Bryan Caplan  

Wing-Walking Revisited

Educational Disintermediation... Discontinuity, Revisited...
Arnold writes:
Suppose that a bunch of mortgage underwriters get laid off. There are two possible full employment equilibria.

(a) They can be instantly employed as dishwashers at 20 cents an hour.

(b)They can be employed as health insurance claims processors at a salary close to what they were making as mortgage underwriters.

The reason that we don't observe (a) is that wages are not perfectly flexible, if for no other reason than minimum wage laws. Point conceded to Bryan.

But the PSST story is focused on why we do not observe (b). The answer is that it takes time for entrepreneurs to figure out that there is a need for more health insurance claims processors, for the mortgage underwriters to seek and obtain retraining, etc.

Building on my wing-walking critique of PSST, I'm asking why the PSST story ignores a third, extremely plausible, full employment equilibrium:

(c) Workers continue to be employed at their old job for 5, 10, or 20% lower wages until an entrepreneur makes (b) happen.

Nominal rigidities can explain the failure of (c) to happen without invoking PSST.  Can PSST explain the failure of (c) to happen without invoking nominal rigidities?  I don't see that it can.

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COMMENTS (4 to date)
Eric writes:

Suggested answer after having thought about it for 5 minutes :-).

c) doesn't happen because the old company is bankrupt. Shifting companies takes time, just as in PSST.

"Why is the old company bankrupt?", you ask. They should have lowered wages which employees would gladly have accepted, to stave off bankruptcy.

"Look at AIG", I say. Wages would have had to be lowered below 0 (or at least below most people's reservation wage) to keep the company afloat without a bailout. Technically, a rigidity at "0" is still a rigidity, and still necessary for the story to work, but this rigidity clearly there, whereas the nominal rigidity most people are talking about is not at "0" but at or near current wage.

Could be completely wrong.

MikeP writes:

My response is much like Eric's.

House builders and financial intermediaries should have seen negative production after 2007. Employees in those fields were neither needed nor wanted at any price.

If the malinvestment is severe enough, you may not simply fail to have PSST: you may actively have PUST.

PrometheeFeu writes:

Because the wage of the mortgage underwriters is completely insignificant compared to the total cost of purchasing a house. Reduce their wage to 0, pass the whole savings to the consumer and you still won't see any more house purchases.

Floccina writes:

I saw a news story about companies that use "Open Books Management". In it they said that the employees of companies that use "Open Books Management" opted for lower pay in place of layoffs which is right in line with c.

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