Bryan Caplan  

Nominal Wages and Behavioral Postulates

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Tyler's not satisfied by the traditional nominal rigidities explanation for continuing high unemployment:

It's also the case that the rate of new job creation has been especially low.  Yet the nominal wages on those jobs-to-be are not constrained by previous contracts or agreements.  Tell stories as you may, but it's hard for me to see that as exclusively an AD problem.

I wonder what is the behavioral postulate for how long all these unemployed workers are all staring jobs in the face yet persistently stubborn about their appropriate nominal wage.  I'm all for behavioral economics, but I don't buy the necessary story here.

In my view, the main problem isn't that unemployed workers are "stubborn" about their nominal wages.  The crucial "behavioral postulates" are rather that:

1.  Hiring new workers for lower wages provokes resentment and resistance from existing employees - the classic insider-outsider mechanism.

2. At this point, the unemployed will probably say "yes" to jobs even if they they perceive their nominal wages as "unfair."  But after a brief honeymoon period, these new workers would probably have low morale.  This wouldn't just hurt their productivity; it would also bring down the productivity of their better-paid co-workers.

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COMMENTS (5 to date)
bill woolsey writes:


I don't disagree with what your arguments here.

But, I had one addition. Suppose that the firms believe that soon (who knows exactly when) nominal expenditures will rise?

Does a firm want the reputation of taking advantage of market conditions to exploit workers, when before long, nominal demand will rise and you can hire them all back at fair wages?

If the decreased nominal expenditure was known to be permanent, perhaps the profit of "taking advantage" of workers would become tempting.

If the low nominal expenditures persist, so that it is begining to look permanent, perhaps the same is true.

If, on the other hand, you are used to nominal expenditures dropping for six months or a year, and then rapidly rising again, why go through a bunch of conflict for maybe a few months of gain?

If nominal expenditure falls, and then doesn't rise like usual, or just falls and falls, then the response of just waiting it out looks like a mistake.

My "solution" is to keep nominal expenditures from falling and if the do fall, raise them back ASAP.

But I do think this policy will make wages more sticky than they would be if people thought there was a good chance that decreases in nominal expenditures are permanent.

John Thacker writes:

I understand the theory and largely agree... but wouldn't we see small and new businesses and outsourcing and temp agencies filling the gap and hiring at the lower wages?

Ted writes:

Why in the world would I care if my employers hired someone new for a lower salary? I might care if an equally qualified new hire for the same job got a higher wage than me (hey, I've been here longer!), but why would I care if he got a lower salary? In fact, my employer just hired 3 new people at lower wages than the rest of us and I, nor anyone else currently employed, particularly cared. Granted, I'm just in high school so I'm doing unskilled labor so the wage differential in absolute terms is rather small, but I don't think I would care even if we were talking about much larger absolute differentials. I would imagine a new recruit might resent being hired at a lower wage, but I certainly wouldn't care.

I don't have time to read that paper you linked too, but on a brief skimming it doesn't seem to provide any evidence of insider-outsider mechanisms working when the new hire is receiving a lower wage. Perhaps you could highlight the passage that suggests that since that results makes no intuitive sense to me. It would only seem to make sense if the new hire got a higher wage.

Also, on the topic of explaining why people aren't being hired I have a small theory that I've been thinking about for a bit that I've love to explore more formally. I think, for the most part, producers and employers are largely inattentive when times are good (I'm adapting some thinking from the "rational inattention" literature)- because that seems to be human nature. If you really wanted to be "formal" about it, you can argue that information-processing for improving your business plan is "costly." They don't update their business models; prices respond slowly to monetary policy etc. I argue, both from common sense and experience, that inefficiencies in a business build up over time. Small inefficiencies here, small inefficiencies there etc. And over time they build up to something substantial. In the good times, producers and employers don't notice these because their bottom line is still good - humans are habit-forming / inattentive and so when the bottom line is positive and your inefficiencies don't matter, you are unlikely to evaluate your business plan - the cognitive and effort costs are too high for you. So, what does a recession do? A recession is a bit like a shock to the business model, particularly in more severe recessions. All of the sudden the producer realizes his bottom-line is potentially threatened by the recession so he scrambles to find ways to improve his firm and keep output and profits up. In other words, it's only worthwhile to pay the "cost" of information processing when a recession hits. Suddenly he discovers he's let all this wasteful stuff build up. Why am I using this phone company when this one is cheaper? Why are these two idiots still here, they have never contributed anything to the company? Why am I still using this outdated old technology when the new technology is better? All of those things would increase efficiency, and so the response of employers to new hires would be muted because they simply wouldn't need them. Hiring would only increase as more employees are needed as more demand exists (so there is a partial aggregate demand story), but because they are so much more efficient you need more aggregate demand than a historical-perspective from the recent boom would suggest.

It would be relatively straight forward to include the idea of firm inefficiencies accumulating due to rational inattention in the Reis / Mankiw / Sims-type framework and I think it would be something worthwhile. Whether or not this idea is correct is an empirical question that would likely be difficult to capture in the data (one might have to resort to the dreaded SURVEY!), but I think the idea is intuitively plausible.

Tom writes:

"I understand the theory and largely agree... but wouldn't we see small and new businesses and outsourcing and temp agencies filling the gap and hiring at the lower wages?"

It's called the Obama Uncertainty Tax. A small business would be crazy to hire now when they have no idea what is happening to health care, corporate taxes, cap and trade taxes, capital gains taxes, and whatever other business unfriendly things that are happening.

Ano writes:

Mr. Caplan,

What you're describing almost sounds like the opposite of "efficiency wages," in that paying people less actually causes them to be less productive.

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