Evidence Review Part III

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One of the most most powerful indictments against consensus mainstream market-centric general-equilibrium modeling is that it does not accommodate pure wage rent (PWR). The descriptor “pure” distinguishes the concept from more familiar versions of wage rent, typically associated with labor unions, regulated firms, or market frictions studied in the search/match literature. Prominent examples of the last category are Dale Mortensen (2003) and Roberto Pinheiro and Ludo Visschers (2015). That literature’s insignificance in stabilization-relevant macro theory makes it noteworthy.

Pure wage rent is macro theory’s biggest elephant in the room, for at least three reasons. First, PWR is consistent with rational behavior.  The GEM Project has microfounded nonconvex WERs, implying that pure wage rent (W=Wn>Wm) is a chronic outcome of optimizing employer-employee interaction in information-challenged workplaces. Second, PWR is hugely impactful. Perhaps most eye-catching, it leaves neoclassical market-centric labor supply in tatters. Chronic wage rent rations both workplace hours and rent-paying jobs for LEV and SEV employees respectively, pushing both-sector employees out of market equilibrium.

Third, PWR is consistent with detailed evidence. The best, still relevant empirical analysis of U.S. wage rent occurred decades ago, a void that reflects the inattention paid to the phenomenon during the mainstream macro run of the New Keynesians. Katz and Summers (1989), hereafter K&S, used the Current Population Survey to demonstrate that many employees receive substantial wage rents as a result of working in particular industries. K&S estimate the average rent among industries that pay premiums to be 28%; controlling for a range of worker characteristics reduces their estimate to 15%. (Of course, if firms rationally use existing wage rent to cream job applicants, 15 percent badly underestimates the true PWR.) The authors additionally show that accounting for fringe-benefit or occupational differences tends to increase, not reduce, the wage differential.

The wage premiums are not caused by unionization. K&S find similar-magnitude rents are paid to nonunion workers. How about Adam Smith’s famous argument, i.e., relatively difficult working conditions being the cause of relatively high labor pricing? K&S present evidence indicating that industries paying wage premiums tend to have better working conditions. They further find a strong negative relation between an industry’s quit rate and its wage.

Probing more deeply, K&S use longitudinal evidence, focusing on worker movement from low- to high-wage industries, to identify another characteristic of the U.S. labor market. Relocating employees immediately pocket 60 to 100% of the industry wage differential. That new hires’ quickly capture most or all the existing premium challenges the familiar argument that apparent labor rents reflect differences in unobserved general human capital. K&S finally investigate the nature of rent-paying industries. They are capital-intensive, experience relatively high rates of return, and invest more heavily in R&D. They are easily recognized as large, highly specialized establishments that are inherently restricted by costly asymmetric workplace information and routinized jobs. This point is particularly impressive. The evidence not only validates the existence of chronic wage rents, it conforms the generalized-exchange prediction that the premiums are paid by LEV firms.

In a finishing touch, K&S combine with Annable (1984) to demonstrate PWR centrality in the poorly understood stagflation decade that began in the early 1970s. Modern macro theorists, ignoring the existence of wage rents, must then ignore that PWR jumped dramatically during that prolonged episode of market failure. The exploding interindustry wage structure set the stage for the subsequent downsizing decade that permanently eliminated millions of rent-paying jobs, becoming the third most damaging macro crisis of the 20th century. It is an instructive to hunt for that crisis in the modern macro literature. It is inconsistent with mainstream friction-augmented general-market-equilibrium (FGME) analysis, so it does not exist.

Assessment:  The detailed picture assembled by Katz-Summers closely corresponds to the labor-pricing and use mechanics derived in the generalized-exchange model class. Their detailed description of wage rents and associated characteristics cannot be accommodated in the mainstream micro-coherent FGME model class.

Blog Type: Wonkish Saint Joseph, Michigan

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