Tuesday, February 11, 2014

Sticky wages, information transfer and piece work

David Glasner intrigued me with this thought:

My own view is actually a bit more guarded. I think that “sticky wages” is simply a name that we apply to a problematic phenomenon for which we still haven’t found a really satisfactory explanation for.

I'd like to take a stab at an explanation after first discussing sticky wages in the information transfer model (based on this post), especially in the context of Roger Farmer's post mentioned in Glasner's. Here is the picture of the average wage during the depression based on Farmer's data (dotted red), FRED data (red), CPI data from FRED (blue) and the ratio of NGDP/L (black, where L is the labor supply):

Purportedly, the fact that NW/L follows the price level P implies that wages in the Depression were flexible (NW = total nominal wages and L = total employees, or the labor supply). The use of an average wage brings up distributional issues. The average wage could be falling due to falling inequality, nominal wage cuts, or some combination of these. Wiping out Wall Street and flexible nominal wages are two completely different mechanisms that both show up as a falling average nominal wage.

But I agree with Farmer that average nominal wage should fall along with the price level! It just doesn't necessarily mean that wages are flexible. Total nominal wages are proportional to NGDP so if NW/L ~ P then NGDP/L ~ P. Can we use this to say employees are taking a nominal GDP cut? The fact that NW/L ~ P more likely derives from NGDP/NW ~ constant [1] than simply nominal wage flexibility.

This analysis in the information transfer framework looks like this. If NGDP/L ~ P in the labor market and NGDP/NW ~ c in the wage market, then NW/L = (NGDP/c)/(NGDP/P) = P/c. [2] A market with a constant price isn't really transferring dynamic information, so information from aggregate demand is being registered in the number of employees, not their wages. Additionally, NGDP/L ~ P leads to (a form of) Okun's law relating the change in RGDP to the change in employment. Here are those two markets (the constant red line indicates that wages are sticky, while the number of employees is not, the black line following the blue price level curve):

However, there is some nominal wage flexibility (or other effects) as indicated by the fact that the labor market does not capture all of the information; if we look at the difference between the model and the price level we can see that in fact there was a lot more nominal wage flexibility (or other effects) during the depression (right graph below) than, say, the 1980s (the center of the left graph below):

Now Glasner and Farmer are economists, and I am not. I'm not even using "economics" as such to analyze sticky wages. But maybe information theory can help find that explanation of sticky wages. It appears that the market for the number of employees is transferring dynamic information -- that the economy responds to NGDP shocks by laying off employees rather than reducing their wages. This means that a market has been set up to transfer information from aggregate demand to the labor supply, but not wages. How did this market get set up?

Potentially it is self-organized around the principles Glasner lays out here. But it seems that given the history of unemployment -- where the unemployed were hanged -- there would be a strong incentive for individuals being laid off to negotiate a lower wage. There could be a coordination failure in this scenario since each person designated to be let go would have to negotiate a lower wage such that total of the wage cuts equalled the amount needed to keep the factory profitable.

How does the morale picture fit historically? When your job could save you from the gallows, employers had significant power and little reason to worry about morale (especially in bad economic times when other jobs were scarce). If the boss wanted wage cuts, the boss got wage cuts. If you had a problem with that, you could be summarily fired. Remember, unemployment began in a time when there weren't any labor laws and little concern for the well-being of employees. Their morale would be low down on the list of concerns when unemployment first became a social problem.

My attempt at an explanation derives from the fact that early wage labor was piece work. You sewed a shirt and you got paid for each shirt you made. This not only provided an excellent metric for determining who was performing worst, hence who to lay off in a downturn, but forced an employer to lay off people, not reduce their wages. If you were still an employee, you could still make shirts and expect to be paid. As piece-work wage labor expanded, social systems started to form that catered to laid-off employees, beginning with workhouses -- effectively accepting a 100% nominal wage cut for room and board. As this custom of layoffs becomes entrenched, even salaried employees would be shown the door rather than given the opportunity to renegotiate their salary (especially given the coordination problem above). Today we are stuck with an information transfer system where the aggregate demand sends signals that are captured by the labor supply, not nominal wages.

Wages are sticky because no market or tradition has been set up for flexible wages. Concern for morale may be a post hoc rationalization for seeming irrational market behavior, or may be actually a concern for the morale problem due to violating an accepted social norm rather than the morale problem due to cutting wages as such.

[1] It is constant relative to a slowly varying function of the economy like the price level. In fact, it is more constant than the employment-population ratio

[2] Note that if things were the other way around where NGDP/L ~ c in the labor market and NGDP/NW ~ P in the wage market, then NW/L = (NGDP/P)/(NGDP/c) = c/P and the average nominal wage would rise with a falling price level.

5 comments:

1. You and I are going to get along swimmingly.

BIG DAYS AHEAD.

2. Let me start by saying I have a policy objective: GI/CYB

http://www.morganwarstler.com/post/44789487956/guaranteed-income-choose-your-boss-the-market-based

Please give it some thought!

GI/CYB is meant to be open source software that takes search / matching problem, and credible threat to force work off the table.

Unemployment (someone wants to work at any price and cannot find work) is purely structural.

This stylized fact leads deniers into crazy discussions about search and matching, which in the days yore might have been plausible but in 2013 are foolish, you can literally work for ANYONE on the planet starting tomorrow. Search / matching is not a problem.

And coming from the firing end of the business world, Bewley's exactly correct, on the firing side wages are sticky bc of ongoing firm moral. This will be proven as the gig economy (bc search matching is solved online) grows relentlessly. Lawns in Austin Texas grow in spurts, I change lawn mowers on craigslist multiple times per year, and have no morale issues to deal with. I use developers from multiple countries - the guys in Pakistan might have low morale when an ongoing project gets dialed back, but it goes away when I start a new project / newco with new developers.

Farmer is correct that Nominal wages fell 1929-1933. We still had unemployment.

And you are headed in right direct as far as I am concerned.

"Wants to work" is fuzzy. You note hanging but I'd suggest it's more simply a "credible threat."

What GI/CYB solves is the single basic mistake made early in most modern economies: Wages are not a tool for providing a safety net.

Wages are entirely based on ROI. If extra value cannot be derived from the labor past the wage paid, there is no job. If I would mow another guys lawn for $40, I will not pay someone$30 to mow mine.

Whether or not wages can feed a man's family is an interesting discussion, but only in a world without a safety net.

When establishing a modern Internet based economy, one question must be asked:

1. Will there be a safety net?

If the answer is yes, everything else logically follows:

1. The guarantee is being made by the state, and it must be paid directly by the state (wealth transfer).
2. Since the state is paying, withholding the payment is the obvious credible threat to make people work.
3. For things to be consumed, they must be wanted and they must be produced.
4. Since there are unmeasured negative externalities to government, and since search / matching is not a problem, those that receive safety net payments must work for someone who pays directly with their own money.

3 and 4 taken together mean that we cannot have the state create make work jobs, bc we cannot be assured that the thing produced will be consumed.

What left is are political questions:

Should we sell the safety net labor to the highest bidder?

No.

Should we set the safety net so that a single worker can support a family?

No.

So we set the safety net so that two earners are guaranteed to be above the poverty line.

And we price the safety net labor at almost nothing, and clears it each week, ensuring that each person has multiple (likely hundreds) of job choices.

Since wages are driven by ROI, those jobs that provide greater value to others will be pay more - taking on harder jobs means you live above the poverty line.

This allows us to roll all of the safety net into a single payment: kids pay more, being old pays more, being sick pays more, extreme temperatures pay more (energy assistance).

And all of it is used as a single credible threat:

You must be willing to do something each week that someone else on the planet will freely pay you their own money to do, or you will receive no assistance from our state.

1. Due to the symmetry between the nominal wage model and the labor supply model, I would imagine setting up a new market for nominal wages (as you suggest) so that P:NGDP→NW and c:NGDP→L (the latter being the "constant" market) would result in a world without involuntary unemployment except at the margin, and with unemployment-based recessions being replaced by recessions where nominal wages fall by 5-10%. I am planning on doing a post based on this "what if" scenario (essentially footnote [2] above) soon.

2. "Digital" (a la Internet) has multiple effects that operate as force multipliers.

It mutes the search / matching problem.

It makes capital and talent global.

It continuously atomizes the workplace by reducing the morale problem for firms that atomize - improving their competitiveness. This is important because it is flowing against inefficient and growing countervailing forces (aka Big Government), but it is still winning, and like a rubberband snapping, when it finally BREAKS the countervailing force, it will go off like a rocket.

And here's the really big one:

http://www.morganwarstler.com/post/35224055375/digital-socialism-atomic-capitalism

We are living in the brief moment of human history, when the force of atomic scarcity is no longer the dominant fact that informs economics. It alters everything. Up is down. Black is white.

I'm drawn to information theory. It started when Michael Luby threw down the patents and created Fountain codes, and then I had a bit of an inside seat as p2p took off.

As such, I'm a distributist. Taleb's anti-fragility is exactly right.

On monetary, Greenspan used to talk about the "weight" of GDP, and how it shrinks in raw tonnage every year.

I think that's just the tip of the iceberg. I agree with VC Steve Jurvetson that the price of everything atomic is headed towards $1 a lb. 3D printing and property law will codify that you own your atoms, but the 3D designs are free (government cannot ever be big enough to deliver DRM). My thesis is that the deflationary effects of digital are growing stronger. I literally can't think of any possible investments that are not ultra deflationary. Let me explain. If tomorrow we grab the lectures of all Ivy league professors and release them online in flipped classrooms for free (like Khan), make it illegal to mark whether a degree is earned on campus or not, and charge people only if they ask questions (questions are collected along video timeline and new answers are multi-tracked where the questions occured - I architected a file format to rival dvd for Knowledge Universe, so I'm not truly crazy) or to take a test. We are effectively providing 9B humans a$200K education, and the GDP bump is negative.

But more so, there are no long \$1.5T in college loans to park money in and turn into financial derivatives.

We are seeing the end of retail, the end of commercial office space, the end of personal automobiles. Again, less and less financial derivatives.

I'm working everyday on Government as a Platform, which ends past debt issues and sells off 80% of government buildings.

The investments that go BOOM, are all fueling this race to need less and less capital.

I can't see where all the money goes. Can you?

I'm a big fan of Sumner. I'm sure he'll get his prize.

But I've come to suspect the real value of NGDPLT is that it is required for the great unwinding.

Meaning, we might set NGDPLT at 1% or less.

And then cheer and accelerate Real growth, which drives down prices, and use printing to keep prices falling ever so slightly.

Basically a controlled dive of GDP.

3. My first thought - though I haven't thought it all the way through (or investigated it historically, which is what I'd actually need to do in order to add something intelligent and useful to the discussion) - is that some piece-work would work in the direction opposite to what you're suggesting compared to a salary system. In the piece-work system, the employer is making close to the same profit on an item no matter if it's a fast worker or a slow worker making the item. And the total rate of production can be lowered simply by lowering the rate of raw material supplied to workers; there's no need to lay anyone off, since their effective wages can easily be raised or lowered this way.

Salaries, on the other hand, tend to be flatter than worker productivity, so letting go the least productive salaried employee makes a bigger difference to overall profit than letting go the least productive piece-work employee.

Piece-work employers were also notorious for progressively lowering per-piece rates, too, weren't they?

Comments are welcome. Please see the Moderation and comment policy.

Also, try to avoid the use of dollar signs as they interfere with my setup of mathjax. I left it set up that way because I think this is funny for an economics blog. You can use € or £ instead.