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.

Good Old Lemons

This post doesn’t have a darn thing to do with economics, statistics, or finance. This is a post about citrus storage.

There are problems with buying citrus.

  • If you get a big Sam’s Club size bag of limes, then they start going hard and thin-skinned by the end of a week.
  • A bag of grapefruit? There’s usually one in the bag that’s goes moldy almost immediately and you know what they say about one bad grapefruit spoiling the bunch.
  • Mandarins shrink and get hard to peel.
  • Lemons – even if you refrigerate them – get soft and un-zest-worthy.

There is a solution. Now, our lemons and limes last upwards of 6-8 weeks with hardly a symptom of age. Mandarins don’t shrivel and grapefruits remain edible. No, silly goose, the answer isn’t free markets and the price system.

Maybe it’s all of the additional vitamin C that I’m getting. Maybe it’s the warm and fuzzy feeling of money well spent. But I’m now excited each time that we purchase citrus. And I get a cozy feeling of satisfaction whenever I see a nice lemon that definitely should not still be any good.

The answer is really simple. You too can achieve such amazing results. All you have to do is:

  • Rinse your citrus under water, rubbing gently to remove any invisible bad-guy germs. In reality, you’re probably getting rid of mold spores.
  • Place the wet citrus into a ziploc bag, seal, and refrigerate. The refrigeration further retards the growth of any unwanted spores. The sealed bag prevents too much air flow and drying.( I don’t bother refrigerating grapefruit and oranges because I eat them quickly enough).

That’s it. You too can have 8 week old limes and lemons that you bought on sale or in bulk that are nearly as fresh as the day that you purchased them.

Enjoy!

Certificate of Need Laws

In 1960 $1 out of $20 in the United States was spent on healthcare. Sixty years later, nearly $1 out of $5 is spent on healthcare.

A dozen facts about the economics of the US health-care system

There are many reasons for this increase in spending (e.g. demographic shift, increased income, and more). In this post, I want to focus on competition in the healthcare industry. There is an excellent Brookings Institution piece from earlier this year on competition in healthcare. Martin Gaynor writes,

“The research evidence shows that hospitals and doctors who face less competition charge higher prices to private payers, without accompanying gains in efficiency or quality … the evidence also shows that lack of competition can cause serious harm to the quality of care received by patients.”

If there are benefits to competition in healthcare, the question becomes how we can increase competition. One of Martin Gaynor’s proposals is to eliminate or reform Certificate of Need (CON) regulations that require health care providers to obtain permission slips from a state health planning agency before the provider opens a new facility, purchases new equipment, or supplies a new service.

These laws were enacted federally in 1972 in an effort to control rising healthcare costs. The logic was that healthcare providers who are reimbursed for services would have incentive to invest in facilities and equipment that allows them to perform more services.

There is mixed evidence that CON regulations have achieved their goals. But, what is clear is that requiring permission erects barriers to entry. Moreover, these barriers to entry become more pronounced if the state health planning agencies are captured by existing hospital interests. Consumers like competition but suppliers do not.

In a new paper titled, “The Impact of Certificate of Need Laws on Heart Attack Mortality: Evidence from County Borders”, economist Kevin Chiu reports that the introduction of Certificate of Need Laws resulted in 6-7 additional heart attacks per 100,000 people. He focuses on heart attacks because the acute nature of heart attacks means you can’t “shop for care”.

The paper is an improvement over the existing literature because it zooms in on counties along state borders with and without CON regulations to get more apples-to-apples comparisons. For example, there could be regional trends that make a Florida to Washington comparison less valuable than a Florida to Georgia comparison. He also performs a number of tests that make the result more believable. For example, CON regulations have zero impact on suicides that normally take place outside the hospital.

Competition reduces prices, increases quality, and encourages innovation. Certificate of Need is one way in which laws have reduced competition in healthcare. The consequences are life-and-death without much apparent upside from cost containment. Currently 35 states still have Certificate of Need Laws. If you’re interested in finding out where your state stands, check out this map from the National Conference of State Legislatures.

The statistically diverse curriculum

It’s important to present undergraduate students with a wide variety of view points. But in my view the diversity of viewpoints is a means, not an end in itself. At the very least, it’s a path to learning how to evaluate arguments, and broaden sensibilities in a very Oakshottian way.

It seems obvious to me (and perhaps I am mistaken) that curricula should be structured around considerations other than mere diversity. After all “fields” of scholarship have formed around the types of conversations that develop when scholars try to learn about some aspect of the universe. There is a structure to knowledge and how it is generated, if only because of the particular history of particular inquiries about the world.

Yet, somehow in every curriculum conversation I have been involved in, I get significant pushback from those that view diversity as an end itself. To put the matter to rest I present the statistically diverse curricula. For the liberal arts core, let’s randomly assign courses and readings to each student such that the average student has the maximally diverse curriculum. The average student will be well rounded. We can even draw courses and readings from some weighted distribution to avoid a bias stemming from viewpoints that have been the most dominant throughout history. I doubt this would satisfy, or even make sense, for those that defend diversity of viewpoints as an end in itself. If the statistically diverse curricula is a no go, then diversity of viewpoints as an end in itself should be a no go as well.

How to Think About Inequality Data and Public Policy

Lately I’ve been thinking about the disagreements among economists about the extent to which inequality has increased in recent decades. I am facilitating a reading group at my university on inequality this semester with some great undergrads, so it has very much been on my mind.

With conflicting data showing different trends, how are we as economists to judge this? How can the general public even have a clue how to judge this?

You may have seen this chart before. It comes from an article in The Economist, which actually does a really good job of explaining the debate over the data if you know nothing about it.

TaxProf Blog

According to some estimates, the share of income going to the top 1% has doubled and is now over 20%. That sounds bad. Maybe we need some more redistribution. Maybe a wealth tax.

But according to other estimates, and taking account of our existing system of progressive taxes and redistribution, the share of income going to the top 1% has not risen at all, is only about 5%. Less worrisome. The existing system of taxes and transfers seems to be doing a pretty good job, or at least no worse than in the last 60 years. No need for a new wealth tax, etc.

So who is right?

Sorry, I don’t have the answer. I think I’m pretty good at digging into economic data (follow me @jmhorp on Twitter for an almost daily dose of data debunking!), but I am no expert in this area. There’s probably only a dozen economists that really understand this data and the trade-offs in different forms of measurement.

So instead of giving you the “correct” answer, I offer you a chance to reflect. Our temptation is to say the “correct” data is the one that comports with our political preferences. If you are a progressive, you probably think inequality is bad and getting worse. Piketty is your man. If you are more of a libertarian, you probably think it’s about the same as recent years. Auten and Splinter must be right!

Stop. And instead, consider how you might view the policy implications of the data you don’t like being the correct data. If you are a progressive, would you still think we need a wealth tax even if the Auten and Splinter data is correct? If you are a libertarian, would you still think things are just fine and maybe we should cut the top tax rate if it turns out that Piketty and co-authors have the real data?

If you answer is the same for the policy implications regardless of what the data say, you might want to check yourself. And if so, why are we even arguing about the data?

Perhaps your answer is “I might have the same policy answer regardless of the data, but there are people out there that are convinced by data.” I think that’s possibly reasonable, and I would like it to be true, but where are these people?

Perhaps the answer is “as a libertarian, I don’t care about inequality so long as the poor and middle class are also sharing in the gains.” Or “as a progressive, I will continue to worry about inequality until the top 1% only has 1% of national income.”

I think these are the normal fallback answers. But really? Libertarians: if the income of the top 1% doubled in a decade, but the bottom 99% increased by 0.5%, you would be fine with this, because at least no one declined? Progressives: you would really support increasing taxes on the rich, despite any downside to this, until incomes were exactly equalized?

Frankly, I don’t believe anyone really holds either of those extreme positions. So surely, the data must matter? We want some reasonably shared benefits from economic growth, but no one really demands that they be exactly equal, right?

So, consider your own biases. Don’t engage in motivated reasoning. And think through how your views might change if you are wrong about the data. Perhaps someday Mother Nature will reveal herself, we’ll have the true inequality data, and we’ll see if we were honest about our reflections.

Review of: “How the Scots Invented the Modern World”, by Arthur Herman

This book describes the development of intellectual life and related events in Scotland from about 1700 onward. Scotland in 1700 was a small, poor, largely agrarian independent nation, still characterized in large part by feudalism. In much of the country, clansmen in their kilts constantly robbed and fought each other. By 1800, it was an economically thriving section of the United Kingdom of Great Britain, and a huge contributor to modern thought on many levels. The subtitle on the front jacket of the book expansively portrays its contents as: “The True Story of How Western Europe’s Poorest Nation Created Our World & Everything in It”.

A key event which helped launch this flowering was an economic one. The 1690’s were an unusually cold decade, leading to famine and poverty in the more northern European countries like Scotland. Scottish trade and industry were constricted by the policies of England, their more powerful neighbor to the south. Other nations of Western Europe in the 1600’s had colonies in the Americas, which seemed to be a source of national wealth and influence. Scotland tried to found her own colony, called Darien, on the coast of the Isthmus of Panama. A huge fraction of the wealth of Scotland was invested in this venture. It failed, for various reasons, which was an economic disaster for the country.

This led to a willingness on the part of the Scottish elite to surrender their independence in return for the chance to participate in commerce on the same terms as the English and under the protection of the Royal Navy. An Act of Union between the two kingdoms was approved in 1707. This led to a rise in prosperity and helped set in motion various influences of modernization.

A lively intellectual life in the burgeoning cities of the Scottish lowlands put Scotland at the forefront of the 18th century enlightenment. The Scottish Enlightenment was more practical and aligned with common sense than was the Enlightenment of the French philosophes.  David Hume and Adam Smith are just two of the significant Scottish thinkers of this era. The works of Hume and of Smith (e.g. The Wealth of Nations) are still required reading today in the fields of philosophy and of economics.

Scots likewise made great contributions to science and technology. Today we measure power in terms of “watts”, a tribute to James Watt, whose improvements to steam engines made them finally practical for widespread use. We drive on “macadam” roads, initially developed by John McAdam.

How the Scots Invented the Modern World weaves all these themes together, going into enough detail with key actors to make them come alive as real persons. Since there are so many books and so little time, I rarely go back and reread a book. Also, I ruthlessly pruned my collection as part of our recent household interstate move. But I have found myself picking up this volume from time to time, and so it survived the cut. I recommend it as an entertaining and enlightening read.

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!

American Moments

The presidential debate on September 29, 2020 was an embarrassment. I don’t remember what the candidates said because I just kept panicking thinking about the fact that other people could see what was happening. Didn’t some adult somewhere have a kill switch?

After an hour of listening, I expressed my sincere wish that this had never happened:

Tyler had a more nuanced take:

It’s not just true in America. Much of what passes for “debate” is just people firing off talking points at each other. Usually it’s not quite so obvious and awkward because there are not such clear rules being broken.

If there’s one thing that Americans agree on, it’s that you wait your turn in line. This is the most basic schoolyard etiquette. No matter how rich or famous you are, cutting in line is deeply resented. It felt like President Trump was not taking turns (so then it was strange for me to fact check this and see that Biden spoke only 2 minutes less total than President Trump).

If it were in my power to undo that night I would. However, a new podcast gave me some more to ponder about in terms of what Americans can be proud of. A lot of true news comes out about Americans making mistakes. That can be useful for others. Audrey Tang said of our misdeeds:

COWEN: … the United States, has made … many mistakes … What’s our deeper failing behind all those mistakes?

TANG: I don’t know. Isn’t America this grand experiment to keep making mistakes and correcting them in the open and share it with the world? That’s the American experiment.

Being open about our mistakes might be the next best thing to not making them in the first place.

Tang, a transgender Taiwanese computer policy expert, said something that I think Americans can be happy about.

Speaking of software, here’s a recent conversation with a 5 year old about what exactly is software and what does it mean to buy it. My son imagined that if I bought it in a store I must have picked something up off a shelf. (I could have explained that software is a nonrival good, but I think it’s too soon.)

Aggregate Demand Regimes

Is inflation correlated with output growth?

Consider the AD-AS model which is often expressed in growth rates. Economists will often say that the short-run supply curve is flatter in the short-run and vertical in the long-run. In other words, aggregate demand policy can have SR output effects, and only has LR price effects.  Sounds good.

But there is a lot of baggage hiding behind “can have effects”. Often we’ll say that lackadaisical businesses cause a flatter SRS and that businesses with rational expectations have a vertical one. Also sounds good.

What causes the steepness of the SR supply curve? I’m sure that there are multiple determinants in regard to expectations. Here’s what got me on this topic. David Andolfatto shared the below graph and asked “Does lowflation necessarily mean low growth?.

Good question. My answer includes expectations concerning the monetary policy regime. Specifically, my answer was “It does in a regime of volatile and uncertain nominal income. Surprise AD growth pushes us up the SRAS.” Andolfatto called me out and in the right way, asking “What’s the evidences for this?

[…crickets…]

I had no evidence. I had the AS-AD model in hand and some logic – but no evidence. My logic is as follows. In a monetary regime that includes a constant rate of AD growth, output and price growth are inversely correlated. If NGDP grows at 5% always, then inflation falls when output growth rises. In other words, AD is exactly what people expect – illustrated as a vertical SRAS curve.

However, expectations are different in a regime of erratic AD. Let’s say that the rate of AD growth is unknown, but that the variance is known. If this is the world that you live in, then you make hay when the sun shines. Businesses sell more in periods of higher income. And, because they’re marching up the marginal cost curve, prices also rise. Alternatively, it may be that output growth is inflexible and prices rise as a goods are rationed.

Regardless of the truth, the above explanation is just story-telling. I had no evidence. What would the evidence even be? Here’s what I settled on. First, let’s express the AS-AD model in quarterly growth rates. In order to get a handle on monetary regime AD variance, I calculated the standard deviation of the NGDP growth rate by Fed Chair. Presumably, the Fed chair has a decent amount to do with monetary policy and the rear that occupies that chair is an indicator of when a regime begins and ends. I calculated the correlation between the GDP deflator and RGDP growth rates by regime. Below is the scatter plot.

What does it tell us? It tells us that regimes of stable AD growth experience a negative correlation between inflation and output growth. It also tells us that a AD growth volatility is associated with a positive correlation between inflation and output growth. So,  Does lowflation necessarily mean low growth? It does in a regime of volatile and uncertain nominal income.

(Of course this is all casual. It makes sense to me at first blush though. Having said that, the line of best fit also looks like it’s driven by the 2 extremely variable times: McCabe & Powell.)

Economists and Cocktail Parties

Sometimes I remark to my students, “This is why economists don’t get invited to cocktail parties.” This post is about that.

From 2008 – 2011 I taught a course at Florida State called “Economics of Compassion”. It is a course co-designed with my mentor Mark Isaac. The class discusses historical and contemporary problems related to poverty, both at the domestic and international levels. Having heard about the course, the Social Justice Living Learning Community at Florida State wanted me to teach the course to their incoming freshman. 

It was quite different from other courses they were taking that seemed to talk in terms of solutions without regard for scarcity. My role was to put parameters on their utopia and get the students to think carefully about a couple questions related to issues they care about:

  • Compared to what?
  • What happens next?

The students seemed to like the class, but, for a committed group of people who want to change the world it was also quite a downer. It was a downer for them the same way economics is a downer for people at cocktail parties.

We start with scarcity. Scarcity is a fact of life. There are never enough resources to satisfy everyone and there will always be unmet desires. For the economist, the notion of trade-offs — you must give up one thing to get another — flow from this scarcity. It means that anytime a solution to a problem is attempted you are always giving something up.

For example, the death of George Floyd this summer sparked conversation about how to reduce police violence. One approaching to curbing this important social problem is to eliminate or reform qualified immunity (QI). This is a legal doctrine intended to protect police and others from frivolous lawsuits. The problem is that QI has made accountability extremely difficult. The logic of reforming QI is that doing so will increase accountability, raise the cost of police violence, and therefore lead to less police violence. That’s good economics.

But, remember there are trade-offs. In a new world where police are opened up to lawsuits, local government might need to increase police compensation to retain or attract qualified men and women. Where does the money come from? Can you reduce the number of police and/or will you have to raise taxes? There are other trade-offs too. Will police become more reluctant to enter dangerous neighborhoods? After all, there is a greater chance that inserting themselves into a risky situation will lead to financial ruin.

Moving from heavy to light. If you haven’t seen Yoram Bauman’s comedic schtick on Principles of Economics Translated, take five minutes and check it out here. As he illustrates, “economic profit” depends on alternatives: A Snickers bar valued at one dollar with no alternative implies an economic profit of $1. However, if the alternative was M&Ms that you value at 70 cents then your economic profit is 30 cents … Your profit from pursuing one course action declines as the value of the alternative increases.

By accounting for trade-offs the net benefit of a course of action goes down. When we bring up trade-offs in conversation, economists effectively eat into people’s mental profits for some course of action.

Another thing to consider, when you’re intervening, that intervention can sometimes have dramatic side effects that you didn’t even think about. You cannot merely move people around as if they’re pieces on a chessboard (head nod to Adam Smith).

For example, it is possible that eliminating qualified immunity leads to less police violence but more neighborhood violence overall if police decide not to insert themselves into situations that could be more costly. Beyond this hypothetical example I have been using, there are loads of other unintended consequences economists talk about.

Thinking in this way is the bread and butter of economists. This is how we see the world. But, don’t try this in social settings. As EconTalk host Russ Roberts once commented (this podcast), a pleasant picnic veered into chilly company when he pointed out someone’s proposed minimum wage could have negative employment effects. The others at the picnic started to inch away from him on the picnic blanket. At parties, I’ve had people talk about the idea that a tax won’t effect them because it is only on sellers, homeowners, etc. I’ve had to ask myself, “Is it worth it to bring up that the tax is likely to be passed through?”

So while my last couple posts sing the praises of economics, I should let you know, at cocktail parties people don’t like to think about scarcity, tradeoffs, and unintended consequences. Economists like to think about the seen and unseen. Many others, especially in social settings, would rather the unseen remain unseen.