Arnold Kling  

Wage Freeze for Government Workers

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If Josh Barro had not written this:

As states and localities continue to fight budget crises, they have an opportunity to close gaps by freezing employee wages. Because public employee compensation rose too fast over the last three years, they should be able to do this while retaining quality employees at least as well as they could back in 2006.

then I would have. It's crazy to be giving people pay increases in the teeth of huge deficits. Thanks to Scott Sumner for the pointer. Sumner takes the opportunity to tell the sticky-wage story of macroeconomic fluctuations.

there is a coordination problem. If you are a factory worker you can't save you job merely by making your wage flexible, you need to make all wages flexible.

This idea of sticky wages as a co-ordination problem was being batted around when I was in graduate school (and probably long before that). I mentioned it back in lectures on macroeconomics, in lecture 4.

If you want to increase employment, I think that wage cuts would work pretty well in the public sector. Public sector expenditure is pretty well set in nominal terms, and government services are quite labor intensive. I would expect that, to a first approximation, 10 percent lower nominal wages in the public sector means, other things equal, 10 percent more public sector employment.

As far as I can tell, any argument for more government spending to reduce unemployment in this recession can be turned into an argument for lower salaries for government workers.

In the private sector, things are not so clear. If we cut construction-worker wages by 10 percent, could we have 10 percent more construction workers employed? I doubt it. We have an excess inventory of housing units to work off. And the unemployed construction workers are not going to be buying the output they would normally buy from other firms, so you get multiplier effects. In that sense, some amount of private sector unemployment is due to recalculation, and wage cuts cannot provide a complete cure.

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CATEGORIES: Macroeconomics

COMMENTS (2 to date)
mulp writes:

The easiest way to reduce wages is to change the currency exchange rate so imports are more expensive.

The US, like Haiti, needs imports to support needed consumption, and to pay for the imports, money must be borrowed from outside the nation because too little is exported, hence the idle labor force.

If imports are made expensive enough, firms will instantly magically make American workers as good as Asian workers at things like making the actual packaged chips or designing and injecting the high precision plastic parts for such things as cell phones and ebooks and HDTVs.

After all, to an economist and MBA, a worker is just a commodity and they require no human capital built up over years of work.

Oops, the natural world doesn't obey the economist's rules, and it will require decades of spending with little or no return in order to reduce imports and by doing so employ the idle labor in producing that which is consumed.

What is ironic is that the thing that keeps the exchange rate so unfavorable is the failure of the US government to default on its debt, so its debt represents the most highly sought after export, bonds that will never fail to produce the promised return.

To improve the US economy, what economists must do is convince the world that this time is different and the US government is going to default, and with that default, US banks and firms will also most likely default. That will affect the exchange rates to reduce wages by 10% at least, and with it the prices of local goods while jacking up the prices of imports and driving down the prices of exports.

John Thacker writes:
After all, to an economist and MBA, a worker is just a commodity and they require no human capital built up over years of work.

Not to an economist. What you've stated is what a protectionist believes. Only someone who believes that free trade will lead to all jobs falling in wages or being outsourced would believe that there's no such thing as human capital. Economists are sanguine about the effects of free trade because they believe in human capital.

You've quite correctly identified that restricting imports would lower US wages, though.

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