The GEM Project is all about the crucial need to restore meaningful wage rigidity to its Early-Keynesian centrality in macroeconomics. MWR is defined by its capacity to rationally suppress wage recontracting. EK theorists made it the keystone of their stabilization-relevant modeling, putting MWR microfoundations at the top of their research agenda. Decades later, the GEM Project finally completed the EK quest. Deriving MWR from optimizing behavior organized by general decision-rule equilibrium wasn’t easy. It was necessary to construct a second venue of rational exchange that operates in tandem with markets to price and allocate resources.
The new venue is populated by workplaces that are inherently restricted by costly, asymmetric employer-employee information. It has been long understood that such constrained information renders the labor market unable to rationally price employee time. Given that intuitive workplace venue, MWR is easily shown to be an outcome of optimization and equilibrium, preserving the fundamental tenets of economic theory.
The Project’s generalized-exchange model has antecedents in multiple branches of the economics literature, including:
- Early Keynesians (Franco Modigliani, Don Patinkin, Paul Samuelson, James Tobin et al.) who founded macroeconomics as a distinct branch of economic theory;
- Middle-20th-century mainstream labor economists led by Clark Kerr, John Dunlop, Lloyd Reynolds, Richard Lester, Frederick Harbison, Charles Myers, and others who named themselves “neoclassical revisionists” and worked to integrate large bureaucratic firms into textbook labor theory;
- Alfred Chandler’s careful look at the consequences of the Second Industrial Revolution;
- Arthur Okun’s Prices and Quantities, published posthumously in 1980, that helped pioneer the rigorous modeling of information-challenged workplaces; and
- Original efficiency-wage theorists, featuring Robert Solow, George Akerlof, and me, who came very close to microfounding MWR more than three decades ago..
Even less attention has been paid to the macro contributions made by Nobel Laureates Ronald Coase and Herbert Simon. Coase (1937) and the new-institutional theorists he inspired have made substantial contributions to GEM modeling by investigating the rational choice between market and intra-firm exchange. Simon (1951) and his organization- theory colleagues insightfully mapped mechanisms and content of optimizing workplace exchange. It defies reason that the new-institutional and organizational literatures, both of which are fundamental to understanding economic behavior after the Second Industrial Revolution, have been ignored in mainstream macroeconomics.
Looking those names, it cannot be said that the GEM Project’s microfounding of meaningful wage rigidity doesn’t have distinguished lineage. As noted, the Early Keynesians thought it was the lynchpin question of macroeconomics. Bob Solow used to tell his newly minted PhDs to go forth and microfound nominal wage rigidity.
The Project’s fundamental, long sought achievement is obviously good news, but here’s the rub. The success occurred in the 21st century, an awkward time in the macro academy. Upon seizing the macro mainstream in the 1990s, New Keynesians relatively quickly reworked EK research priorities. Discouraged by its stubborn difficulty, they abandoned the centrality of MWR research, quietly accepting the adequacy of convenient, albeit irrational, assumptions of nominal wage rigidity. The dominating current version is Calvo’s rotating short-term wage stickiness. NK theorists use the Calvo short-cut, despite its violation of the optimization mandate of the New Neoclassical Synthesis, to provide some stabilization relevance for their dynamic stochastic general-market-equilibrium modeling. Such relevance is needed to support the appearance of the NK consensus model being, as advertised, settled theory.
The crushing problem here is that the NK short-cut, especially in its description of the macro-micro nexus that reverses neoclassical real-to-nominal causality, is always sufficiently misspecified to condemn much of modern analysis to stabilization-irrelevancy. Even more consequential, the absence of rational MWR denies NK model-builders critical guidance that would be forthcoming from a coherent, evidence-consistent mainstream theory. For example, involuntary job loss would no longer be optional in serious macro modeling. It was unsurprising that the most important stabilization authorities dismissed mainstream macro thinking as useless during and after the 2008-09 Great Recession. The profession urgently needs to resurrect MWR.
Blog Type: New Keynesians Saint Joseph, Michigan