Wage stickiness feeds the gig economy

A few posts back I discussed the plight of a guy who did various odd jobs to “scrounge up” some money while unemployed.  This morning I heard a long story on NPR about the “gig economy,” which argued that this phenomenon has become quite widespread in recent years.  Obviously this raises some questions about the official unemployment rate and GDP figures.

My own view is that people in the gig economy should be thought of being sort of half employed and half unemployed.  Because of wage stickiness, they are often kept out of more desirable, higher paying and more productive jobs in the formal sector.  Of course there are always a few workers who actually prefer the independent lifestyle of the gig economy, but it seems highly unlikely that this number suddenly rose sharply in late 2008 and early 2009.

One objection to the sticky wage model is that it predicts that corporate profits will fall during a recession, and right now corporate profits are at a record high.  I have several responses to this criticism:

1.  Corporate profits did fall sharply during 2008 and early 2009, exactly as predicted.

2.  Some of the strength of corporate profits is due to earnings overseas, especially in developing countries that are still growing rapidly.

Nevertheless, even with these two caveats there is still a bit of a puzzle.  As Tyler Cowen recently noted, this is not your grandpa’s AD shortfall.  Or perhaps it is, but it’s not your grandfathers SRAS curve, and hence the equilibrium wage and price outcomes look somewhat different.

Let’s compare this recession to the interwar slumps.  During 1920-21, 1929-33, and 1937-38, both wages and prices fell, but wholesale prices fell much more rapidly.  This raised real wage rates, reducing output and corporate profits.  In this recession wages and prices haven’t fallen significantly, but are rising at a slower rate.  Real wages haven’t changed much.

It turns out that the differences between the interwar recessions and today are much less important than the similarities.  During the interwar years the economy was much more oriented toward producing commodities, and hence firms then were more likely to be price-takers.  (Compare iron and steel and coal to Apple Computer.)  Thus prices fell more sharply than wages, even in a fairly laissez-faire labor market like 1921.  In the Great Depression, government policies further slowed downward wage adjustments.

Today the economy is better described as monopolistic competition, and firms have quite a bit of pricing power.  Consider the two stylized facts:

1.  Suppose in the interwar years NGDP growth falls 10% and prices fall 5% and wages fall 2%.  In that cases real wages rise 3%.

2.  Suppose in the recent recession NGDP growth falls 10% and prices and wages both fall 2%.  In that case real wages don’t rise, and corporate profits recover much more quickly.

In case #2 high real wages are no longer the problem, but it continues to be true that sticky wages are a problem.  When NGDP growth suddenly slows by 10%, you need to reduce wage and price growth by 10% as well, if you want to maintain full employment.  That doesn’t happen, so nominal shocks continue to produce recessions, without raising real wages or cutting corporate profits.

It turns out that economists never should have focused on real wages, it’s the wrong variable.  Wages don’t follow changes in the price level; they follow changes in NGDP growth.  In recent years Chinese wages have been rising at about 15%, despite inflation of about 5%.  Why the big gap?  Because Chinese NGDP growth has been closer to 15%.  That’s what determines wages in the long run.

But in the short run wages are sticky, and thus do not parallel changes in NGDP.  Hence nominal shocks matter.

Some might be inclined to see wage stickiness as a “problem” that we must do something about.  In my view that’s a big mistake.  It would be like the designers of the Tacoma Narrow Bridge lamenting that “gravity is a problem that needs to be eliminated.”  No, both gravity and wage stickiness are aspects of reality.  We need to build strong bridges and a stable NGDP monetary policy precisely because there’s nothing we can do about gravity and wage stickiness.

I need to qualify the preceding argument in one respect.  Although the government cannot prevent wage stickiness, it may be able to prevent labor cost stickiness.  The French government recently decided to cut the employer payroll tax and raise the VAT by 1.6% to prevent any loss in revenue.  Because France doesn’t have her own monetary policy, most of this VAT will pass through in the form of higher prices.  This really will reduce labor costs, although the program is probably too small to have a major impact on the French economy.  Still, it’s one type of fiscal policy (not “demand” stimulus) that actually makes sense.

PS.  Ironically, Sarkozy has this to say about the plan:

Sarkozy said there is no risk of inflation from a VAT increase because there is so much competition.

Let’s hope he’s wrong, otherwise it won’t work.


Tags:

 
 
 

31 Responses to “Wage stickiness feeds the gig economy”

  1. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    1. February 2012 at 11:44

    ‘It would be like the designers of the Tacoma Narrow Bridge lamenting that “gravity is a problem that needs to be eliminated.”’

    I was reminded of this just last Sunday when rookie PGA golfer Kyle Stanley collapsed on the 18th hole at Torrey Pines. Stanley is a native of Gig Harbor–just across the Narrows from Tacoma.

  2. Gravatar of Benjamin Cole Benjamin Cole
    1. February 2012 at 11:49

    Excellent blogging.

    Without Market Monetarism, monetary policy is easily muddled.

    The parallel would be trying to organize commerce without the insights of Adam Smith. Feudalism? Socialism? Many approaches might be appealing if you don’t know Adam Smith.

    Likewise, if an economist does not know Market Monetarism, they appear liable to make oddball critiques and off-the-mark prescriptions.

    The econo-shamans are making a strong defensive stand, but I think the time for Market Monetarism is arriving.

  3. Gravatar of Greg Ransom Greg Ransom
    1. February 2012 at 11:56

    Right. Hayek. Not Keynes.

    “It turns out that economists never should have focused on real wages, it’s the wrong variable.  Wages don’t follow changes in the price level; they follow changes in NGDP growth.”

  4. Gravatar of Greg Ransom Greg Ransom
    1. February 2012 at 12:14

    Your words here Scott almost directly replicate statements made on hese issues by Hayek — relative prices and price levels — including wage– should adjust to a steady NGDP or total income stream and the NGDP should not be yo-yo’d to maintain a given ser of relative price relations and levels, be they wages, interest ratea or price level inflation rates.

    Hayek says that someplace in about 10 words.

  5. Gravatar of Greg Ransom Greg Ransom
    1. February 2012 at 12:18

    So how do you get there? Hayek, White & Selgin argue you do so with private banking and the denationalization of money.

    Private innovation in NGDP instruments likely would be part of the picture.

  6. Gravatar of JJA JJA
    1. February 2012 at 12:49

    This is almost off-topic, but it actually supports the idea of having a constant NGDP growth trend.

    In my staff there are quite many people with loans for their homes (mortgage in English, I presume). A fall in the nominal income would be a total disaster for them. Consider a good engineer with a marriage and a couple of children and a house bought a couple of years ago. Yes, wages are sticky.

    Inflation is not a problem. The payments for the house will be managed. The cost of living will be managed even if there is a bit less real purchasing power for a new car and holidays.

    Hence there are quite a few reasons why big corporations like my employer are not so happy with the idea of lowering wages. The best and most productive employees would have problems with their loans and be less productive during the work.

    Yes. Let there be nominal growth.

  7. Gravatar of Morgan Warstler Morgan Warstler
    1. February 2012 at 13:33

    My Guaranteed Iincome is far better stimulus because it both ends uneployment and creates downward wage pressure.

    New rule: good stimulus encourages liquidation /market clearing

  8. Gravatar of DonG DonG
    1. February 2012 at 13:44

    It seems you are using “sticky wages” interchangeably with employee costs. It sure doesn’t work that way near me. Sticky wages are fixed with layoffs. Layoff the bottom X% based on productivity and the top Y% based on cost. Bam! High profits with stuck wages.

  9. Gravatar of bill woolsey bill woolsey
    1. February 2012 at 14:03

    I am glad you are off the real wage kick.

  10. Gravatar of Robert Simmons Robert Simmons
    1. February 2012 at 15:19

    Don’t we hope that Sarkozy is (almost) right? Lots of competition = flattish supply curve, so that a small bump in inflation (CPI) will go hand in hand with a large increase in RGDP?

  11. Gravatar of Matt Waters Matt Waters
    1. February 2012 at 16:17

    “It seems you are using “sticky wages” interchangeably with employee costs. It sure doesn’t work that way near me. Sticky wages are fixed with layoffs. Layoff the bottom X% based on productivity and the top Y% based on cost. Bam! High profits with stuck wages.”

    It’s called sticky wages because only the wage component is really sticky. All other parts of employment cost can be contained. For whatever reason, companies cannot cut wages, but will have no issues increasing employee contributions to benefits or ending 401(k) matching.

    Companies cut 401(k) matching before layoffs because ideally managers would maximize return on capital by getting their price down to where their factories would run at full capacity.

  12. Gravatar of Matt Waters Matt Waters
    1. February 2012 at 16:39

    Scott, could you make a post on why, exactly, wages are sticky across so many cultures and time periods? Why, exactly, is it rational for managers to lay people off instead of cutting wages?

    I’ve tried thinking through it a lot and still haven’t really come up with a satisfactory answer. The only real answer I have is that, in a modern economy, most of our production takes an immense amount of coordination.

    Ideally, every single laborer’s time would be cleared in a market like oil or pork bellies. However, the immense transaction costs in the labor markets makes this impossible. Commoditization is only really possible for goods and services which can be easily specified contractually. As a laborer’s output becomes more complex and ambiguous, such as the institutional knowledge gained by someone working at one place for years, an employer and employee use idiosyncratic contracts and prices instead of a commoditized model.

    But even under an idiosyncratic agreement model with high transaction costs, why doesn’t the manager reduce wages as they’re allowed to do? I just can’t wrap my head around that question and really can’t give a better answer than a manager doesn’t want to be hated by his employees for reducing their wages, even if employees couldn’t find a new job somewhere else for more pay.

  13. Gravatar of ssumner ssumner
    1. February 2012 at 17:33

    Patrick. Gig Harbor? Interesting coincidence in this post.

    Grag, I’m always glad to replicate Hayek’s conclusions. But I don’t know if free banking would get you there. I support part of the free banking agenda, but want the government to set the medium of account (NGDP futures.)

    JJA, Yes, I cite loan repayment issues as one argument for steady NGDP growth.

    Morgan, I strongly agree that NGDP targeting makes it easier to promote free market policies. It makes it more likely that new opportunities will open up during creative destruction.

    DonG, No, I mean sticky hourly wages.

    Bill, I think I’ve always thought W/NGDP is better than W/P. But maybe I said otherwise a while back.

    Robert, We hope the economy is competitive and the SRAS is flat. But we also hope that the VAT is passed along, because it will allow the SRAS to shift right (due to the lower payroll tax.) Just thinking out loud there are two issues here–slope of the SRAS and shifts in SRAS. I think you are talking about slope and I am talking about shifts.

    Matt, It’s a puzzle to me too, but there is lots of evidence for two types of nominal wage stickiness.

    1. Slow adjustment in nominal wages.

    2. Very strong resistance to wage changes below 0% increase. I.e. nominal wage cuts. Although 99% of commenters disagree with me, the discontinuity at 0% across many different trend rates of positive inflation suggests money illusion. It suggests workers prefer a 3% wage increase during 5% inflation to a 1% wage decrease during 0% inflation. Even though the later is actually better. There’s really no other explanation. (Some cite fixed expenses like mortgages, but even that’s not enough to explain the data, as not all expenses are fixed.

    The big problem isn’t real stickiness, it’s nominal wage stickiness. That means money illusion.

  14. Gravatar of Wage stickiness feeds the gig economy « Economics Info Wage stickiness feeds the gig economy « Economics Info
    1. February 2012 at 19:00

    [...] Source [...]

  15. Gravatar of david david
    1. February 2012 at 19:01

    Scott, do you think it is predominantly wage stickiness or price stickiness? Or what mix of both?

  16. Gravatar of Robert Simmons Robert Simmons
    1. February 2012 at 19:54

    Are you saying that passing the VAT along shifts the supply curve, or that passing it along wouldn’t impact the supply curve and thus allows the payroll cut to shift it? I think it’s the second because the first doesn’t make sense to me, but I’m not certain.

  17. Gravatar of Greg Ransom Greg Ransom
    1. February 2012 at 20:55

    I don’t know if free banking gets you there either, but White and Selgin certainly have effective arguments both empirical and theoretical making their case. I don’t count myself as having a strong enough handle on either the science or the particular institutional proposals on offer to stake out strong stand of my own.

    Scott writes.

    “Greg, I’m always glad to replicate Hayek’s conclusions. But I don’t know if free banking would get you there. I support part of the free banking agenda, but want the government to set the medium of account (NGDP futures.)”

  18. Gravatar of liquidationist liquidationist
    1. February 2012 at 20:58

    I know that Scott becomes annoyed with commentators who suggest that Market Monetarist are soft on inflation (even to the extent of banning the word, at one stage) but let’s look at the facts.

    As long as the only problem is deficient AD then conventional monetary policy (lowering interest rates or expanding the money supply, however you wish to define it) will work. Inflation targeting as practiced for the past 30 years would work. No-one would be interested in NGDP-targeting outside of economics academia,

    However what if the fall in AD is driven by a lack of desire by business to invest at the current relative price levels? If real wages don’t fall then you have a potential for the money market to fail to clear even at low rates. We have hit the zero bound and conventional policy fails to work.

    Increase the money supply by unconventional means (and this is the policy that Market Monetarism lives or dies by) and we have a short term boost in AD (and even possibly RGDP) but if real wages don’t fall then the zero-bound equilibrium will reassert itself.

    But along with the short-term boost to AD comes inflation. Other things being equal nominal wages will rise less than other prices. Real wages fall, investment and profit margins increase. This leads me to conclude: At the zero-bound NGDP-targeting = real wage reduction via inflation

  19. Gravatar of Greg Ransom Greg Ransom
    1. February 2012 at 21:03

    Here’s the Hayek quote:

    “Stable monetary conditions require that the stream of money expenditure is the fixed datum to which prices and wages have to adapt themselves, and not the other way around.”

  20. Gravatar of Lorenzo from Oz Lorenzo from Oz
    1. February 2012 at 21:12

    Underemployment is a perfectly good concept. After all, unemployment is just underemployment (working less paid hours than one wishes to) when hours worked are approximately 0.

    And I am always up for knocking the concept of “real wages”. Particularly as, has already come up in comments, it is very unhelpfully interdeterminant between terms of labour (ratio of labour costs to price of output) and terms of wages (ratio of wages received to prices of expenditure).

  21. Gravatar of Morgan Warstler Morgan Warstler
    1. February 2012 at 21:33

    “Morgan, I strongly agree that NGDP targeting makes it easier to promote free market policies. It makes it more likely that new opportunities will open up during creative destruction.”

    Note: two times in one day, Scott explicitly agrees with my red meat Tea Party Wet Dream analysis, after just wondering aloud why he can’t get people to buy into his theory.

  22. Gravatar of anon/portly anon/portly
    2. February 2012 at 00:16

    “Patrick. Gig Harbor? Interesting coincidence in this post.”

    The Tacoma Narrows bridge connects Gig Harbor with Sumner. (And many other cities and towns, to be sure).

  23. Gravatar of Jason Odegaard Jason Odegaard
    2. February 2012 at 05:58

    The gig market would be difficult to measure. One possible source could be Craigslist – I wonder if they could provide reports on if there have been increases in gig offering posts since the recession started. Presumably those numbers would also be low during low unemployment.

  24. Gravatar of ssumner ssumner
    2. February 2012 at 06:38

    David, I see the big problem as wage stickiness. If wages were correlated with NGDP I think prices would adjust pretty well. But not vice versa. However, I have an open mind on this issue–surely both are problems to some extent.

    Robert, I’m not used to applying VAT to the AS/AD graph, but my intuition is as follows. Suppose France is a small part of the entire Eurozone, and the ECB targeting eurozone inflation. Also assume PPP holds. Then the ECB is basically targeting the French price level net of VAT. In that case a 1% VAT will shift both AD and AS vertically upward by 1%, leaving leaving net of VAT prices and output unchanged. It’s very possible I’m wrong, but my instincts were that if the VAT is not passed on to consumers, then the net gain from lower employment costs would be exactly offset by the net loss from firms absorbing the VAT, leaving no incentive to produce more. Does that make sense?

    If France was a closed economy and the BOF was targeting headline inflation, the policy would be ineffective.

    Greg, Yes, I’ve read their work, but there are too many assumptions for my taste.

    liquidationist, You said;

    “As long as the only problem is deficient AD then conventional monetary policy (lowering interest rates or expanding the money supply, however you wish to define it) will work.”

    That’s quite an assumption. It’s true that inflation was way below target in 2009-10, and hence inflation targeting would have produced much better results than actual policy, if the Fed had actually done it. And it’s true that inflation was a bit above target in 2011, so pure inflation targeting would not work. But of course in 2011 the economy had both supply and demand problems. So all that’s quite consistent with market monetarism, but doesn’t prove what you seem to think it proves. Yes, sometimes inflation targeting will work, and sometimes it won’t. NGDP targeting works in a wider variety of circumstances.

    Lorenzo, I agree.

    anon/portly, Even better! A double coincidence.

    Jason, I wish we had good studies that tried to estimate its size.

  25. Gravatar of david david
    2. February 2012 at 06:48

    David, I see the big problem as wage stickiness. If wages were correlated with NGDP I think prices would adjust pretty well. But not vice versa. However, I have an open mind on this issue–surely both are problems to some extent.

    Well, we have sticky wages, prices, and debt. And information, a la Mankiw.

    Wage stickiness alone has the countercyclical real wage problem.

  26. Gravatar of liquidationist liquidationist
    2. February 2012 at 07:01

    “Yes, sometimes inflation targeting will work, and sometimes it won’t. NGDP targeting works in a wider variety of circumstances. ”

    My point is that in “normal” times NGDP-targeting and inflation targeting will both work equally well via CB policy to adjust the money supply via the loan market which will increase investment and employment even with no change in real wages.

    At the zero-bound this breaks because business will not invest long term at the current wage level no matter how much short term AD is boosted. I am claiming that for this reason the main effect of NGDP-targeting at the zero-bound is to use inflation to effect a reduction in real wages.

  27. Gravatar of Greg Ransom Greg Ransom
    2. February 2012 at 09:43

    Is that a comment on the science or on the institutional proposal?

    We wouldn’t take seriously a would-be scientist of the biological world who rejected modern biology because “there are too many assumptions for my taste.”

    Scott wrote,

    “Greg, Yes, I’ve read their work, but there are too many assumptions for my taste.”

  28. Gravatar of ssumner ssumner
    3. February 2012 at 08:47

    David, Check out my 1989 JPE paper on countercyclical real wages, I have another interpretation of the data.

    Liquidationist, I don’t even agree they work equally well in normal times, due to supply shocks.

    Greg, Ok, the assumptions are not well enough justified for my taste.

  29. Gravatar of Federico S Federico S
    3. February 2012 at 09:54

    This post reminded me of a general question I had — I think most people would agree that targeting stable growth in the level of NGDP constitutes “good” monetary policy if wages (and other nominal contracts) are set based on expectations of NGDP. But what evidence do you have that this is actually the case? Are there any papers that try to get at this? It’s possible that people set nominal contracts with something that frequently looks like nominal GDP growth, e.g., inflation +2%. It’d be really great if you have any suggested reading on this.

  30. Gravatar of ssumner ssumner
    4. February 2012 at 06:29

    Federico, Good question. I don’t have any formal studies, but when the two differ sharply, it seem like NGDP is more important:

    1. Internationally there are big gaps in places like China, and wages follow NGDP growth, not inflation.

    2. In the US when NGDP and inflation are very different (relative to trend) then NGDP seems to affect wages more. In 2007-08 wages did not rise rapidly, even though inflation did. NGDP growth was modest.

  31. Gravatar of TheMoneyIllusion » The morning after . . . in France TheMoneyIllusion » The morning after . . . in France
    7. November 2012 at 10:47

    [...] seems Mr. Hollande has been reading TheMoneyIllusion.com: By lifting the two highest value-added tax rates in 2014, Hollande is revisiting a policy he [...]

Leave a Reply