The GEM Blog has largely devoted July to demonstrating the criticality of meaningful wage rigidity (MWR) in any serious effort to making sense out of the plentiful evidence on involuntary job loss (IJL). The critical facts are three-fold: IJL significance in macro instability, the persistence of the unemployment that results, and the long-term wage loss that absent recall it produces. All three facts were recently the subject of Pawel Krolikowski’s lead article in the American Economic Journal: Macroeconomics (2017, 9(2), pp. 1–31). From that article: “In the United States, job displacements affect many participants of the labor market. The Bureau of Labor Statistics (2010) reports that 6.9 million workers with at least three years of tenure experienced job loss due to layoff from 2007 to 2009.2 In conjunction with this high incidence, there exists a vast literature documenting large and persistent earnings losses associated with displacement. For example, Davis and von Wachter (2011)… find that at the time of displacement real earnings fall sharply, and even 20 years after displacement, annual earnings are 10 to 20 percent below pre-displacement earnings. Existing models used to study unemployment fluctuations have difficulty generating this observed magnitude and persistence of post-displacement earnings losses. The model presented in this paper provides an explanation for these phenomena.”
Krolikowski uses New Keynesian market-centric general-equilibrium theory to guide his model-building. That is not surprising. Had he not employed the mainstream macro model class, his work would not have appeared in the AEJM. Publication is a powerful incentive supporting the use general-market-equilibrium analysis, but that benefit is tarnished, especially given Krolikowski’s subject matter, by the fact that such modeling is unable to accommodate the existence of involuntary job loss, let alone explain its macrodynamic behavior.
Explaining Job-Loss Evidence
The GEM Project’s explanation of job loss follows from its derivation of meaningful wage rigidity in the context of optimizing workplace exchange organized by continuous general decision-rule equilibrium. MWR, producing nominal labor-price inflexibility over stationary business cycles and chronic wage rent, uniquely induces causality from aggregate-demand disturbances to forced job loss and evidence-sized movements in employment, output, and income. MWR uniquely enables total spending to play the starring role in the analysis of macro instability.
Krolikowski adequately summarizes the IJL data but ignores the critical role played by chronic wage rents. Inattention is not because such rents do not obviously exist. Wage rents are pushed aside because they are another economic phenomena that mainstream market-centric thinking has difficulty accommodating. Despite that, competent labor economists do not dispute their existence.
More than two years ago, I devoted a post to the insightful analysis of labor rents by two very good economists. Katz and Summers (K-S) 1989 Brookings paper, “Industry Rents: Evidence and Implications.” Such rents are predicted by, and provide substantial support for, the rational generalized-exchange modeling featured on this website. 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:
- 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-benefit or imperfectly-controlled occupational differences could be the source of the apparent 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. (See Chapter 7 of the e-book.)
- 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. (See 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 class of establishments that populate the rent-paying venue of the GEM Project’s generalized-exchange model class.
Katz-Summers documented wage rents in rationed employment provide the obvious explanation for the persistence of unemployment that begins with being laid-off as well as the significantly reduced wage received in subsequent employment. It is not surprising that K-S found that rents are paid by the class of firms that the generalized-exchange theory identifies as the large-establishment venue (LEV). Nor does it surprise that the K-S rent size is in line with the wage loss experienced by unemployed workers in their subsequent employment, typically in the non-rationed small-establishment venue (SEV).
Pretending to Explain Job-Loss Evidence
Krolikowski’s fundamental problem is that his mainstream general-market-equilibrium model cannot accommodate neither MWR nor the involuntary job loss that he wants to explain. He sidesteps the difficulty by accepting the mainstream convention of simply ignoring the interrelated phenomena of wage recontracting and MWR. He does what he has been taught: switch the theoretical focus to voluntary job loss. That switch permits the use of ubiquitous labor-market search-match theory in his pretense of modeling the job-loss evidence produced by the Great Recession and elsewhere. If pretending is set aside, he must recognize that the unemployment in his model is wholly voluntary and, as a result, has nothing to do with the actual evidence. Almost all of the 6-million-plus job loss occurring in 2007-09 is known to have been involuntary. Krolikowski’s model explains nothing.
Blog Type: New Keynesians Saint Joseph, Michigan