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Sticky Situation

The foundation of modern macroeconomic theory (yes theory, the empirical work is scant) is based on the idea that prices (nominal) are sticky. Simplifying greatly, if you adhere to a classical view of the world where all agents have perfect information (no good economist assumes this of course, but it makes a nice straw man for the modern macro interventionists) any time there are real or perceived shocks to either supply or demand in any sector of the economy, prices will quickly (instantaneously?) adjust to re-equilibrate markets. In other words, so long as prices are flexible, quantities supplied always equal quantities demanded and therefore there can be no unemployment or “over”employment, or under-utilization or over-utilization of capital goods.

Modern macro theory correctly points out that not all markets are always and everywhere in equilibrium (though of course we like to think that competitive forces ought to be pushing outcomes toward such situations). And in order to explain the constant disequilibrium it relies on suggesting (observing too) that some prices are in fact “sticky.” In other words, prices do not adjust fast enough to get quantities supplied and demanded in line so that markets can clear.

For today’s post I am not going to discuss the empirical work here, or even the symmetry of the position above (i.e. we always hear of prices sticky downward but less so the other direction), but rather another instance of cognitive dissonance that should be felt by a certain set of folks who hold this view. Not many professional economists will be afflicted by this, here I intend to point the finger at readers of famous progressive economic bloggers who do not have the capacity to think through all of this.

What am I talking about? Let’s reflect for a moment on a meme particularly relevant to armchair progressives. A common view is that workers are systematically exploited by their capitalist employers. And what is the implication of this view? That wages and compensation are below what the worker’s marginal contributions are to the enterprise.

Let’s reflect for a moment on the crude analysis of why we see unemployment, particularly in the downward phase of business cycles. We see unemployment because nominal wages are sticky, and in a recession when for whatever reason there is a decrease in trend output, the only way to prevent a labor surplus from emerging is to have wages fall so that labor demand can increase to match the excess supply of labor that would result from an unchanged wage. This is one reason for example that New Keynesians like the idea of monetary stimulus/inflationary efforts by the central bank: since firms for psychological reasons are loathe to lower nominal wages, the only way to stimulate employment is to cause real wages to fall even as nominal wages are rigid. The way to do this is to make sure that all other prices rise economy-wide, which is what can happen with an appropriate amount of money printing.

Now, can you begin to see where the dissonance should start bearing down on us? In the crude Marxian exploitation version of labor markets espoused by many armchair progressives, wages if anything are sticky “up.” That is, wages rarely rise, but ignoring that, whatever level they are at is “too low” since workers are producing far more value than they are receiving in exchange. Now, there are some good economic reasons why wages might be below workers’ marginal contributions to their firms, but I am pretty confident that none of these underlie the thinking of those who are claiming all wage earners are exploited (e.g. the nature of job training, the timing of wage payments vis-a-vis output sales, various labor market frictions, etc.). At the same time, armchair progressives who read a few blog posts about “shortfalls in aggregate demand” who subsequently vociferously support inflationary policies and expansionary fiscal policies find themselves having to argue quite the opposite – that wages are too high. And the evidence that wages are too high is the massive unemployment or underemployment that you observe in recessions.

Now, I’ve yet to see a progressive argue that firms are always and everywhere greedy profit maximizers except during a recession. But this would be the implication of arguing that firms regularly underpay workers, and then release these workers when demand for their products falls. If in fact workers were being paid less than they were producing, firms could withstand reductions in how much they sell, or reductions in the prices they obtain from paying their workers and still profitably employ their workforce. That a wave of layoffs or hiring freezes occurs during rececessions is pretty solid evidence of the idea that these particular workers are not producing very much of value for their firms – in other words, pretty solid evidence that these workers are not being exploited.

Of course, this discussion could quickly devolve into various other theories of exploitation and social constructions that are the reason we see some workers with low productivities. That’s a discussion for another day, as is the discussion of whether in fact wages and prices are very sticky today (after all, union contracts are not very pervasive anymore, menu costs are not very high, large amounts of job churn mean that the permanent workforce is smaller than in the past, and so on).

4 Responses to “Sticky Situation”

  1. Rod says:

    Absent unions and other forces that goof up the market for labor, labor has a market price like everything else. The Greedy Capitalists exploit their suppliers, or, in the case of mining and drilling, they exploit the Earth, often at great expense. Wealth gets created or destroyed at every step, whether it be manufacturing, McBurger selling, or freelance labor selling their services.

    I like to think that one of the ways out of our current economic mess is to let the energy sector do its thing in the biggest way possible. Up in Wellsboro, PA, it’s like there are twenty dollar bills sitting there trapped inside the Marcellus Shale. All that wealth taken from the ground could not be a better way to enhance the value of those twenties and let all that wealth trickle down to where it creates jobs and prosperity for everybody. Instead, we have BO out in Oklahoma proclaiming that the path to prosperity is found in borrowing or printing money to pay for subsidies of alternate forms of energy, at a net loss of billions of dollars.

    It really galls me that Obama is all over the news taking credit for record oil production. Gag me with a dirty spoon.

  2. Rod says:

    Worker exploitation is not a problem any more. If anyone wants to own the means of production, they should see a stockbroker and buy one of those companies that are prospering on the backs of the workers. I have even grown to hate the term “workers.” They are employees, and they cost a lot more than they get in their paychecks. Karl Marx would have renounced communism if he would have had employees.

  3. Rod says:

    I know a considerable number of people who work for Merck, one of the greatest corporations in the world (I used to say it was THE greatest, but that was before the lawyers and government got their sights on the company).

    All of my Merck friends are exceedingly thankful that they work for Merck. They refer to the company as “Mother Merck,” where once the company has hired you and determined that you are up to Merck’s high standards, things like being paid well and being happy with the company are a foregone conclusion. Even the janitors at Merck are well-paid, but in return the company insists that all of its employees do a first-rate job and that they maintain high standards in every aspect of their work.

    A funny anecdote — one of my hunting buddies was once in charge of the rats used for testing (PETA ALERT), and when he was a greenhorn employee, he had to buy a desk and other furniture for his office. He called a local supplier of office furnishings and ordered a Steelcase desk and chair, which was, he thought, a prudent way to furnish an office adjacent to the rat lab. He also needed to buy a screwdriver to open a paint can, so he bought a cheapie screwdriver, knowing it would be just used as a lever for the paint can lid. Well, his boss told him that that was not the way they did things at Merck. He told my friend that he should order a Knoll desk, and that he should get a Stanley screwdriver for the paint can. Those were two good ways of illustrating how Merck did things.

    My friend worked at Merck’s research facility in West Point, PA, and he said that Merck wanted the best researchers, including the best doctors and other scientists and the best people skilled in injecting rats and keeping the live animal research. As for pay, Mother Merck approached compensation the way your mom would adjust the temperature for your bath: “Is that too cold? I’ll run the hot water a while longer to make it just the way you like it!”

    Anyway, maybe I should have dropped every other ambition I ever had and gotten a job — any job — with Merck. Contrast Merck with Bethlehem Steel, which spent money like gangbusters on executives, golf courses, and lavish labor agreements but could not make a ton of steel for less that twice the cost for Nucor. All you can say about that is how lucky it was that Eugene G. Grace was a golfer and not a tennis player.

  4. chuck martel says:

    Wages are sticky all right but they’re also mandatory. When a company’s cash flow starts to head south it can negotiate with suppliers, miss rent payments, keep unnecessary lights turned off and park and sell some vehicles. But they still have to make payroll on the appointed time each week. And it’s easier to lay some employees off than it is to cut the wages of a whole bunch more. That’s just the way it is.

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