Generalized-exchange modeling has an unrivaled capacity to predict consequential macro events. This post summarizes three important stagflation-related predictions of GEM theory, each of which is out of reach of friction-augmented general-market-equilibrium (FGME) analysis.
Unstable Wage Structure
The GEM Project fundamentally alters our understanding of highly specialized economies by demonstrating that chronic wage rent is rationally paid in workplaces constrained by costly, asymmetric information. (See below.) The size and location of such rent are embedded in the interindustry wage structure. Despite providing crucial evidence on the nature of the stagflation decade, relative-wage behavior has been ignored in mainstream analysis.
By contrast, generalized exchange macrodynamics powerfully explain the wage structure. Chapters 2 and 7 of my The Price of Industrial Labor (1984), a pioneer in GEM thinking, remain the most insightful empirical analysis of interindustry labor-price behavior during the stagflation decade. A quarterly coefficient of variation (CV), using data from the BLS monthly establishment survey covering 116 three-digit industries, is constructed. The CV is the ratio of the standard deviation to the arithmetic mean. It reveals a stable wage structure interrupted by stagflation. By the end of the 1970s, the CV was 25% higher than its 1960s average. The wage structure blew apart, an important phenomenon that FGME modeling cannot come close to explaining. Indeed, most mainstream macro theorists remain unaware that it happened.
The book establishes three critical facts about the blown-apart wage structure. First, about half of all nonfarm nonsupervisory workers were able to defend their real wages against the labor-adverse terms-of-trade shifts, especial the huge increase in energy costs, that have been featured in earlier posts. The remainder of the work force took the hit. Second, the fortunate employees were located in large, capital-intensive establishments. Third, the primary cause of the altered wage-structure was the sharp jump in energy prices. Those stagflation facts are uniquely predicted by GEM theory.
FGME theorists must ignore that evidence. A prime example is Robert Lucas, who aggressively used stagflation to fuel a successful anti-Keynesian insurgency, is quoted on setting aside the crucial third fact in Snowdon and Vane (2005, p.279): “The direct effect of the OPEC shock [on stagflation] was minor in my opinion.” The need to ignore essential facts is the special burden of mainstream macroeconomists.
Downsizing Crisis
The stagflation decade, viewed through the lens of generalized exchange, had a critical initial condition and a primary shock, both of which must be ignored in mainstream thinking. The former is the compact interindustry wage structure that characterized the early postwar period. Relatively modest large-establishment labor rents were the norm prior to the 1970s. The primary shock is the large terms-of-trade disturbance described in the previous two weeks’ posts. Macro theorists overlook how the relative-price shock interacted with meaningful wage rigidity to produce substantially higher wage rents that exerted downward pressure on trend profits.
By the 1980s, profit expectations had fallen below the level necessary to support the existing level of productive capability in many capital-intensive industries, inducing permanent job destruction that was, after lengthy albeit rational delay, followed by labor-price reference-standard recalibration and wage givebacks. Rational retrenchment depressed trend productivity growth. Beginning in the 1970s, the U.S. economy experienced a prolonged period of interacting high price- and wage-inflation, elevated unemployment (largely attributable initially to layoffs and central-bank efforts to contain inflation), and eventually leading to a rising incidence of both the downsizing of good jobs and cost-related bankruptcies. Difficult, long-lagged permanent job loss and reference-wage recalibration, for the most part occurring after the stagflation decade, eventually helped realign labor pricing and use to profit expectations that were more consistent with full employment.
As modeled in Chapter 3 of the website’s e-book, significant downsizing and wage concessions, most famously occurring in a “rust belt” of heavy manufacturing and aggravated by rising imports from Japan and Europe, had not been experienced since the Great Depression. The reappearance of the painful phenomena, on a scale with which there was no postwar experience, excited a great deal of media and policymaker attention. Mainstream FGME theorists, increasingly challenged within the profession to construct rational-behavior models, looked the other way.
Chronic Wage Rent
Pure wage rent (PWR) is an outcome of optimizing employer-employee interaction in workplaces constrained by costly, asymmetric information and routinized jobs. Those circumstances dictate that rational labor pricing occurs inside the firm and chronically exceeds relevant market-opportunity costs. PWR is a necessary condition for the existence of the price-wage-price spiral that was the lynchpin of the stagflation decade, but it is much more.
The Project demonstrates that PWR plays significant roles in the existence of involuntary job loss, the persistence of cyclical unemployment, the existence of good and bad jobs, the distribution of firm revenues among factors of production, the existence of pure profit, the determination of consumption and investment, and more. The PWR model is also consistent with the broad range of available, relevant evidence. Despite those virtues, PWR is an orphan concept, nowhere to be found in the mainstream literature dominated by friction-augmented, market-centric general equilibrium. The derivation of pure wage rent requires the generalization of rational price-mediated exchange from the marketplace to workplaces restricted by costly, asymmetric information and routinized jobs.
Blog Type: Wonkish Saint Joseph, Michigan
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