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August 30, 2005
The Non-Mystery Of Labor Compensation (Bob Hall Explains It All, Take Three)
At Angry Bear, pgl joins Max Sawicky in his skeptical view -- the latest manifestation of it, at any rate -- of my lack-of-slack orientation. Actually, this is a follow up to earlier comments from pgl, following up a blast from Brad DeLong, following up my response to Max, who was following up our Econoblog debate (with Tom Walker joining him on the prosecution's team).
I've been mulling over pgl's earlier post, as he honed in a argument that I did not adequately address in the Econoblog exchange, and haven't since. Here's the money passage:
... David is arguing for a classical demand and supply explanation. But not only do we need to think in terms of quantity variables (EP and LFP), we should also think in terms of real compensation, which have not kept pace with productivity, and real wages, which have been flat. The introduction of price as well as quantity variables is where I think Brad has David cold.
Fair enough. But I don't think that the facts on the price variables clearly bear witness to slack labor markets. Here's a picture of real labor-compensation growth for the past fifteen years:
Much of the commentary on labor income has focused on the growth of salary and wages, but I'm not sure what theory of the labor market would make wages the correct series upon which to focus. Benefits are a part of the returns to employment as well. Because total compensation includes benefits as well as wages, it is that series that best represents payments from firms to workers.
If we focus on total compensation growth, it is not obvious that one would want to characterize growth in labor income as extraordinarily weak over the past five years. For the period from the fourth quarter of 1996 through the fourth quarter of 2000, four-quarter growth in real compensation averaged 1.02 percent. For the period from the fourth quarter of 2001 through the second quarter of this year the average was 1.55 percent. This reverses the picture one would get from looking at wage growth alone, where the corresponding averages were 1.2 percent and 0.59 percent. In terms of total compensation -- which I argue is the right thing to look at -- the recent past has actually been better than the go-go days of the latter 1990s.
It is true that the trend has been down over the past year-and-a-half, but that observation is not clearly out of line with productivity developments:
One might wonder why the labor-return and productivity patterns aren't even closer-- as Max and Tom did in the Econoblog discussion -- but here is where Bob Hall steps into the conversation again. Hall's extended discussion of how to think about labor markets centers on the frontier of models in the tradition of Peter Diamond, Dale Mortensen, and Chris Pissarides. Without going into too much detail about these models -- you can find much more in Hall's paper, or in the article by Richard Rogerson I referred to in the Econoblog feature -- these models treat employee/employer relationships as the outcome of costly search and negotiation processes, as opposed to the anonymous spot-market like constructs of typical macro models. Here's a key passage:
Our model delivers wage rigidity by disconnecting wage bargaining from conditions in the labor market. Once a qualified worker and an employer have found each other and determined that they have a joint surplus, costs of delay, not outside conditions, determine the bargain they make.
The wage does respond to productivity, but only half as much as in the standard model. The result is a strong response of unemployment to productivity and other driving forces. The wage no longer has a strong equilibrating role. If productivity falls, the part of the surplus accruing to employers falls sharply and they cut back on recruiting effort. The labor market softens dramatically.
That last part is particularly striking in light of the picture (courtesy of knzn) I posted earlier showing the dramatic fall off in help-wanted advertising post-2000.
There are, of course, many variants of the Diamond-Mortensen-Pissarides model, with differing implications for the how various types of shocks alter equilibrium levels of employment, unemployment, wages, and so on. I don't think anyone is claiming that any one of these models has all the answers just yet. I certainly am not. But they do lead the way to a view of the world where it is sensible think of labor markets as "soft" without the implication that there are obvious monetary policies that will make things all better. That's what I'm talkin' about.
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