Wage stickiness as a macro problem
By Scott Sumner
A commenter recently made these observations:
Working in an office, I still don’t see the libertarian position on laying people off versus sticky wages. What I have seen is firms tend to lay people off versus larger wage cuts because:
1) If a firm cuts wages for all workers, then the top workers will simply find another position with company that pays higher. (It might take 18 months.)
2) Firms not only have low marginal productive workers but low marginal productive departments. (Often the department were created to expand the firms core business and are not long term successful.) So it is easier for firms to cut a marginal department altogether versus cutting into productive core business.
3) Firms can measure the marginal productivity of a worker so it is easier to identify ones to lay off.
4) And finally, firms like the subtle message of creating fear with their workers that if you don’t produce then you can be laid off.
I see this type of thing all the time. While these comments are interesting, they have very little bearing on wage stickiness as a macro phenomenon. Rather they explain why real wages might be sticky. But the macro problem is nominal wage stickiness, which is an essentially unrelated phenomenon. (Actually, both types of stickiness exist.)
When General Motors lays off lots of workers during a recession, it is not because the wages of GM workers are sticky, it’s because the wages of nurses and schoolteachers and accountants and fast food cooks are sticky. Because most non-GM wages are sticky, a 10% fall total labor compensation leads to roughly 10% fewer hours worked in aggregate. That’s a recession. During recessions, people tend to buy far fewer cars but roughly the same amount of food and haircuts and ER visits. Thus the sticky wages of nurses and grocery workers and barbers don’t cause many of them to lose their jobs, whereas GM workers would lose jobs even if they reduced their nominal hourly wage in proportion to the fall in NGDP.
Thus you can’t understand why wage stickiness leads to unemployment by thinking about wage stickiness at specific firms, it is aggregate wage stickiness that matters. (Microfoundations don’t help here.) Similarly, it makes almost no difference if the wage demands of the newly unemployed are flexible, the problem they face is that the wages of the nurses and schoolteachers and accountants and fast food workers who still have jobs are sticky, and hence there’s no money to hire the unemployed, even if they took a pay cut. If wages of existing workers are sticky, then only higher NGDP will put people back to work.
It’s a giant coordination problem. Don’t believe me? In 1993 the Mexican price level plunged by 99.9%, almost overnight. And yet there was no immediate upsurge in unemployment. Why not? Because all workers agreed to an immediate 99.9% reduction in nominal hourly wages. But that sort of thing is the exception, not the rule, and in the Mexican case required legislative action. (It was called a “currency reform.”)