Taking the Pledge

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Along with being sidelined by stabilization authorities in the 2007-09 Great Recession, the most embarrassing feature of today’s macro consensus is the pile of obviously important evidence that must be ignored. Most damaging, mainstream theorists have somehow agreed to sweep under the rug the rich, ubiquitous implications of meaningful wage rigidity (MWR). (See, for elaboration, the eBook’s Chapter 1.) Deliberate ignorance of crucial evidence just because it doesn’t fit the established theory is dishonest, unworthy of scholars who aspire to be taken seriously by policymakers. What follows briefly summarizes my favorite example of evidence that is powerfully relevant, long available, and broadly ignored: Katz and Summers’ (K-S) 1989 Brookings paper, “Industry Rents: Evidence and Implications.”  While providing substantial support for coherent generalized-exchange modeling featured on this website, their results are a difficult fit for consensus market-centric thinking and have consequently been pushed aside by mainstream theorists.

K-S use Current Population Surveys to demonstrate that many employees receive substantial wage rents simply because they work in particular industries. Highlights of the K-S findings are the following:

  • They estimate the average wage differential among industries that pay premiums to be 28%.
  • Controlling for a broad range of worker characteristics (education, occupation, gender, etc.) reduces their labor-rent estimate to 15%.
  • Responding to the familiar mainstream argument that fringe-benefits or imperfectly-controlled occupational differences could be the source of the wage premium, K-S demonstrate that closely accounting for such differences tends to increase, not reduce, measured wage rent.
  • Are the premiums caused by unionization? The evidence indicates similar-magnitude wage rents for nonunion workers. (Chapter 7)
  • How about Adam Smith’s famous argument, i.e., relatively difficult working conditions being the cause of relatively high labor pricing? Available evidence indicates that industries paying labor rents tend to have better working conditions.
  • K-S find a strong negative relation between an industry’s quit rate and its wage. (Chapter 5) They demonstrate the association to be rooted in the labor-price premium rather than observed worker characteristics.
  • Here is the knockout punch. K-S use longitudinal evidence, focusing on worker transfer from low-wage to high-wage industries, to identify a powerful characteristic of the U.S. labor market. Newly relocated employees pocket 60 to 100% of the industry wage differential. New hires’ quick capture of the lion’s share of the existing premium destroys the central mainstream argument that apparent labor rents reflect differences in unobserved human-capital. Job transfer itself cannot enhance workers’ intrinsic productivity.
  • K-S investigate the nature of rent-paying industries. They are capital-intensive, experience relatively high rates of return, and invest more heavily in R&D. They are easily recognized as the large establishments that populate the rent-paying venue of the GEM Project’s generalized-exchange model class.

Think about the implications for single-venue versus two-venue macro model classes. The same K-S evidence that must be ignored in coherent market-centric theory that occupies modern mainstream theory provides support for coherent generalized-exchange modeling.

Consider three summary points. The first is a useful reiteration. The standard objection to wage rents, forcefully argued by Topel in the addendum to the K-S Brookings paper, is that premiums are in fact caused by unidentified human-capital differences. A durably favorite class of Ptolemaic argument is to use unidentifiable causes to explain away difficult evidence. In the K-S paper, however, the go-to reason crumbles when confronted by newly relocated workers’ quick capture of the lion’s share of the available rents.

Second is a useful elaboration. Important causation in the generalized-exchange model runs counter to the mainstream market-centric narrative, i.e., that human-capital heterogeneities induce wage differentials. In the GEM Project, labor pricing in high-wage industries  is not the outcome of market competition for human capital. Instead, wages exceeding opportunity costs are rationally paid in order to manage workplace incentives. The resulting rents allow firms to cream their pool of job applicants. Along with most of the literature, K-S badly overstates the value of observed worker characteristics, especially in large-establishment routinized jobs.

Finally, pulling it all together, K-S evidence provides support for critical predictions of two-venue macro modeling that are rooted in the rational existence of substantial wage rents paid by large corporations. (Chapter 2) Add widely documented job downsizing to the evidence mix, and there is deep support for the fully-specified meaningful wage rigidity microfounded in generalized-exchange macroeconomics. (Chapter 3) In theorists’ quest to construct a model that is both coherent and stabilization-relevant, the important K-S evidence recalls the role Rosalind Franklin’s X-ray images played, higher up the tree of scientific achievement, in the original modeling of the structure of DNA. Crick and Watson were good enough, principled enough, theorists not to ignore her evidence.

I pledge that the GEM Project will not ignore stabilization-relevant evidence. I invite the gatekeepers of what is acceptable in contemporary macroeconomics to take that pledge. We would all be better for it.

Blog Type: Wonkish Saint Joseph, Michigan

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