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.