Bryan Caplan  

What Bewley Learned

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I mistrust prescient empirical researchers.  If you claim that your research confirms your predictions in every detail, you might be a genius, but you're probably just extremely unobservant.  One of the reasons I so greatly admire Truman Bewley's Why Wages Don't Fall During a Recession is that he repeatedly admits surprise. 

Bewley's top surprises:

1. Keynes defended a relative wage theory.  In Bewley's words:
[W]orkers are so concerned about the relation of their pay to those of workers at other firms that no company dares cut pay.  Resistance to wage cuts can be avoided only if all firms in an economy cut wage simultaneously so as to preserve traditional wage differentials.  Since such reductions would be difficult to coordinate, nominal wages are rigid downward.
Though initially sympathetic to Keynes' story, Bewley totally abandons it.  Why?  Because his interviews utterly contradict Keynes' assumptions.  Internal pay equity is virtually all that matters for morale:
Workers usually know so little about pay levels at other firms that pay differences among firms have to be large before they affect worker attitudes.  Companies promote ignorance of pay at other firms by not sharing wage and salary surveys with employees and by discouraging them from seeking outside offers.
2. Bewley also loses his typically Keynesian faith in efficiency wage theory.  His subjects almost unanimously reject efficiency wage theory, or at least the shirking version of it:
Most managers insisted that the theory did not describe their own behavior, but rather a form of bad management.  They thought of punishment only as an extreme measure for dealing with antisocial behavior and said that the best results were obtained by a forthright and positive management style.
87% of Bewley's subjects said the model "does not apply"; 8% said "applies in some cases"; just 4% endorsed it.

3. Bewley started as a fan of implicit contract theory.  In the endnotes, he confides, "The failure of the implicit contract theory was a disappointment, as it was one of my favorite theories."  The theory's most glaring problem:
Implicit contract theory implies that labor market conditions affect layoff decisions... [W]orkers are laid off when the revenue they add to their firm is less than their cost minus a quantity that reflects the decrease in their welfare caused by the layoff.  It is natural to assume that the decrease in welfare is greater in a poor than in a good labor market, for it takes longer to find a new job in hard times.  Therefore, other things being equal, firms should lay off fewer workers if the unemployment rate is high than if it is low.  Yet most employers told me that labor market conditions either had no effect on layoff decisions or had an effect contrary to that predicted by the theory; high unemployment made it easier to dismiss workers since those let go would be less likely to find other jobs and thus more likely to be available when needed.
[Aside: If you think that people won't admit ugly truths in interviews, re-read the last sentence carefully!]

4. While Bewley's story is broadly Keynesian, he makes no effort to build a broad Keynesian coalition.  Instead, he decisively rejects virtually all existing Keynesian (and New Keynesian) theories:
The only one of the many theories of wage rigidity that seems reasonable is the morale theory of Solow and Akerlof.  All others fail because of the lack of realism of their basic assumptions.
I suspect that this harsh verdict explains why even Keynesian macroeconomists still haven't taken Bewley's message to heart.  He doesn't just have a grand theory of unemployment.  He has a theory of unemployment that, taken seriously, would put even the greatest minds in his discipline out of work.



COMMENTS (7 to date)

Bewley's sounds like a very interesting book. I have a question: what's the difference between the efficiency wage theory and the idea that wages are rigid to maintain morale within the firm? Shirking is just one rationale behind efficiency wages, isn't it?

Jim Rose writes:

On internal pay equity is all that matters, collective bargaining agreements are on the internet in Australia. You can look up salary bands in these union agreements.

salary bands are published in newspaper job ads for most jobs, union or non-union, anyway. posting of salary bands filters applicants through self-selection based on salary expectations.

Recruitment agents have a very good idea of your salary possibilities around town. That is one reason why job seekers patronise them.

Bewley should get out more, look abroad, read newspaper job ads too, and most of all, spend more of his time talking to the workers and less of his time talking to the bosses.

Bewley say that

Workers usually know so little about pay levels at other firms that pay differences among firms have to be large before they affect worker attitudes.

See http://www.seek.com.au/ where you can search by jobs by salary range!!!!!!!!

Seek shows that there are 31,006 job vacancies in Australia paying at least $100k per year of which, 18,145 jobs in Australia pay $100-120k per year, and 571 Education & Training jobs in Australia pay at least $100k per year.

another seek search showed that 139 Healthcare & Medical jobs are in Sydney CBD, Inner West & Eastern Suburbs paying at least $100k per year of which 1 was a hospital Resident or Registrar job in the Sydney CBD, Inner West & Eastern Suburbs paying at least $100k per year.

Bewley cannot be excused as pre-internet because his book is 1999. Recruitment professionals predate 1999 because I used one to find a better paid job in another country. They explicitly used salary quotes as their lure.

Bostonian writes:

I think high unemployment makes it easier to fire because "everyone is doing it" and the company can blame a bad economy for its decision, getting less bad press than it would for layoffs in good times.

Kitty_T writes:

Layoffs when "everyone is doing it" doesn't just take stigma off the employer, it takes (some) of the stigma off the laid-off employee. As most managers really do care about the welfare of their employees, even the ones they'd prefer to be rid of, that makes firings easier.

Daublin writes:

+1 to the other comments about layoffs when everyone else is doing it. The company doesn't even have to be doing badly. A well, the larger economy does not need to be bad in the company's own domain.

The unemployment of the last few years is largely concentrated among unskilled 18-25 year olds. That doesn't stop lots of other companies from laying off skilled older folks and blaming it on the bad economy.

I've never heard of "implicit contract theory", but if it implies that firms become reticent to fire during times of broad unemployment, then it doesn't hold up to a reality check.

Daublin writes:

The fourth point does point to a way to improve wage rigidity, if it is correct. If the primary reason for wage rigidity is that people are locked into firms that cannot shift wages within the firm, then it would improve matters to have higher churn through the existence of firms. Have more firms fail, and have more firms being created to fill the void.

The new firms should be able to set wages in a profit-maximizing way.

Jim Rose writes:

Large numbers of British job stayers experience nominal wage cuts, from a low of 5% in 1979 to a high of 24% in 2009 based on payroll records collected in the new earnings survey.

From 1993, when the inflation rate has been about 3 percent, the nominal wage cuts are in the neighbourhood of 20 percent of workers in the same job 12-months ago.
From http://www.frbatlanta.org/documents/news/conferences/13employment_elsby.pdf

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