Sorrow and Anger
By Bryan Caplan
On Thursday, Casey Mulligan lectured on his The Redistribution Recession at GMU. Lots of interesting, neglected evidence on the spike in labor market distortions since 2007. Yet the talk was marred by Mulligan’s commitment to a market-clearing model of labor markets. When pressed, he was quite insistent that given the expansion of the safety net, the unemployed do not want to work at the current market wage.
To be fair, Mulligan explicitly disavowed the view that the unemployed are happy about their situation. But in his view, the unemployed would be even less happy to keep doing their old jobs for prevailing rates of compensation. Unemployment’s bad, but so are wage cuts.
Why should you reject Mulligan’s view? There’s the obvious fact that wages don’t fluctuate like stock prices, even in the face of large shocks to the labor market. The best argument, though, is introspection. Ask yourself:
When someone gets laid-off, what is his main emotional reaction likely to be?
When someone gets a nominal wage cut, what is his main emotional reaction likely to be?
In Mulligan’s model, lay-offs and wage cuts are two sides of the same coin, and workers should respond identically. But of course they don’t. Part of the reason is that – especially during recessions – labor markets don’t clear. People who keep their jobs are lucky, earning above the market-clearing wage. The rest are unlucky, and often struggle for months or even years to find a remotely comparable position.
Yet there’s more psychology going on. When you’re laid-off, you feel exiled from your group. You’re rejected, unfit, unworthy. Many people in this situation break down and cry. When you face a pay cut, in contrast, you feel betrayed by your group. You’re insulted, snubbed, scorned. You might weep, but you’re more likely to crumple up the memo explaining the pay cut and hurl it in the trashcan. Especially during a recession, you probably won’t be brave enough to quit in retaliation; instead, you’ll shave the quality of your work to extract a petty revenge.
Most Keynesians will probably see Mulligan’s market-clearing model as an excuse to reject everything he says. But this is hasty and unfair. There’s no reason why we can’t (a) admit that labor markets don’t clear during recessions, yet (b) insist that expanding the welfare state seriously retards the labor market’s naturally sluggish adjustment mechanism. Keynesians’ benign view of governments’ “response” to the Great Recession is not implied by their model. Indeed, the Keynesian model specifically implies that Keynesians should look upon new labor market distortions with anger, or at least sorrow.
Update: Check out Mulligan’s EconTalk podcast with Russ Roberts.