Arnold Kling  

Discontinuities

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Bryan writes then when technological change occurs, we should observe


Cut wages in existing industries drastically enough to keep firms afloat and workers fully employed.

That is true for small changes. Mathematically, it assumes continuous functions.

It may not be true for large changes. Suppose that somebody brings a tractor to a farm, so that the farmer can do the work himself without the help of hired labor. The marginal product of the worker might now be below the subsistence wage.

Tyler Cowen uses the acronym ZMP to stand for Zero Marginal Product. The point is that new production methods can drive the marginal product of existing workers way down. Firms also face non-wage costs (e.g., health insurance) of retaining workers.

Even with discontinuous changes, the phrase "drastically enough" can be invoked to suggest that wage cuts could cure unemployment. But suppose that "drastically enough" means 25 percent or more. If you want to say that the PSST story of unemployment depends on wage stickiness because such a large wage reduction could take care of things, then fine. You have scored a debating point without practical significance.


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COMMENTS (9 to date)
Mike Hammock writes:

I know it's pedantic, but it bothers me that Tyler Cowen says "Zero Marginal Product" when he really means "Marginal Revenue Product is less than Marginal Factor Cost".

[typo fixed, menas to means--Econlib Ed.]

Becky Hargrove writes:

Mike,
Good point, and ultimately, capital or labor in any given situation will continue to be a choice. The added benefit of production efficiency is not the only way to approach any economic activity, and there will be times when people choose the "low" production option as a way to fulfill their larger goal in which monetary efficiency is but part of the equation. Ideally, the "low" efficiency option would be something that they enjoy doing, and that they are capable of carrying out.

andy writes:

What does AS/AD have to do with nominal wage rigidity? You can easily claim that nominal wage rigidity is what is causing the problems, while thinking that AS/AD is not a proper way to model economics.

BTW: are we talking about nominal wage rigidity of the employees or of wage rigidity of the unemployed? Considering that Bryan mentions 99-week unemployment benefits, I would conclude that we are speaking about wage rigidity of the unemployed; but that has absolutely nothing to do with AS/AD..?

david writes:

This won't work - if your response is that there are discontinuities prohibiting continuous general equilibration, then those same discontinuities would trap entrepreneurial search over the production possibility space. There would easily be no way for even a potentially successful pattern to grow (PSST) if there is no market pressure for a potentially sunset industry to shrink (Caplan's point).

In short: it harms the search for PSST as it does the standard Walrasian t√Ętonnement.

Nathan Sumrall writes:

Andy,

"What does AS/AD have to do with nominal wage rigidity?"

In the AS/AD model, AS and AD determine the price level and the level of output, which itself determines the level of employment (just enough to produce the level of output determined by AS and AD).

The noninal wage rate depends on the price level and level of employment, and thus ultimately on AS and AD.

andy writes:

Nathan...

To make his story work, Arnold needs the very assumption he's trying to escape: nominal wage rigidity. With nominal wage rigidity, innovation affects employment and output, not just wages - and old industries contract before entrepreneurs discover greener pastures. But if Arnold makes this move, PSST becomes a fruitful add-on for AS-AD, not a radical new approach.

What I say is that you don't need AS/AD to claim that wage rigidity causese unemployment. It is perfectly consistent to claim that AS/AD does not model economy correctly, yet agree that nominal wage rigidity is a problem.

Mark Michael writes:

Re: the last paragraph:

"Even with discontinuous changes, the phrase 'drastically enough' can be invoked to suggest that wage cuts could cure unemployment. But suppose that 'drastically enough' means 25 percent or more. If you want to say that the PSST story of unemployment depends on wage stickiness because such a large wage reduction could take care of things, then fine. You have scored a debating point without practical significance."

But don't use this as an excuse to not recognize that labor is subject to the law of supply & demand as are other inputs to the production process. Listening to Fed officials & others comment on our 9% unemployment rate, you'd think wages in America are so "sticky" that they are either totally inelastic or they're outside the Law of S & D.

Consider that to reduce unemployment from 9% to 5%, we'd need a net drop in general wages of 4%. Is that so large it's unthinkable? Off the table? Take one of the "stickier" wage rates - our 22 million government workers. What if they had 5% of their wages as end-of-year bonuses which they'd get only if their wasn't a recession and their agency's productivity was above some metric. Would that be so terrible? Wall Streeters get big chunks of their income as bonuses. Ditto in Silicon Valley - stock options or income in the form of stock.

I think I saw an article in the WSJ saying that 55% of American workers had flexible wages. Rust Belt companies like Lincoln Electric, Nucor Steel, pay their workers huge bonuses when the company is profitable that can nearly double their base pay.

Another thought: When China & India were able to compete with their American counterparts in industries such as software development, technical support, & (of course) manufacturing the labor market segment involved suddenly was greatly expanded. That should drive down the price of labor across the board. Blame it on satellite communications, efficient transportation, etc.

Labor has become more & more a global market. Yet, at least the public discussion by elite opinion makers, pols, and Fed officials seem to ignore the simple Law of S & D as applied to it.

Andrew writes:

I think Bryan wins this one. In the real world the tech and PSST changes that we have experienced are not so extreme that there exists no decrease in wages which would return us to full employment, which leaves wage stickiness as the mechanism.

PSST is a great augment to AS\AD; indeed PSST tells us why the worker's wages need to fall, but it doesn't explain why he is unemployed, for that we need nominal wage stickiness.

bryan willman writes:

@andrew - i wish to repectfully disagree.

i assert that there are substantial numbers of people and firms who have been rendered entirely redundent in the current economy, and that those people and what is left of that capital will not find employment at any price without very substantial redevelopment.

if you are a traditional travel agent lowering your price to zero will not help, simce it costs more effort to talk to you on the phone than to type on a web page. such a person must learn to do some entirely new thing.

their comparative advantage must change, or their pattern of specialization must change.

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