If wages fell during a recession

A paper I wrote with Dan Houser is forthcoming in the Journal of Economics Behavior and Organization. “If wages fell during a recession”

https://www.sciencedirect.com/science/article/abs/pii/S0167268120303577

The title comes from Bewley’s famous book “Why Don’t Wages Fall During a Recession?” In that book, Truman Bewley asks managers why they do not cut wages in a recession when equilibrium analysis tells us that the price of labor should fall.

We run an experiment in which employers and workers encounter a recession. The employers could cut wages, or they could keep them rigid as we normally observe during recession. The concept of a “cut” assumes a reference point from which to go down from. We establish that reference point by letting the employer set a wage before the recession and repeating that payment to workers for 3 rounds.

We use a Gift Exchange (GE) Game to model the relationship between employers and workers. Employers offer a wage that is guaranteed to the worker. Employers have to trust that workers will not shirk. We do observe a few subjects shirking, and those people are not very interesting to us. We are interested in the workers who respond with positive reciprocity because that means there is “good morale” in the “workplace”. The employers interviewed by Bewley were afraid that wage cuts would damage the good morale that is necessary for a business to run.

After three rounds, there was a recession. The total surplus available in the GE game shrank by 10%.  In the Inflation treatment, the exchange rate of tokens to dollars increased, such that if firms kept nominal wages rigid there would in fact be a 10% real wage cut.

If workers resent nominal wage cuts, then firms should keep wages rigid in a recession. If worker morale falls and workers decrease effort, then firms will be hurt more by the fall in productivity than by a large real wage cost.

In fact, about half of the firms did cut wages. So, we did not observe wage rigidity and we’d like to do follow-up research on that point. It did mean that we had variation and could observe the counterfactual that we were interested in.

Workers don’t like wage cuts. Workers who had been selecting an effort level near the middle of the feasible range dropped their effort significantly if they experienced a wage cut. The real wage cuts under Inflation did not have as sharp of an effect on effort, which suggests some nominal illusion.

Here’s a cumulative distribution of effort choices among workers (Recession treatment had no inflation). After half of the workers experienced a wage cut, the effort distribution moves toward 0.05, the minimum effort level.

We measured loss aversion at the end. We can’t say that loss averse workers resent wage cuts, because everyone resents wage cuts. There’s maybe some evidence that loss averse employers are less likely to cut wages. Thanks for reading! Please reach out through my Samford email if you’d like to know more.

The relationship between loss aversion and wage rigidity deserves more attention from behavioral economics.

Special thanks to Misha Freer, Cesar Martinelli, and Ryan Oprea for conversations that helped us. Also, we are indebted to everyone that we cited, of course, and to all the people we failed to cite.

2020 Nobel Prize to Milgrom and Wilson

The big news in our world is that the Nobel Prize was announced today for economists. (We call it “the Nobel Prize”.)

Paul Milgrom and Robert Wilson win for 2020. They are known for auction theory and design. Here is a popular introduction from the Nobel Committee.

This prize is special to me because auction design was one of the very first practical problems that presented me with a chance to put economic ideas into practice. As an undergraduate at Chapman University, I had the privilege to spend time talking with people like Vernon Smith and Dave Porter. Some people think of Vernon Smith as being someone who “does things in the lab”. The thing that he actually did was often auctions.

My master’s thesis at Chapman University was a project on auctions. A practical problem to motived our inquiry. Students at Chapman were upset about the way that the most convenient parking spots were allocated. Concerns about parking showed up in quantitative student satisfaction surveys.

We designed an auction to price and allocate the most coveted parking spots. In this scenario, multiple items are being sold because the parking lot has many spots. Hence the “multi-unit” in the title of our paper Information Effects in Uniform Price Multi‐Unit Dutch Auctions.

We had an important question, since we were actually going to run an auction that would affect people’s lives. How to we choose from among the different possible auction formats?

Paul Milgrom (with Robert J. Weber) provided guidance to us in their 1982 paper in Econometrica.

Among other things, in that paper, they compare the revenue properties of English auctions and Dutch auctions. In an English auction, the price starts low and bidders compete to out-bid each other until the price is so high that only one bidder remains. That is the popular conception of an auction. There is another mechanism class (Dutch) in which the price starts higher than anyone wants to pay and drops until a buyer jumps in. Once you start thinking about how many ways one could run an auction, then you need some way to decide between all the mechanisms.

Theory can help you predict who will be better off under different formats. And, in my case, needing to figure out the revenue properties of different auction formats can help you learn economic theory!

Economic Research on Gender, Race & Ethnicity, and Inequality

How much research do economists devote to the topics of gender, race and ethnicity, and inequality? In a recently published article in Econ Journal Watch, Arnold Kling and I looked at articles published in the American Economic Review as well as the conference papers of the American Economic Association on this topics. We find that economists devote a large amount of space to the topics combined in recent years: over 10% of published articles and over 20% of conference papers. We also find that the share of research on this topics, as measured in these two AEA outlets, has been increasing over time (we go back to 1991, when the current JEL Code system was introduced).

Of the three areas we looked at, papers on gender saw the clearest increase, rising as both a share of published articles and conference papers. Published AER articles addressing inequality have also been increasing over this time period, though AEA conference papers on inequality have been stable. Both published articles and conference papers on race and ethnicity have been stable over the period we studied as a share of the total, though the absolute number has increased.

What is the significance of our results? Our main motivation was to challenge other economists who suggest, in various ways, that economists ignore these topics or don’t study them enough (for examples see these popular writings on gender, race and ethnicity, and inequality). Our research clearly shows that economists devote a good deal of attention to these topics, and for many areas it has shown a clear increase.

It is still possible that economists don’t dedicate enough time to these topics. We make no strong claim in the paper about what the correct amount of time for each topic would be. However, we do note the opportunity cost that comes with an increasing focus on these topics.

More importantly, those who suggest in public venues that economists ignore these areas are doing a disservice to all the scholars that have devoted their careers to studying these important topics and publishing their results in one of the top journals in the discipline. We have much more to learn about gender, race and ethnicity, and inequality, but dismissing the research that has already been done is unfair to a discipline that has increasingly focused on these areas.

Abraham and Kearney on the Decline in Employment

Katherine Abraham and Melissa Kearney just published
“Explaining the Decline in the US Employment-to-Population Ratio: A Review of the Evidence” in the Journal of Economic Literature.

The unemployment rate measures people who are actively looking for work and can’t find a job. The authors are not examining short term fluctuations in unemployment (which shot up in pandemic times). They are looking at at long term decline in employment rates of working-age adults in the US. The trend began in 1999. Employment of adults in the US dipped after the Great Recession and still has not recovered a decade later. Less-educated males have experienced the largest drop in employment.

I’m reviewing the entire paper with my Labor Economics class. Most of what the authors talk about can be found throughout our Labor Econ. textbook, but I like using the paper to organize and motivate the collection of facts and theories.

Here’s a summary of their thorough examination of possible causes of the decline in working.

They estimate, drawing on other empirical work, that two factors have a considerable and measurable impact on the decline in formal employment. Import competition from China (the US changed their position on trade with China in 2000) and automation (industrial robots) both result in lower demand for US workers.

There are three contributing forces that the authors declare them to be minor casual factors. Increased receipt of disability benefits disincentivizes working, higher minimum wages results in less jobs, and the increased incarceration rate in the past few decades takes adults out of the labor force.

The paper is called “A Review of the Evidence”. The following is a list of factors that could in theory be responsible for the decline for working but for which data is scarce:
Lack of child care
Changes in leisure options (i.e. young men play video games)
Changes in social norms (i.e. young people can stay “in the basement”)
Increased use of opioids (could be a result of diminished job opportunities)
Rise in occupational licensing
Frictions or matching issues

All of those indeterminate items represent research opportunities.