Helping a Useful, Problematic Idea: Lazear and Spletzer’s “Churn”

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I know Edward Lazear from his time heading the Council of Economic Advisers. We have research interests in common. His academic work has long focused on translating what has been learned by personnel departments into neoclassical economic theory – a pursuit shared by the GEM Project. Lazear’s major problem was then, and remains today, that he relies on mainstream friction-augmented, general-market-equilibrium modeling to guide his analysis.

A Useful, Problematic Idea

Useful idea. In a 2012 NWER paper, Lazear and his coauthor James Spletzer (L&S) called attention to a labor-related fact that they named “churn”: the hiring of replacements for employees who have voluntarily left their jobs. The authors argue that much of the hiring and job-separation that occurs reflects churn, not overall employment expansion or contraction.

From L&S: “Hires occur for two reasons—to grow a business and to replace those who have left. Hiring can be for expansion or it can be associated with churn. Analogously, separations reflect a decrease in the size of the business or the departure of a current employee who is replaced by a new employee.” Their friction-enhanced general-market-equilibrium analysis produces a set of  misguided conclusions about business cycles: “Churn is procyclical. Churn declines during recessions because separations, which during good times would have been associated with a replacement hire, are allowed to go unfilled during recessions. As a result, employment declines. Churn also declines during recessions because workers become reluctant to quit their jobs, and in response businesses reduce their hiring. Hiring declines during recessions.”

Problematic idea. As noted, L&S work wholly within the mainstream general-market-equilibrium framework, a choice that causes their modeling of churn to be – putting it kindly – badly incomplete. Two omissions are especially damaging. First, involuntary job loss, shown by the evidence to be the dominate reason that employment contracts during recessions, is excluded. L&S mention layoffs but never effectively integrate the concept into their analysis. Instead, they loosely assign cyclical-employment causality to firms “allowing separations to go unfilled”. Forced layoffs are a class of labor adjustment that is crucially relevant to stabilization policymaking relevant. Actual cyclical unemployment cannot be understood as allowing separations to go unfilled.

Second, wage rents are ignored. The evidence strongly indicates that labor pricing in excess of market opportunity costs is chronic in complex, bureaucratic firms. That phenomenon must powerfully influence voluntary job quits and therefore powerfully inform the useful analysis of churn. Harris and Todaro (1970) taught us that, if one economic venue pays rents and another does not, a queue of workers seeking high-wage employment rationally organizes itself. The size of the queue is motivated by the magnitude of the wage premium and perceptions of the likelihood of obtaining a rent-paying job. In specialized economies, rational wage rent must be a critical part of any rigorous model of churn.

GEM Project Helping Hand

The generalization of rational, price-mediated exchange from the marketplace to bureaucratic workplaces is central to adequately modeling churn. The GEM Project enables the derivation of meaningful wage rigidity (MWR) needed to suppress wage recontracting and thereby introduce involuntary job loss and chronic labor rents into coherent general decision-rule equilibrium. The Project separates involuntary job loss into temporary layoffs and permanent job destruction. More fundamentally, it intuitively separates the economy into two venues of rational exchange: large, highly specialized firms with imperfect workplace supervision and small firms with cost-effective supervision.

In the small-establishment venue, worker hours supplied and demanded are equilibrated in the labor market with short lags rooted in price-discovery frictions – the familiar textbook labor-search story. Cost-effective supervision of on-the-job behavior (OJB) restricts worker discretionary action to the marketplace, inducing investment in information acquisition related to stay-quit decisions as well as the on-going quest for rent-paying LEV jobs. Rational behavior equating the market wage and the marginal disutility of work generates labor churning, into and out of jobs, into and out of unemployment, and into and out of the labor force. Market information costs limits workers’ grasp of the true state of the economy as well as their own opportunity costs, requiring stochastic decision-making. That market-centric framework is used by L&S to analyze churn. Their badly incomplete story ignores highly-specialized bureaucratic firms.

In the large-establishment venue, cooperative labor input is more loosely restricted by costly, asymmetric workplace information as well as routinized jobs. As a result, it cannot be measured by hours alone. Optimal exchange must relocate from the marketplace to the workplace, a distinct venue constructed by the profit-seeking firm to facilitate efficient labor management. Such firms pay wages that minimize unit costs while workers use their latitude on the job to pursue axiomatic preferences that govern their satisfaction with management policies.

The rational LEV wage, embodying cyclical downward rigidity as well as chronic rent, is the lynchpin of dynamic workplace decision-rule equilibrium. Employee stay-quit decisions, for those who remain in the labor force, collapse to rationally choosing to stay. Employers and employees both invest in acquiring information relevant to managing workplace reference standards that influence the transformation of labor hours into cooperative input. Management understands its central labor problem to be nonmarket in nature: How to induce, given costly, asymmetric workplace information and routinized jobs, employees’ voluntary acceptance of management’s goals?

Given imperfect workplace information, management choices concerning employee reference standards and production capability are stochastic in nature. Firms play the averages with respect to OJB and unit labor costs, while their employment decisions are motivated by profit expectations. LEV compensation practices, rationally suppressing wage recontracting in lieu of forced job loss, powerfully constrain marketplace decision-rule optimization and generate crucial intermarket spillovers from temporary and chronic job/hours rationing. Those constraints on household and small-firm decisionmaking permit the coexistence of dynamic general (decision-rule) equilibrium and the failure of markets to clear. The economy now features involuntary job loss and joblessness at both business-cycle and nonstationary frequencies. Putting the pieces together, interacting workplace and marketplace venues, especially as the economy adjusts to their inconsistent labor pricing, uniquely microfound recognizable churn.

Is the Game Worth the Candle?

Microfounding L&S modeling aligns churn with the fundamental tenets of economic theory, i.e., optimization and equilibrium The concept becomes eligible for mainstream consideration, eligible for assuming its place as a building block of stabilization-relevant macroeconomics, and eligible for helping establish Lazear’s personnel economics as a research school of consequence. All that is surely candle worthy. Cumulative score: Worth it: 19 (Lewis, Solow, Harris-Todaro, Bernanke, Lucas, Samuelson, Kerr et al, Okun, Hicks, Sraffa, Hayek, Keynes, Burns, Robinson, Modigliani, Phelps, Stiglitz, Jensen, Lazear). Not worth it: 0.

Blog Type: Wonkish Saint Joseph, Michigan

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