Labor Hoarding and Labor Demand Elasticity
By Bryan Caplan
Keynesian economists have long argued that firms practice labor hoarding during recessions. In laymen’s terms, employers often refrain from laying off workers even when – due to low demand – there is little or nothing for those workers to do.
Why would firms willingly keep paying superfluous workers? The standard story is that firms are planning ahead. If they keep their workforce intact, they won’t have to reassemble it after the recession ends. But you could just as easily appeal to firing aversion: For purely psychological reasons, many employers are only willing to terminate workers as a last resort.
At the same time, Keynesian economists have also occasionally argued that labor costs are irrelevant during recessions. Why? Because “the problem is demand.” Or as Krugman puts it:
Um, we have a problem with demand, not supply; time to
reread Keynes on wages.
If firms already produce more than they can sell, why would lower wages entice employers to hire additional workers? This is basically a variant on the “Zero Marginal Productivity” theory of unemployment – but the problem is not that workers aren’t physically productive, but that firms can’t find buyers for workers’ physical products.
Now suppose we take Krugman’s story for granted. As long as you accept the reality of labor hoarding, he’s still wrong! When firms weigh the burden of temporarily useless workers against the cost of rehiring after the recession is over, wages clearly affect the size of the burden. Why wouldn’t it? Indeed, the tradeoff between retention costs and hiring costs plausibly leads to high labor demand elasticity even during severe recessions. When cash flow is low, keeping a superfluous worker on the payroll at 80% of his normal wage sounds a lot better than keeping him on at full price.
I’ve repeatedly argued that free-market economists should take Keynesian macro more seriously. But Keynesian economists need to lead by example. Before they confidently declare that key elasticities are zero, they should consider the many subtle margins of the labor market.