Resurrections and a Wrecking Ball

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The GEM Project is about resurrections, reviving particular schools of thought long left for dead. Most central is the large-workplace modeling conducted by a loose collection of 20th century labor economists. Clark Kerr, John Dunlop, Frederick Harbison, Charles Myers, Richard Lester, Lloyd Reynolds, Arthur Ross, Albert Rees, George Schultz, Henry Phelps Brown, and their colleagues were neoclassically trained, modeling rational employer and employee behavior subject to large-firm technological constraints. They closely investigated worker preferences and the interpersonal and intertemporal wage comparisons that they saw greatly influence satisfaction on the job. Especially notable is John Dunlop’s (1957) exhaustive study on internal wage systems, featuring the power and ubiquity of established reference standards in intra-firm determination of labor compensation. The on-site labor economists produced a nuanced, still accurate picture of what occurs in the large-establishment workplace that is broadly ignored by modern economists.

A second, related resurrection is the original morale-centric efficiency-wage literature that, along with Solow (1979), I (1977, 1980) helped to pioneer. That relatively small body of work combined employees’ preference for equitable treatment and costly, asymmetric large-workplace information. The latter induced a bimodal separation of rational labor pricing in economic  theory. Large establishments rationally set wages inside the firm, while their small counterparts are market-wage takers. Efficiency-wage theory was unhappily reformulated by subsequent authors, returning the significant action to the more familiar marketplace. (Chapter 4)

The third resurrection concerns a better-known but still banished literature: the Early Keynesian macro centrality of wage rigidities. Building on Modigliani and Patinkin, Samuelson organized the Neoclassical Synthesis around the assumption of short-term labor-price stickiness that dominated macro thinking for decades after the death of Keynes. The Early Keynesians used wage rigidities to make their aggregate models stabilization-relevant, putting macroeconomics and macroeconomists on the policymaking map.

In the familiar story, the assumption of wage stickiness sufficient to suppress recontracting robbed the Early Keynesian model class of coherence. That serious methodological failure eventually resulted in its replacement in mainstream thinking by the ubiquitous coherent market-centric general-equilibrium analytic framework. The unfortunate new-consensus side-effect is its reversion to being stabilization irrelevant.

The long-standing conundrum between coherence and stabilization-relevance has been solved by generalizing rational exchange from the marketplace to workplaces restricted by asymmetric information. There is not much original brilliance in the GEM Project. Its analytic core is the tripartite resurrections of ignored literatures on workplace labor economics, original efficiency wages, and the Early Keynesian Neoclassical Synthesis. The overall result, however, is the most significant innovation in the development of stabilization-relevant macroeconomics: the microfounding of large-establishment meaningful wage rigidity (MWR), featuring downward inflexible wages over the stationary business cycle and chronic time-varying wage rents. MWR pushes most employees off their market supply schedule and motivates long-lagged rational adjustment processes that accommodate wage givebacks. (Chapters 2, 3)

Meaningful wage rigidity is the fundamental reason for the generalization of rational exchange. The workplace venue enriches a wide range of decision-rule modeling, but for macroeconomics it is labor pricing that really matters. (Chapter 8) Moreover, I admit to a related guilty pleasure. I sometime imagine MWR as a powerful analytic wrecking ball that can be aimed at the Ptolemaic arrogance mainstream macro theorists. It’s fun to consider how to prioritize the targets.

The ubiquity of the search/match/bargain attempt to use frictional (voluntary) unemployment to account for evidence on cyclical joblessness comes quickly to mind. With microfounded MWR, wage recontracting can be rationally suppressed; and we no longer have to pretend ignorance that most of the increase in joblessness in recessions is caused by involuntary job loss. But wait. Hasn’t the most bitter pill been having to take seriously that the welfare cost of recessions directly results from technical regress or some other candidate real shock.

A deeply embarrassing example here is the use of counter-intuitive cyclical variations in workers’ preference for leisure. We have the champions of rigorous modeling relying on arbitrarily convenient cycles in preferences! Aim the MWR wrecking ball, and that silliness is happily obliterated. Nominal demand disturbances, either as a primary shock or propagating real shocks, easily induce same-direction changes in employment, output, and profits that are consistent with the cyclical evidence. And what about profits? It is an enduring scandal that pure profits cannot exist in coherent mainstream thinking and thereby cannot provide the crucial signals that everybody else knows and understands. The MWR wrecking ball smashes the universality of Wicksell-Wicksteed market-centric income distribution. (Chapter 3) The GEM Project assigns a central role to pure profits, making coherent macroeconomics more acceptable in business schools and to real-world decision-makers.

Looking elsewhere, to the extent that the Lucas critique relies on his famous substitution of rational expectations for inflation catch-up in the (Phillips curve) wage equation, the wrecking ball blows it away. Large-establishment labor pricing rationally reverts to a primary reliance on catch-up. (Chapter 4) The MWR wrecking ball also happily blows up go-to match-technology mechanics that posit a powerful link between resources allocated to recruitment and the overall level of unemployment. Mainstream macroeconomists have somehow been convinced to take that ludicrous story seriously. Nobody else does. Perhaps best of all, the wrecking-ball rubble delivers macroeconomists from the demeaning but previously necessary task of making involuntary job loss disappear. Pretending that forced layoffs, the best-known business-cycle characteristic, do not exist is profoundly embarrassing.

Blog Type: New Keynesians San Miguel de Allende, Mexico

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