Macroeconomics today would be much more stabilization-relevant but for Arthur Okun’s untimely death in 1980. His posthumously published Prices and Quantities proposed a promising class of macro modeling centrally microfounded by intra-firm optimization. Absent his insight, standing, and powers of persuasion, the book’s nonmarket approach failed to win acceptance. It has long been ignored by modern theorists, whose mainstream thinking is organized around the market-centric dynamic stochastic general equilibrium (DSGE) analytical framework. If Okun has been set aside because economists lack his willingness to think outside the familiar confines of market exchange, the current state of macro theory stands as a rebuke to the economists with whom he collaborated, mentored, and inspired.
The Great Idea
Okun worked in the Keynesian tradition of market disequilibrium. At the time of his death, he was thinking and writing about the nature of modern, specialized economies, focusing on macro stabilization and what it is about modern economies that engenders wage and price rigidities. He believed, along with other Early Keynesians, that such rigidities were the key to understanding the 1970s stagflation crisis. I was head of the research unit at the Fed tasked to make sense of the massive market failure needed to produce persistent simultaneously high unemployment and inflation and, of course, knew Okun and his work at the Brookings Institution. Indeed, I was one of the many Washington economists working on stagflation who believed that Okun would be the one to solve the wage microfoundations problem.
His instinct was to look inside the firm for optimizing choices that motivate nonmarket pricing. His organizing idea was a particular class of implicit contracts, which he named the “invisible handshake”. From Prices and Quantities (1980, p. 81): “The world of employer-worker attachments creates a complex optimization problem for the firm’s personnel management. The firm is not only required to minimize the wage costs of a given employment but also to develop effective mechanisms to promote and assess productivity, and to build a reputation that will both enhance the supply of willing applicants and hold down quit rates. Job seekers, in turn, must assess the relative attractiveness of job offers that differ in many dimensions. The resulting arrangements for setting wages and adjusting employment establish the role of various determinants of wages. Most of all, they determine the way that cyclical changes in product demands are translated partly into changes in employment and partly into changes in wages.”
Okun’s interest in optimizing personnel managers put his research on a productive track, moving theorists toward a much improved Keynesian supply side with which to microfound stabilization-relevant macroeconomics. But he never got there. Like all the Early Keynesian work that preceded it, Prices and Quantities simply assumes the existence of meaningful wage rigidity. I believe that, had Okun lived, he would have at least assured that his intra-firm optimization approach remained high on the academy’s research agenda. However, given that he ideas were not compatible with the broad conversion of the macro academy to modeling rigorously constructed on general market equilibrium, Okun’s macro thinking quickly fell into obscurity. Until the GEM Project generalized rational economic exchange, the invisible handshake was no longer developed, taught, or (I suspect) read.
GEM Helping Hand
The GEM Project rigorously models OJB in information-challenged workplaces, microfounding MWR, the payment of chronic wage rent, and the existence of pure profit. It enhances Okun’s intra-firm analysis by rooting it in the bedrock economic method of optimizing, price-mediated exchange that is provided a second class of equilibrium: a rest point in the space of rational workplace decision rules. The specialized workplace is a transactions venue governed by decision rules, constraints, and mechanisms of exchange that differ fundamentally from those motivating activity in the marketplace. Workplace equilibrium is recognizable to practitioners and informs insightful descriptions of labor-price rigidities as well as other macro phenomena that are problematic in the context of the flexible wages inherently required by general market equilibrium. Firm-specific workplace equilibrium (its existence, stability, uniqueness, and tractable aggregation properties) microfounds general workplace equilibrium, which in turn motivates more policy-useful formal macroeconomic modeling.
Is the Game Worth the Candle?
Despite having been frequently scrubbed from the mainstream research agenda, powerful ideas tend to be resilient. In the case of Arthur Okun, generalized-exchange modeling builds on his fundamental themes, making them relevant again. That revival, and the respect it pays to Okun, is well worth whatever candles it takes. Cumulative score: Worth it: 8 (Lewis, Solow, Harris-Todaro, Bernanke, Lucas, Samuelson, Kerr et al, Okun). Not worth it: 0. As the score builds, keep in mind the major objection of mainstream theorists to generalized-exchange macroeconomics: Adding a second (workplace) venue of rational exchange is too much work. Its benefits are not worth the effort.
Blog Type: New Keynesians Saint Joseph, Michigan