What Bewley Learned
By Bryan Caplan
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.
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.