off staff. Then the company has a semblance of control over the people that leave. A good layoff of unproductive people will not really hurt production that much: The people that stay will cover for the missing employees. Cut too many, and you will lose some of the good employees due to overwork, and then you are in trouble again though. What we end up seeing is companies that either stop hiring, or where new employees are all getting paid quite a bit less than those that have been there for a bit. It's quite the opposite of what we see in the good times, where the best way of getting good compensation is to job hop.

So if monetary policy instead manages to lower everyone's salaries at once, through inflation, then we beat the first mover problem.

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