Gravity and Wage Stickiness
Imagine you have a team designing a new bridge. One guy suggests that cost could be reduced if you used less steel. Of course that might make the bridge more susceptible to collapse, so he also suggests reducing the force of gravity in the area of the bridge. Obviously, the idea would be viewed as highly impractical.
This is roughly how I feel about proposals to end wage stickiness. There are a few types of wage stickiness that could be addressed by economic reforms—notably the minimum wage laws. But the vast bulk of wage stickiness is an inevitable part of a free market economy, not subject to public policy.
David Beckworth has an excellent podcast with Jonathon Hazell, which discusses important new research on the topic. Some economists had argued that wage stickiness was actually not much of a problem, as the wages or new hires was quite flexible, and it was new hires that mattered for decisions to change output at the margin.
Research by Hazell and his co-author Bledi Taska found that even the wages of new hires are quite sticky, at least in the downward direction:
In the end, the finding is very simple, which is that, surprisingly, wages for new hires are, in fact, quite downwardly rigid, though flexible upwards. . . .
I think, probably, it’s to do with internal equity, as originally conceived of in this very famous book by this Yale professor, Truman Bewley, which is called, Why Don’t Wages Fall During Recessions? It’s an amazing book. Bewley imagines the following, that, I think, probably applies to my analysis. He says, “Look, the first logic, the simple logic, that you might have, is that wages for new hires would fall during recessions,” exactly because of the LSE professor example. I become a new professor, I’m willing to accept a lower wage, because I have no reference point.
Then Bewley says, “Not so fast.” What about this idea that he calls internal equity? Internal equity works like the following. I arrive at LSE, and I go around the hallways, and I say, “I just got hired, great job, I’m on $10 an hour.” Then, my colleague, who’s the same rank as me, he’s not a tenured, chaired professor, he’s just another assistant professor who got hired just the year before, he says, “Well, you’re only being paid $10 an hour, I’m being paid $20 an hour, they’ve screwed you.”
People occasionally ask me why we need to stabilize nominal GDP growth. Why not instead try to eliminate wage rigidity, and let the free market determine NGDP?
First of all, it’s not clear exactly what the “free market” means in reference to money, which due to network effects is a natural monopoly. The monopolist that controls the supply of money will always need some sort of policy regarding the value of money, even if by default. So why not a sensible policy, which avoids aggravating the distortions caused by wage stickiness?
As in so many areas of life, the pragmatic solution is often the best solution.