Howitt - Looking Inside the Labor ...

Howitt - Looking Inside the Labor Market, Ekonomia instytucjonalna, Ekonomia instytucjonalna, Ekonomia ...

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//-->Looking Inside the Labor Market: A Review Article*ByPeter HowittBrown UniversityWhen unemployed workers are available, why don’t firms cut wages until the excesssupply is eliminated, as would happen in the ideal markets depicted by conventional economictheory? This question has been central to the great macroeconomic debates that arose from theKeynesian Revolution. Keynesian economists, from Modigliani (1944) through Fischer (1977)and the various authors represented in Mankiw and Romer (1991), have argued that wagerigidity reflects social, institutional and other forces that prevent the labor market from clearing,create involuntary unemployment and justify macroeconomic intervention.On the other side, new classical economists have argued that what appears to be wagestickiness is actually aresultof market-clearing forces, operating in a complex real-worldenvironment.1For example, Lucas and Rapping (1969) argued that intertemporal substitutionmakes short-run labor supply highly elastic, so that declines in demand result in relatively littlemovement in the market-clearing wage. Barro (1977) argued that efficient wage contractsstipulate sticky wages so as to provide income insurance to risk-averse workers, but that thisdoes not stop a contract from also specifying an efficient level of employment,as ifmarketswere clearing. Rogerson (1988) even derived such a contract-based explanation from an Arrow-Debreu general equilibrium model with indivisible labor.Many alternative explanations have been proposed for apparent wage stickiness,involving bargaining, monopoly unions, market misperceptions, hold-up problems, multipleequilibria, dual labor markets, adverse selection, the stigma of unemployment, shirking,intersectoral reallocation, search and recruiting costs, fairness, insiders versus outsiders, menucosts, and so on. Yet none of these explanations has found enough empirical support for anyoneTo appear in theJournal of Economic Literature,March, 2002. For helpful comments and suggestions I would liketo thank, without implicating, Daron Acemoglu, George Akerlof, Ernst Fehr, Pierre Fortin, David Laidler, JohnMcMillan, Ignacio Palacios-Huerta and David Weil.1As Laidler (1999) has recently documented, these new-classical arguments are more new than classical. Wagerigidity of the sort that mainstream Keynesians emphasize was in fact a central theme in the writings of orthodoxpre-Keynesian monetary economists, going back at least as far as Thornton (1802).*to claim victory, and the issue remains unresolved, as do most of the other issues that havedivided Keynesian macroeconomists from their opponents.When Truman Bewley (1999) was puzzling over the question of why wages didn’t fallduring the 1990-91 recession, it occurred to him that instead of constructing yet another model,or undertaking yet another econometric test of existing models, he might learn something bysimply asking the people whose behavior is so puzzling why they behave the way they do. So,during 1992 and 1993, he interviewed 336 managers, labor leaders and employment counselors,mostly in Connecticut but some in other nearby states, asking them not only why they thinknominal wage cuts are so rare but also a variety of other questions designed to elicit their viewson nearly every known theory of wage adjustment and unemployment.The answers came as a surprise to him. According to knowledgeable and intelligentparticipants in labor markets, the most important factor inhibiting wage cuts is one that hasnothing to do with any conventional economic theory, namely the psychological factor ofmorale.The explanation for downward nominal wage rigidity that emerges from these interviewsgoes roughly as follows. Good morale among a firm’s workforce has a positive effect on thefirm’s profits, by increasing the workers’ productivity, effort, creativity and cooperativeness, andby reducing absenteeism and turnover; well motivated employees also tend to provide goodcustomer service, giving the firm a good reputation. However, morale is fragile, and willdeteriorate quickly if workers feel they are being slighted or treated unfairly or if, for whateverreason, they cease to identify with the goals of their organization.According to this theory, workers would interpret a cut in nominal wages as a hostile act.Unless they saw it as necessary to save the firm from financial ruin they would regard it asunfair. Because of this, and because of the shock of a discontinuous fall in their standard ofliving, morale would fall, and therefore so would the firm’s profits. This is why firms believethat cutting pay in response to rising unemployment would normally be a bad idea. Likewisethey believe that replacing existing workers with outsiders willing to work for less would alsogenerally be a bad idea, and for the same reason; it would upset the internal equity of a firm’swage structure and would strike workers as unfair, creating serious morale problems.Laying workers off when demand has fallen is not, however, regarded as unfair, andalthough it demoralizes those who are laid off, those employees leave the organization and2therefore their discontent does not spread through the workplace as it would had they remainedat the firm with reduced pay. So except in cases of extreme financial difficulty a firm’s responseto a fall in demand will typically be to cut jobs rather than cut wages.This contribution to the growing literature on behavioral macroeconomics threatens todisturb the tranquil state of macroeconomic theory that has prevailed in recent years. Peacefulcoexistence between Keynesians and their opponents has been maintained by a set of groundrules, the common acceptance of which has allowed differences to be addressed, if not settled, inorderly fashion. The most important of these rules are that all individual behavioral relationshipsshould be derived from the premise of individual rationality, and that all observable actionsshould be shown to obey the conditions of a rational-expectations equilibrium. Although theserules were once quite controversial, having been championed by new classical economics andresisted by Keynesians, the leaders of new Keynesian economics have agreed to live by them,not out of any deep commitment but because the rules have seemed flexible enough not toconstrain their arguments. For example, the conditions of rational expectations equilibrium donot imply continuous market-clearing, as long as one takes into account institutional or otherconstraints not recognized in the purest forms of walrasian equilibrium theory. Thus macrotheory has come to be defined by many as constituting dynamic general equilibrium theory.Bewley defies these rules by maintaining that what drives people is not just pecuniaryself-interest, as in conventional general equilibrium theory, but the psychological factor ofmorale. Moreover he argues, contrary to the most basic notions of rationality, that morale isaffected crucially by nominal wages, independently of what happens to real wages. That is,money illusion matters. Taken at face value, the argument undermines the microfoundations ofmodern macroeconomics, and implies that the rules by which macroeconomists have agreed tostudy the labor market preclude an understanding of how that market actually works.He is not the first notable theorist to propose such non-conformist ideas concerning thedetermination of wages. In particular, Robert Solow (1979) based his efficiency wage theory onthe idea that a worker’s effort will depend not only on material incentives but also on morale.Akerlof (1982) argued that what matters to a worker is not just his or her own wage and workingconditions but whether or not they are “fair” in relation to those of some reference group, andthat a worker also cares about the well-being of fellow workers. Akerlof and Yellen (1990) drewon theories developed by psychologists and sociologists to argue that people who are paid less3than they think they are worth reduce effort in proportion to the shortfall. As yet, however, thesechallengers have not been taken seriously enough by defenders of the orthodoxy to spark a majorcontroversy comparable to the great Keynesian debates.Bewley’s argument will be hard for conventional macroeconomists to ignore, partlybecause of the extraordinary thoroughness and honesty with which he evidently conducted hisinvestigation, and the sheer volume of direct evidence he provides, and partly because thequestion he investigates has been brought back to center stage recently years in the controversyover the appropriate long-term inflation target for monetary policy. In particular, Akerlofet al.(1996) have revived Tobin’s (1972) idea that downward nominal wage rigidity prevents somelabor markets from clearing when inflation is low, because the required adjustment in real wageswould imply a nominal wage cut. Many Keynesians are likely to stop playing by new-classicalrules that have been so thoroughly discredited, when so much is at stake, unless a strongcounterargument is presented.1. Empirical evidenceEach of Bewley’s 336 interviews was done in person, most of them lasted for one or twohours, some as long as five; two of them were followed by re-interviews, many of them byfollow-up telephone conversations, and about thirty of them by plant visits. Instead of submittinga questionnaire to his subjects or asking them each to respond to a predetermined list ofquestions, as was done in a similar context by Blinderet al.(1998), he told the interviewees whathe was trying to understand, sent them a list of possible questions in advance, and then let themtalk freely, asking questions only towards the end of the interview. He allowed the set ofquestions to evolve from one interview to another as he learned from experience what wasimportant and what wasn’t. In the process he gathered detailed information shedding light onalmost every theory that has seriously been proposed concerning wage (in)flexibility.He reports that at the outset he did not pay much attention to morale, but it soon becameapparent that managers see morale as the overriding factor in determining the success of theiremployee relations. His adaptive strategy allowed him then to shift his questioning over time tofocus more on the issue of morale. It also allowed him to gain the cooperation of many people towhom the theories he originally wanted them to talk about seemed ridiculously naïve.4This method of empirical investigation has several drawbacks, most of which Bewleyacknowledges and addresses in the book. The fact that it involves survey data rather than officialgovernment statistics is notper sea problem, considering that almost all statistical agencies alsocompile their data from what are in effect surveys. In this case, however, the relativelyunstructured interview form and the qualitative, interpretative nature of the questions beingasked make for results that are not easily quantified. The bulk of the book consists of a selectionof direct quotations, organized by subject. Frequent tables are presented tabulating the results.But the classification schemes underlying these tables are largely subjective. Moreover, many ofthe tables describe the fraction of interviewees that mentioned a particular subject, sometimes inresponse to questions that varied from one person to another, sometimes in a freeform discussionwith no prompting.Perhaps the most troubling aspect of Bewley’s empirical method is that he asked peoplenot just what they do but what they think – not just whether they have cut wages but why or whynot. Actions might be verifiable but thoughts aren’t. Because of this, and because of thepossibility (Friedman, 1953) that people could be behaving as if they thought one way eventhough they are not conscious of any such thoughts, economists are right to be skeptical of dataconcerning self-reported mental states.In this case, however, the reports deserve to be taken at face value, mainly because theyshow an unusual deal of consensus. Bewley reports that “All employers thought cutting the payof existing employees would cause problems.” (p.173) Sixty-nine percent of the employersinterviewed stated that cutting pay would hurt morale and demotivate workers. Most of theremaining thirty-one percent reported that it would lead to problems with turnover, and whenthese employers were asked why not just cut the pay of all but the best workers most of themsaid the main reason is that this would cause too many problems with morale. (p. 174)Moreover, Bewley’s findings concur with other direct surveys of employers in differenttimes and places. Kaufman (1984) interviewed managers of 26 small non-unionized firms inBritain in 1982, and reports that most of them stressed fairness and morale as the main reason fornot cutting wages. Blinder and Choi (1990) interviewed managers of 19 firms in 1988, all ofwhom responded that an unfair wage policy would reduce the quality of job applicants, all butone of whom responded that it would reduce workers’ effort, and all but three of whomresponded that it would create turnover problems. Most of them also explained that whether or5 [ Pobierz całość w formacie PDF ]