During recessions, demand for both housing and labor plummets.  But the two markets respond in very different ways.

In the housing market, we usually see dramatic price falls.  Lots of properties sit on the market for months.  But almost any property owner can swiftly sell by cutting his price.  In economic jargon, then, housing surpluses are largely voluntary.*  The lingering problem is just that some sellers stubbornly cling to pre-recession pricing.

In the labor market, in contrast, wages almost never fall.  Vast numbers of workers lose their jobs when demand goes down – and employers almost never offer the option to stay on at a reduced wage.  So in economic jargon and ordinary language, their unemployment is largely involuntary.  In every recession, lots of workers who are willing and able to work at the market wage genuinely can’t find jobs.

Which market works better (or “less badly”) during recessions?  “Housing” is the obvious answer.  Sudden price falls provoke angry complaints, but at least property owners can still sell by cutting their asking price.  And despite some inefficiencies, buyers gain by roughly the same amount that sellers lose.  In the labor market, in contrast, unlucky workers’ labor income utterly vanishes – and lots of perfectly good labor goes to waste.

Now you could object that the so-called “obvious answer” overlooks the indirect effect on Aggregate Demand.  (See here, here, and here for earlier discussions).  When housing prices plummet, so does property owners’ net worth.  Owners respond by cutting spending, which makes the Aggregate Demand shortfall even worse.  In the labor market, in contrast, wages stay steady, mitigating the Aggregate Demand shortfall.  Right?

Hold your horses.  This complaint doesn’t even follow on its own terms.  If housing prices were as rigid as wages, property owners’ net worth would indeed be higher on paper.  But their effective net worth would still sharply fall.  With flexible prices, they can sell their house for sure at, say, 30% less than they paid.  With rigid prices, they have a chance to sell their house at face value.  In which scenario are owners effectively poorer and stingier overall?  It’s a tough question.

The same goes for labor markets.  With rigid wages, the value of workers’ human capital is higher on paper.  But that doesn’t mean that rigid wages actually make workers in general feel richer.  Instead, it means that employed workers feel somewhat richer, while unemployed workers feel much poorer.  In which scenario are workers effectively poorer and stingier overall?  Again, it’s a tough question.

If housing prices were as rigid as wages, every recession would feature horrific involuntary vacancy rates.  By-the-book economists would say, “Housing prices need to fall.”  Hard-line Keynesians would object, “That would just make the vacancy rate even worse by reducing Aggregate Demand.”  Intellectual bystanders would shrug, “Well, economists disagree.  Who knows?” 

Fortunately, housing prices are flexible, so this dispute almost never arises.  But we can learn a valuable lesson from the absence of this dispute: Flexibility really is a good thing.  The direct effects of flexibility are good, and there’s no reason to think that the indirect effects of flexibility are bad.  If there’s any way to make labor markets work more like housing markets during recessions, we should try it.

* The main counter-examples are properties where the legal status is in
dispute – most obviously, when a bank forecloses but the occupants
refuse to leave.