In the 2007-09 Great Recession, involuntary job loss (IJL) exceeded six million, accounting for more than three-quarters of the overall increase in unemployment. The centrality of IJL in that contraction is typical. For each of the seven recessions since detailed job-separation data became available, forced job loss was the principal engine of rising joblessness.
Recession mechanics inherently feature IJL, producing a class of welfare damage that Keynes and the Early Keynesians put at the center of their reconstruction of macro theory. The real-world significance of the phenomenon explains the urgency, and disappointment, with which the GEM Project criticizes the search/match/bargaining model class, the go-to labor theory for mainstream macro theorists, for having nothing useful to say about job separation. This blog uses Robert Shimer’s Labor Markets and Business Cycles (2010), which I believe is the literature’s best summary of modern S/M/B thinking, to illustrate that claim. It is a discouraging story.
From Shimer (pp.104-105): “This section extends the search model with capital to consider the impact of fluctuations in the employment-exit probability…. Such shocks have a direct impact on the employment and unemployment rates by affecting the flow of workers from employment to unemployment. These shocks do not play any role in a model without labor market frictions since they can be costlessly reversed, but they can be an important contributor to aggregate employment fluctuations in an environment where finding a job is time-consuming…. There are two basic approaches to introducing fluctuations in the employment-exit probability into this model. The first is to generate the fluctuations endogenously. In Mortensen and Pissarides (1994), employed workers are subject to idiosyncratic productivity shocks and quit their job when the idiosyncratic shock is too bad. Shocks to aggregate productivity change the endogenous threshold for exiting employment, a potentially important amplification mechanism. The second, simpler approach treats the employment-exit probability as an exogenous shock, possibly correlated with productivity…. I follow the simpler approach here, allowing for the correlated shocks to the deviation of productivity from trend and the deviation of the employment-exit probability from its normal value.” Each element in Shimer’s introduction to job separation obscures the actual process captured in the data and described by practitioners. Modern S/M/B theorists choose to misunderstand job loss and, consequently, have nothing useful to say about its nature and implications when the critical phenomenon does occur.
Two points about Shimer’s approach to the problem are most relevant. First, it is as good as it gets in the mainstream literature. Usually, job separation is simply ignored. Second, his analysis does not come close to passing practitioners’ laugh test. Since actual behavior is captured in the economic data, the mainstream story also disappoints careful applied macroeconomists. Indeed, it is difficult to imagine serious analysts coming up with an explanation of the well-documented job-separation process that is more off-base. Most egregious, Shimer et al. simply ignore what everybody knows: Voluntary quits do not cause rising unemployment in recession. By definition, unemployment requires active job search, and S/M/B theorists cannot explain why so many rational employees quit their jobs in order to search for an alternative while total employment is contracting. Moreover, the evidence indicates that, in recession, employment found after job separation pays reduced wages. It is unsurprising that countercyclical quits, the endogenous engine of S/M/B modeling, is nowhere to be found in the evidence.
Involuntary job loss is not a subtle, easily overlooked occurrence. When occurring in the millions, it is really big news that stirs national debate. Ignoring IJL in the construction of macro models of employment stability requires willful theorist action. We must ask why so many economists, especially those who aspire to policy-relevance, are so determined to look the other way. Why do they stubbornly choose to be so obviously out of touch with what is actually happening? Shimer’s personal choice to eschew overtly relying on quits to generate job cyclicality by making job separation an exogenous black box sidesteps the most overt embarrassment. The problem, of course, mutates into his model now being constructed on unsupported free parameters, failing the crucial mainstream test of micro-macro coherence. Deep down, Shimer’s job-separation assumption differs from the broadly discredited Early Keynesians’ positing of meaningful wage rigidity (MWR) only in the latter fitting the evidence while his will never come close to serious empirical validation.
Here’s the pitch. The GEM Project provides a powerful alternative to the dead-end use, both logically and empirically, of the S/M/B model class to explain job instability in modern, highly specialized economies. It identifies that today’s mainstream macro theory falls short almost wholly because of the ill-considered consensus assumption that restricts rational, price-mediated exchange to the marketplace. Once that groundless free parameter is played, for no better reason than model-building convenience, Shimer’s dead-end, albeit coherent, story or some close variant becomes inevitable. Job quitting and unemployment, both voluntary, become the only available raw material with which to work. The models that result are, by any reasonable standard, unsuited for policymaking advice.
Why do smart, serious macro theorists get stuck with implausible stories about important phenomena? Why are we stuck with folly when the proper story is so obvious? I believe the answer to be that we have pushed aside what we all used to know: Any adequate analysis of job loss must feature MWR capable of suppressing wage recontracting. The GEM Project’s MWR story has a lot to recommend it, notably including its consistency with the huge best-practices management literature. Both offer the same description of how highly-specialized economies reconcile differing employer and employee objectives in the aftermath of the Second Industrial Revolution and the consequent advent of large, specialized, bureaucratic corporations. Theorists who care about stabilization relevance must reject restricting employment-exit analysis to market-centric modeling that cannot coherently accommodate meaningful wage rigidity. The GEM Project, deriving MWR as a continuous-equilibrium phenomenon from axiomatic model primitives, can help modern theorists become stabilization-relevant without giving up micro-macro coherence. That offer is surely too good to turn down.
Blog Type: New Keynesians Chicago, Illinois