Wage rigidities and how real labour markets work

10 Feb, 2014 at 17:44 | Posted in Economics | 1 Comment

Bewley found little evidence to support many popular labour economic theories. He mentions that he “found no support for real business cycle theory. During hundreds of hours of contact with businesspeople, I never heard one description of an exogenous productivity decline.” bewleyLucas-Rapping theory of unemployment (that it is caused by workers voluntarily quitting their job) is found to have little basis in reality. Unemployment is primarily caused by layoffs and quits actually decline during a recession. Nor do workers quit rather than accept a pay cut as they are never given the choice. Unemployment is an unpleasant situation that no one chooses; rather most unemployed were desperate for work. The main theories of strikes were also found to be inaccurate. Strikes do not occur as there is information asymmetries over the financial health of the company (which is usually known) or to test the profitability of the firm (unprofitable firms were as reluctant to compromise as profitable ones which had greater resources to fight the strike).

Bewley finds that most labour economic theories are inaccurate and fail due to unrealistic assumptions. The only exception to this is the morale model of Solow and Akerlof. Bewley criticises the traditional economic view of people being self-interested and having to be either bribed or coerced into performing tasks. Instead he found that employers ascribed different motivations to their staff. Instead they focused on building good relationships with their employees and encouraged them to take pride in their work and to enjoy their job. They want their employees to show initiative and to perform tasks without having to be constantly told to do so. They felt that treating workers like just another expense like equipment would be counterproductive. As intuitive it may be to ordinary people, it is surprising to economists that people resent being treated like machines whose only purpose is to make money.

In conclusion, Bewley has written a fascinating book that contains many insights in how labour markets work in reality. It reveals major holes in economic theory beyond the simple belief that wages adjust until they are in equilibrium.

Robert Nielsen

[h/t Lord Keynes]

1 Comment

  1. “Unemployment is primarily caused by layoffs and quits actually decline during a recession.”

    Partly true. Unemployment is also caused by skill obsolescence due to new technologies deployed in large scales. (I worked doing that and I am sorry I ever used my knowledge to make people lose their jobs and that is why I also quit my job because I could not stand building a machine 1m x 1m to replace 1,000 people most of who did not have any skills to get another job. It’s a monstrosity)

    Why wages do not fall: this is partly true also. Given enough time and enough pressure wages will fall. In USA, where most economics books are written, recessions have not lasted more than a few years. But in countries in many years of recessions, wages eventually fall. However, prices have the tendency to rise because of imported inflation in most cases.


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