Tyler Cowen’s recent blog post (“How are nominal wages sticky for the unemployed“) has stirred up quite a discussion on the blogosphere. I thought it proper for an “Austrian” to intervene and offer an opinion from what I think is a fairly unique perspective. This is written on the spot, so I apologize for any confusions or minor mistakes; I hope my general point is understood.
The point of Cowen’s post is difficult to distill. But, I think he is trying to point out a weakness in the “standard Keynesian theory”, in that the unemployed are not really the workers who contribute to any form of wage stickiness. That is, the unemployed are oftentimes willing to work for whatever wage they are offered. The workers who contribute to wage stickiness are the employed, since these are the ones actually earning what Cowen refers to as the “total wage bill” — that is, total aggregate nominal (money) demand is being distributed only to the employed. This may go in conjunction with his hypothesis that the unemployed have a zero marginal product — this is Paul Krugman’s accusation, at least (he wrongly attributes it to the Austrians).
The responses to Cowen have been mixed. Brad DeLong argues that wage inflexibility indeed does play a major role in the creation of mass unemployment, also criticizing what he calls the “Hayekian view” of blaming government institutions on wage inflexibility (and, as a result, largely missing Cowen’s actual point). I feel that Arnold Kling also misses the point, as he agrees that wage inflexibility does not play a major role in the current recession, when I don’t think that’s what Cowen was arguing at all. Scott Sumner is probably more on target than either DeLong or Kling, although he (as I) finds it strange that, if we accept the premise of wage inflexibility, wages are taking so long to adjust. He suggests it has to do with lack of adjustments to more recent macroeconomic problems (whatever those may be).
Cowen’s actual point is fair (although, I am not entirely sure anybody ever disputed it). Those who, in the Keynesian paradigm, affect wages are those who earn them, not those who do not. I think, though, that the problems with any theory of unemployment that rests with natural sticky wages (that is, natural to the market and not a market pervaded by government protectionism) is explaining how the workers have any say. For the most part, I have seen references to labor contracts, but labor contracts — like any contract — can be broken. Today, what disallows firms the flexibility of breaking contracts are the added costs to breaking them by government. This includes the red tape, the added costs of reparations to the worker, and the increased costs of hiring new workers. Oftentimes, it makes more sense to keep an old worker at the same wage than hire a new one, because the costs of doing all of this exceed what money could be earned by paying a lower wage.
This also serves as a response to DeLong. It’s not just a problem with unions, cartelized agreements to prop up wages, or minimum wage. There are various institutional factors which make wage adjustments very inflexible. This should almost be taken for granted, since the modern market is highly regulated — especially the labor market.
I think, though, that Krugman is right in rejecting Cowen’s suggestion that the unemployed suffer from zero marginal product (excepting the role of diminishing marginal returns and the limit to firm expansion in times of depression, any amount of workers can be employed at any level of productivity if wages are low enough). His own rationale, however, is flawed. I think the picture could be made much more accurate by looking at the issue from an Austrian angle. Specifically, I mean if we considered the labor market in conjunction with the structure of production in general, as I suggest in my recent article “Rethinking Depression Economics“.
I am not assuming away wage inflexibility, by the way. I just don’t think that the worker has much say in his wage, except if he empowered by the government. Otherwise, the worker is largely dependent on the employer honoring the contract (and, we should also consider that labor contracts would probably look substantially different if there were a free market in labor). I think there is a degree of “price stickiness”, and I think it is inherent in the theory of price formation. The fact is that the employer will have to weigh the causes of a loss in profitability, and then will have to decide what actions to take to return profitability. This includes lowering wages, but it would be naïve to assume that the employer exercises perfect information. This suggests some short-term wage inflexibility.
This leads me to my greater point. The recession is a period of price and good restructuring. The structure of production is changing in accordance with consumer demands during a period of great chaos and uncertainty. Many investments are being liquidated, and some are being partially liquidated. This will create unemployment, and wages will have to adjust accordingly. Short-term price inflexibility plays a role, but so does the fact that the labor market is tied in with the general market, especially the capital goods market. The productive employment of individuals also relies on the productive employment of capital goods.
What do I blame continued unemployment on? Institutionally-caused inflexibility on wage prices and sub-par productivity caused by continued government intervention in the economy. Without government’s artificial obstacles, I think the labor market would have cleared relatively soon after the initial collapse and the economy would be well on its way towards full recovery (if not already there).
Most will probably disagree with me here, but I think that most economists subtlety agree with my thesis here. I think, though, that most of them simply ignore it in favor of focusing on aggregates. The problem, for instance, is wage stickiness and aggregate demand. Some call the former a “microfoundation”, but there really has been little attention as to why prices are sticky and what this really means. Aggregate demand also assumes the necessity for restructuring, but those who think in terms of AD pay little attention to the way the restructuring takes place (economization of resources by individuals), and thus do not realize the implications of what are really counter-productive fiscal and monetary policies. Besides, few people are willing to openly admit that the problem is not aggregate nominal (money) demand, but the employment of capital goods (which is why biggest criticism of those who support nominal income targeting [since the problem is not nominal income]).