Much Ado about Match Capital

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This blog continues last week’s look at Robert Shimer’s Labor Markets and Business Cycles (2010). I like that the author is upfront about two problematic labor-market restrictions that are frequently attached to consensus market-centric DSGE modeling. First is the assumption of outsized match capital (MC) in labor recruitment, generating particular search frictions. “In the search model, firms use some of their employees to recruit new workers, and the difficulty of recruiting depends on the ratio of recruiters to unemployed workers.” (p.113) Substantial idiosyncratic difficulty in matching job applicants to job vacancies is routinely assumed in mainstream macro thinking. The second restriction, also a manifestation of match capital, concerns wage determination. “Although perhaps more subtle, this assumption is no less important. In the presence of search frictions, matched workers are in a bilateral monopoly situation.” (p.113) Positing bilateral monopoly is a fateful step, introducing slippery labor-price indeterminacy into macro modeling.

Shimer along with other mainstream theorists puts match capital at the center of his struggle to make general market equilibrium coherent and stabilization-relevant. Here’s the predicament. Match capital is not now, never was, and never will be up to the task of suppressing wage recontracting. The assumption, as an acceptable short-cut to stabilization-policy relevance, falls far short of the Early Keynesian (EK) upfront assumption of meaningful wage rigidity (MWR) that does short-circuit recontracting. The EK restriction is at least aligned with the evidence. There is no plausible reading of the data or practitioner testimony that supports the strong MC story.

The notion that match capital is generally substantial, resulting from widespread idiosyncratic recruitment and motivating a significant nonmarket wage range within which the matched worker-firm combination rationally prefers not to renegotiate, is simply wrong. There is no debate that costly, applicant-specific information-gathering during recruitment must be rooted in idiosyncratic human capital embodied in both the job seeker and the position to be filled. But here’s the rub. In the market for routinized jobs, which describes most of the vacancies to be filled by new hires in large establishments, unit costs generated by worker-search and firm-hiring activities are transparently small. Substantial idiosyncratic human capital is a misleading assumption of convenience, not fact. Large firms respond to most vacancies in their workforces, demonstrated in the GEM Project to be rationally receiving wage rents, by collecting applications from eager job-seekers who are either unemployed or are employed by small (market-wage paying) establishments. (For elaboration, see Chapter 4 in the website’s eBook.) Recruiters can, but often do not, check recent employment histories. More likely, they rely on probationary periods for new hires, delaying their acquisition of the rights and benefits of regular employees. Personnel departments have learned that trial employment provides more useful information about work habits and productivity than references or interviews.

For most new hires, efficient matching processes are insufficiently idiosyncratic to generate outsized unit recruitment costs and Nash rents that must be divided between the new employee and his/her employer. The wage to be paid is, after all, always posted; it is not indeterminate. Everybody knows it cannot be negotiated. There is no bilateral monopoly. Assuming otherwise badly misleads. The exception, of course, is the relatively small incidence of recruitment for positions that actually require substantial idiosyncratic human capital. Such matching exercises do not rely on information gathered by personnel departments. The task occurs at much higher pay grades, with support information frequently provided by professional search firms. Personnel-department recruiters in large firms instead process applicants for the thousands of nonsupervisory production jobs, where idiosyncratic human capital is not an issue. BLS data confirm that employment class to be the vast majority of workers in highly specialized economies. (Doesn’t everybody know all this?)

And the troubles for the outsized-MC story keep on coming.  Bilateral monopoly assumed by mainstream theorists implies either an incoherent wage structure, as new hires are priced idiosyncratically, or adjustments to the firm’s overall average wage in the Nash-rent-division phase of each and every employee recruited. Either outcome is well understood by practitioners to be disastrous, a carefully chosen word. Large corporations, already rationally paying wage rents, have developed much superior, cost-effective recruitment strategies. Existing workforces costlessly disseminate information on the firm’s hiring intentions among families and friends. Potential recruits are not required to be, and are probably not, presently unemployed. If the firm wishes wider distribution of its plans, paying directly for information dissemination (newspapers, the internet, other advertising, modest payments to existing employees for attracting applicants, etc.) is much more cost efficient than increasing its average wage.

Moreover, consider a persistent nominal-demand contraction. Given downward rigid money wages, profits are adversely affected. With plausible demand elasticities, the profit-seeking firm must dismiss employees, creating forced joblessness. But that is not what would rationally happen in the world of generally outsized MC, which cannot suppress wage recontracting. Even in bilateral monopoly, reduced demand generates wage-cutting incentives for both employee and employer. The former rationally accepts a wage cut in lieu of job loss that does not violate his or her opportunity costs; the latter rationally offers such a cut. That parties to bilateral-monopoly arrangements never have mutual incentive to cut the nominal wage is simply wrong.

Finally, it is significant that low-MC employees constitute most of those who involuntarily lose jobs in response to adverse demand disturbances. Given sufficient nominal contraction, millions of workers once hired with little MC capital are forced into unemployment largely because their employer refuses to cut their wages. Nobody really believes that the six million lost jobs in 2007-09 were voluntary quits. When will mainstream theorists become tired of the embarrassment that inevitably results from trying squeeze recognizably-size job separation out of market-centric coherent general-equilibrium modeling? When will they tire of trying to dance on the head of a pin? When will they suck it up and get on with the core task of coherently modeling wage rigidity sufficient to suppress wage recontracting?

Blog Type: New Keynesian Chicago, Illinois


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