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La ricetta keynesiana che non piace ai keynesiani

Wage stickiness and unflattering accounts of the unemployed and poor:

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Wage stickiness and unflattering accounts of the unemployed and poor

by  on July 19, 2015 at 1:35 am in EconomicsEducationFood and DrinkPhilosophy | Permalink
It is common for left-wing progressives to complain that conservatives serve up unflattering accounts of the unemployed and poor, such as by calling them “moochers” and the like.
But many versions of the standard Keynesian account, once we deconstruct them a bit, don’t paint such a flattering picture of the unemployed either.  In one Keynesian scenario, many of the unemployed have lacked jobs for years because they have sticky nominal wage demands.  Under one scenario, they could find jobs for $x an hour but won’t take the work.  If government policy could reflate the economy enough, those jobs in nominal terms would offer more and the unemployed would be in essence fooled into taking the offer.  The job would be paying the same in real terms, so the ex ante stubbornness is a big mistake, at least under this account of the matter.
Such a mistake is made throughout years of material suffering and psychological deprivation, including serious problems for one’s children.  Yet a mere nominal trick, by boosting pride just a bit, will move them back into a job.
It is of course a well-known stylized fact that, at least in America, unemployment rates for the poor and undereducated are much higher than for wealthier or better educated people.  So a general citation of “money illusion” won’t rescue the victims from the rather unflattering Keynesian portrait painted here.
Alternatively, the relevant mechanism may operate through the demand for labor, rather than the supply.  Perhaps low-skilled workers cannot be employed at lower wages because their resentment at the low wage would be so high that they would impose unacceptable morale costs on the organizations employing them.  In other words, insult them with a sub-par wage offer and they turn destructive toward the entire organization.  Companies of course prefer to keep these workers at arms’ length under this hypothesis.
If Charles Murray had come up with that hypothesis, he would have been savagely attacked for it.  Yet there is growing evidence, for instance from the work of Alan Blinder, that it is a major cause of wage stickiness.
Left-wing Keynesians are reluctant to acknowledge their own implicit unflattering treatment of the poor, which I should add came (in part) from snobby and elite British economists, including Keynes.  Often microfoundations are considered an embarrassing topic, and the emphasis is on “well, we know that wages are sticky,” with a desire not to look too closely under the hood, or to consider how those stories jive with other deeply held views, many of which try to raise the relative status of the poor and unemployed.
Bryan Caplan is consistent and is also happy to satisfy the publicity condition.  He believes in nominal stickiness as a driver of unemployment (under many circumstances) and he holds a relatively skeptical view of the decision-making capabilities of many (by no means all) of the poor.
The most flattering macro theories toward the poor, undereducated, and unemployed are the complementarity, increasing returns, and RBC “the poor are maximizing given some bad constraints” approaches.  Insider-Outsider models make the unemployed victims of exclusion who don’t even get a chance, rather than potential troublemakers ready to sabotage an enterprise at a moment’s notice.  The same can be said for Scott Sumner’s “musical chairs” account.  As for schools of thought, the rational expectations theorists provide the most flattering picture of the poor, yet in the context of macroeconomics they are very frequently mocked for their unrealistic assumptions.  Search theory models of unemployment, which for instance I have tried to promote, also paint a not unfavorable picture of the jobless, but they too are not very popular in the New Old Keynesian economics.  If I were to generalize, and yes there are many exceptions, but still I would say that these more flattering pictures of the unemployed are more likely to be associated with or embraced by the political Right.
Consistency is hard to come by, and probably always will be
- See more at:

When Keynesians want to gloat, they often point to the overwhelming empirical evidence in favor of nominal wage rigidity.  For the latest example, see Krugman on the Irish labor market.  Their unemployment is 14.5%, but the nominal wage index has only fallen by about 2.5%.  Krugman's conclusion:
It is really, really hard to cut nominal wages, which is why reliance on "internal devaluation" is a recipe for stagnation and disaster.
The gloating is easy to understand.  After all, nominal wage rigidity is the driving assumption of the Keynesian model.  Unemployment is just a labor surplus; since wages are the price of labor, the fundamental cause of unemployment has to be excessive wages.  And as long as the wage rigidity is nominal, you can neutralize it by printing money or otherwise boosting demand.

What's hard to understand, though, is Keynesian neglect of - if not outright hostility to - the logical implication of their argument: Wages must fall!  If they're right about nominal wage rigidity, it seems like "Wages must fall!" would be the mantra of all good Keynesians.  But few words are less likely to escape their lips.

Why would this be so?

1. Keynesians could say that nominal wage rigidity is such an intractable problem there's no point discussing it.  That's why Krugman emphasizes that "Ireland is supposed to have flexible markets -- remember, before the crisis it was hailed as an example of successful structural reform."  If wages won't even fall in laissez-faire Ireland, what hope does the rest of the world have?

There are two big problems with this story.  (a) Even if it's true, Keynesians should still militantly oppose any government policy - like the employer health care mandate - that increases labor costs.  (b) Government doesn't face a binary choice between conventional labor market regulation and laissez-faire.  There's a third choice: Low-wage interventionism.  If wages won't adjust on their own, why don't Keynesians ask government to actively push them down?  If that sounds too brutal, see Singapore forclever ways to numb the blow.

2. Keynesians could say that monetary and fiscal policy are easier to promote than wage cuts.  But Keynesians are the first to insist that fiscal policy is a valuable supplement to monetary policy.  Why not hail wage cuts as a valuable supplement to both?  At minimum, Keynesians should heatedly resist any government policy that pushes labor costs in the wrong direction - and remind us that "wrong" = up.

3. Keynesians could - and often do - retreat to the view that wage flexibility is a self-defeating solution to the problem of wage rigidity.  The idea is that wage cuts reduce demand, which in turn exacerbates unemployment.

But this argument is full of holes.  As I've pointed out before, there are strong reasons to think that wage cuts will increase aggregate demand, making this solution doubly attractive.  Consider: Labor income equals wages multiplied by hours worked, so the effect on labor income is ambiguous; and as a matter of pure arithmetic, lower wages imply higher profit income.  In any case, if nominal wage cuts really are as rare as a blue moon, what makes Keynesians so sure that wage cuts would backfire if tried?  Without lots of empirical counter-examples, they have every reason to stick to the common sense position: "If wage rigidity is the cause of unemployment, wage flexibility is the cure."

At this point, Keynesians could just bite the bullet: "Wages must fall!"  But in my experience they don't - and I don't think they're going to start now.  The reason, I'm afraid, is politics.  Keynesians lean left.  They don't want to say, "Wages must fall!" They don't want to think it.  "Wages must fall!" sounds reactionary - a thinly-veiled reproach to centuries of anti-capitalist intellectuals and militant unions.  After all, doesn't it mean that every "pro-labor" regulation and "victory for the workers" has anugly downside - more workers unable to find any job at all?

Keynesians are right to ridicule people who deny the reality of nominal wagerigidity.  But they'd be a lot more persuasive if they put leftist qualms aside and focused on the logic of their own model.  Keynesians have every reason to rant against excessive wages.  They have every reason to rant against regulation that increases labor costs.  They have every reason to rant against unions.  And there hasn't been a better time to rant since the Great Depression.  Oh my Keynesian brothers and sisters, let us rant together.

P.S. I'm doing a Stossel taping in NYC tonight (12/15).  The show won't air until January, but I'm hosting a meet-up after the show at 10 PM, at Becco - 355 West 46th Street.  Hope to see you there.

Labor Market Rigidity: Psychology, Technology, and Peter Pan

Real Wages During the 1981-82 ...David Friedman on Robert Frank...
Back in 2008, some of my favorite economists argued that unemployment wouldn't rise much, even if there were a big nominal shock.  Why not?  "Labor markets aremore flexible than they used to be."  Why?  That was a little hazy, but the main reason seemed to be better management due to more advanced information technology.

I never bought this story, and unfortunately, as David Henderson points out, I wasright.   Today's firms do have better management and more advanced information technology than they used to.  But the most important cause of labor market rigidity,at least in the U.S., is psychology.  People resent wage cuts, especially nominal wage cuts.  This resentment varies over place and time, but even economists feel it.  The awful unintended consequence of this resentment: Employers cut employment instead.  If you talk to employers off the record, they often explain that wage cuts hurt productivity by angering workers, but lay-offs raise productivity by scaring them.

Why was I so skeptical of the view that labor markets had changed?  Because cutting wages when labor demand falls isn't rocket science.  You don't need computers or just-in-time inventory systems to do it.  You don't even need a calculator.  Just cut wages by 2 or 3 percent, and see what happens.  The upshot: If workers didn't have a knee-jerk hatred for wage cuts, especially nominal wage cuts, employers would have solved the unemployment problem millenia ago.  And given this knee-jerk hatred, all the computing power in the world isn't enough to stabilize unemployment in the face of big nominal shocks.

Is labor market rigidity a market failure?  I'm afraid so.  But strangely enough, this market failure is largely caused by anti-market bias!  The main reason workers hate wage cuts is that they imagine that wage-cutting employers are satanically "unfair."  If workers saw wage cuts for what they are - a full-employment mechanism - they'd sing a different tune.  While they wouldn't be happy to see their wages cut, they'd grudgingly accept that a little wage variability is a fair price to pay for near-total employment security.  Once this economically enlightened perspective took hold, employers would eagerly cater to it - and the market failure would largely go away.

According to Peter Pan, "Everytime a child says 'I don't believe in fairies,' there's a little fairy somewhere that falls down dead."  As far as I know, he's wrong about fairies.  But if Peter had warned, "Everytime a person says, 'I don't believe in markets,' there's a worker somewhere that loses his job," he wouldn't have been far from the truth.  Scoff if you must!  People can and do cause market failure by believing in it.

On Thursday, Casey Mulligan lectured on his The Redistribution Recession at GMU.  Lots of interesting, neglected evidence on the spike in labor market distortions since 2007.  Yet the talk was marred by Mulligan's commitment to a market-clearing model of labor markets.  When pressed, he was quite insistent that given the expansion of the safety net, the unemployed do not want to work at the current market wage.

To be fair, Mulligan explicitly disavowed the view that the unemployed are happy about their situation.  But in his view, the unemployed would be even less happy to keep doing their old jobs for prevailing rates of compensation.  Unemployment's bad, but so are wage cuts.

Why should you reject Mulligan's view?  There's the obvious fact that wages don'tfluctuate like stock prices, even in the face of large shocks to the labor market.  The best argument, though, is introspection.  Ask yourself:

When someone gets laid-off, what is his main emotional reaction likely to be? 


When someone gets a nominal wage cut, what is his main emotional reaction likely to be? 


In Mulligan's model, lay-offs and wage cuts are two sides of the same coin, and workers should respond identically.  But of course they don't.  Part of the reason is that - especially during recessions - labor markets don't clear.  People who keep their jobs are lucky, earning above the market-clearing wage.  The rest are unlucky, and often struggle for months or even years to find a remotely comparable position. 

Yet there's more psychology going on.  When you're laid-off, you feel exiled from your group.  You're rejected, unfit, unworthy.  Many people in this situation break down and cry.  When you face a pay cut, in contrast, you feel betrayed by your group.  You're insulted, snubbed, scorned.  You might weep, but you're more likely to crumple up the memo explaining the pay cut and hurl it in the trashcan.  Especially during a recession, you probably won't be brave enough to quit in retaliation; instead, you'll shave the quality of your work to extract a petty revenge.

Most Keynesians will probably see Mulligan's market-clearing model as an excuse to reject everything he says.  But this is hasty and unfair.  There's no reason why we can't (a) admit that labor markets don't clear during recessions, yet (b) insist that expanding the welfare state seriously retards the labor market's naturally sluggish adjustment mechanism.  Keynesians' benign view of governments' "response" to the Great Recession is not implied by their model.  Indeed, the Keynesian model specifically implies that Keynesians should look upon new labor market distortions with anger, or at least sorrow.