Why firms do not like cutting wages

Nominal wage downward rigidity is a feature of many macro-models that help justify positive optimal inflation rates. In fact, that is pretty much the only way to get a monetary monetary model not to conclude that the Friedman Rule and its deflation is optimal. This rigidity is always assumed on the presumption that somehow employers and employees do not like to reduce nominal wages. Are they subject to a nominal fata morgana or is there more to it? Instead of pontificating from theory and limited data, maybe asking market participants could help.

Philip Du Caju, Theodora Kosma, Martina Lawless, Julian Messina and Tairi Rõõm conducted a survey of firms across 14 European countries. They conclude that issues with unions contracts or collective bargaining were of secondary importance to worker morale and staff retention. This means that including renegotiation costs seems misguided. This does, however, not explain why this is so important to staff morale. After all, what really matters is the real wage. What is this psychological factor that makes us think foremost in nominal terms? Or is it that managers only have the impression that this matters? What we need here is some experimental data where some employees are hit with a nominal wage decrease and others not, and see whether it makes a difference. Good luck finding a manager willing to do that, though. And I wonder whether the surveys results would be different in economies where the social mission of employers is less developed.

Did home ownership made things worse in the Great Recession?

I have complained several times already that house ownership should not be encouraged by public authorities, mainly because it prevents diversification of risk by households and because there is slim evidence at best that home owners are happier and better contributors to society. It also quite obvious that high ownership rates have contributed to make the last recession worse in the United States. A recent trio of papers studies this last point.

Silvio Rendon and Núria Quella show that higher homeownership rates fed by easy financing lead to higher unemployment rates. This is because homeowners have higher reservation wages through a wealth effect. They find that in the US this has increased the unemployment rate by an incredible 6 percentage points. You may also want to add to this that homeowners are less willing to move for a new job, further increasing the unemployment rate, something the model does not capture.

Ahmet Ali Taṣkin and Firat Yaman look at unemployment duration in the US and find that renter stay unemployed the shortest and homeowners the longest, especially those who do not carry mortgages. Following this result, facilitating home financing would lengthen a little unemployment spells and increase the unemployment rate, under the hypothesis that job losing rates are unaffected.

Stijn Baert, Freddy Heylen and Daan Isebaert show that the unemployment spell length depends on the housing tenure situation in Belgium. The homeowners with mortgages exit the fastest, those without mortgages the slowest and renters lie in between. Easier home financing would thus reduce the unemployment rate here, again assuming it does not affect the rate at which people lose jobs. Keep in mind that Belgium is unique in that unemployment insurance benefits can last forever.

When job search frictions are good

Generally, frictions in markets are viewed as something to avoid, except in rare cases like when they prevent excessive and damaging volatility. For labor markets in particular, frictions lead to unnecessary delays in matchings, misallocations of talent and higher unemployment. It would be difficult to find an advocate for frictions on the labor markets, unlike for some financial markets.

Well, there are in fact some advocates, such as Andriy Zapechelnyuk and Ro'i Zultan. Their point is that frictions on the labor market are costly for those unemployed, thus the employed will exert extra effort to avoid becoming unemployed. The same applies to employers who dread the cost of an unfilled vacancy and avoid firing workers. While this could leads to misallocations not being dissolved, Zapechelnyuk and Zultan claim that it is possible to find some level of search frictions that is optimal for welfare as long as there is a sufficient level of moral hazard in job search. This means also that higher unemployment benefits could lead to lower productivity for those working as they feel less hard-pressed to perform to avoid losing their job. But keep in mind that these unemployment benefits also allow the unemployed to wait for a better match, so it is really difficult to sort all these effects out without some quantitative exercise, which this paper is unfortunately lacking.

Why americanize your name?

Why do immigrants americanize their name? Evidently, they feel that this will help them integrate into the host society and bring them some advantages. It is well documented that the more integrated an immigrant is, or the more alike to a native she is, the more likely she is to find better jobs, earn higher wages, and feel better.

Costanza Biavaschi, Corrado Giulietti and Zahra Siddique analyze immigrants to the United States from the 1930's and find there can be a mighty pay-off. Those who chose the most common American name got up to 14% higher pay. And I like how they determined linguistic complexity of the names by using Scrabble points from the American version of the game.

How do immigrants assimilate in job search?

How immigrants integrate into the native population has been a concern in many countries for a long time. Typically, this has been done by looking at how they marry, they educate themselves, how much they earn, and how they conduct criminal activities. Their labor market behavior, particularly how they search for a job, is less studied.

Audra Bowlus, Masashi Miyairi and Chris Robinson fill that gap by applying a search model to Canadian data. Two crucial parameters in those models are the job arrival and job destruction rates, which the authors allow to differ between natives and immigrants. In addition, they add a switching process wherein an immigrant stochastically acquires the characteristics of a native. This allows to determine that it takes on average 13 years for this to happen, quite a long time I think. More interesting, however, is that immigrants get significantly fewer offers, 36% lower when unemployed and 93% lower when employed, and they lose their jobs faster as well. This means that if an immigrant transitions to another job, it is almost always through unemployment. As a natural consequence, their wages catch up very slowly with that of natives. In fact, the search process accounts for more than half of the wage gap.

Firms polarize, too

While the last decade will be remembered for the financial crisis, another marked new trend that is emerging in all industrialized economies is that of polarization. Not of the political kind, although this is also quite new and annoying, but rather in terms of a widening in the distribution of wages, with a gaping hole in the middle. Call it the disappearance of the middle class, globalization finally hitting the middle class, or the increasing weight of the top earners, there is not that much debate about the origin of this change in wages. It is skill-biased technological change, namely the emergence of the computer and robot taking over the routine jobs of the middle class. But those who can manage those computers carry a substantial skill-premium on the labor market. This has been amply documented when comparing the distribution of wages across education groups as well as across economic sectors.

Petri Böckerman, Seppo Laaksonen and Jari Vainiomäki look at firm-level data and find the same. Specifically, they take Finnish wage statistics and look at how the distribution of wages changes within firms, taking R&D expenses as an indicator of technological change. That is actually much better than previous aggregate-level studies for two reasons: First, the authors do not have to rely on time dummies only to identify the evolution, second they can better understand what is happening at the microeconomic level. For example, the wage bill share of middle-educated workers performing routine tasks decreases with increases in R&D expenditures, a clear sign that the middle class is getting pushed down.

The true life-time profile of wages

If you look at just about any paper that considers the life-time profile of wages, you invariably find the same picture: a hump-share with wages increasing until age 50 to 55, and then a steady decrease. This decrease is every time justified with older people getting less productive and thus getting lower wages. But I have yet to see anecdotal evidence of that. Everybody I know has constantly increasing labor income. So what is wrong?

María Casanova has it figured out. You need to make the distinction between several types of people: those who continue working throughout until age 65, those who retire early, and those in the middle who take part-time jobs. The latter take significant hits on their wages as they typically change jobs, I presume to find a way to enjoy more leisure. In terms of income, this is a double whammy: wage and hours go significantly down. And this is what pull down the wage profile for the 50 to 65 year olds. Indeed, those remaining at full-time jobs actually see slight increases in labor income from increases in wages. This means that all those models that have people working full-time until retirement and use the hump-shaped age profile of wages or labor income have it all wrong.

Update: Link and title added, sorry for this negligence

The role of marginal non-participants in the labor force

While the unemployment situation in the US is gradually getting better, the numbers on the labor force participation continue to decline. This worries a lot of people because this can be a sign that some of the unemployed are getting discouraged and drop out entirely out of the labor force. But it may also simply be the continuation of a trend for a few decades already of a steady decline in the labor participation rate, in which case this would be much less worrisome.

Regis Barnichon and Andrew Figura add to this discussion that we should not only think about three categories (employed, unemployed, and not in the labor force), but four by adding the marginally not in the labor force. They are not in, but are close to getting in the labor force, an typical case being a discouraged formerly unemployed. These people tend to join by being unemployed first, while other nonparticipants join the the labor force by transitioning straight to employment, because they value not being in the labor force (students, retirees, mothers) and can only be attracted with a job. Barnichon and Figura document that the numbers of marginals has declined for quite some time, which can explain of decline of a half percentage point in the unemployment rate from 1976 to 2010. This cuts across all demographic groups, so a demographic shift can be ruled out as an explanation. The last recession may have unraveled all that, though, we will need a few more years of data and a full recovery to determine whether the trend continues.

Paid maternity leaves are regressive

Quite a few countries guarantee paid leaves for new mothers that not only allow them to get back the same job they left, but also gives them the financial wiggle-room to well take care of their new offspring. This time at home without worries is good both for the mother and the child, although one can suspect that this time off work can have adverse implication on human capital and the future career path for the mother. Paid maternity leaves are also often promoted as a way to conduct social policy across all social strata, as they apply to everyone.

Not so fast, say Gordon Dahl, Katrin Løken, Magne Mogstad and Kari Vea Salvanes. They look at Norwegian data, where the paid leave was increased from 18 to 35 weeks between 1987 and 1992. As it did not crowd out unpaid leave and expanded the time spent at home for the mothers, we should see some positive effects on child development in the country. None of that seems to have happened, not even on parental earnings, labor market participation, fertility, marriage and divorce. So it seems to be a rather useless reform. Worse, this expansion redistributed resources the wrong way. Indeed, in the absence of crowding out unpaid leaves, the reform corresponds to a pure leisure transfer to upper and middle income families (lower income families tend to have fewer working mothers in Norway). The reform is thus regressive. And we have not mentioned that there are obvious costs to someone for paying mothers while they do not work.

How the Internet is changing our daily lives

There is no doubt that the Internet has changed the lives for many of us, both at home and at work. Email, online retail, online news and plain googling around have transformed the way we communicate, inform ourselves, work and shop. How much this happened is an open question, and it must be very heterogeneous.

Scott Wallsten offers some important insights thanks to the American Time Use Survey. Comparing survey responses from 2003 to 2011, he figures out what time spent online must have crowded out. One third of it comes out of leisure, mostly TV viewing, another third of it working, one eighth less sleep, one tenth less traveling, and the rest from household chores and education time. Can we consider that this mix also represents what we do on the Internet (except for the sleeping part)? Not necessarily, as it must also have transformed the productivity at doing things. For example, news reading is now much more efficient, in my case working, too, but it is easy to wander off during surfing, and this must be increasing leisure time.

Note that the ATUS measures only "computer use for leisure" but I figure that a survey respondent working at home on the Internet must have be confused what to answer. Indeed this is the only way it would make sense that online time would have reduced work time. As far as I can see it, online time at work is not measured.

Why severance pay?

In many countries, it is customary or even mandated that firms should pay employees they let go a severance package. While that may make sense as compensation for a labor contract that is getting broken, mandating it under all circumstances may make little sense on a first glance. It adds to firing costs and may lead firms to retain less productive workers too much. And from having witnessed that first hand, this can induce an employee to become a poison for everyone else to tease out severance pay after getting fired.

Donald Parsons goes through the rationale of mandating severance pay and compares it to a labor market where no such pay is mandated. It turns out there would be not much difference, as firms do voluntarily offer severance pay, as mentioned to break a contract, but also to avoid having an employee move to the competition. On a aggregate level, such pay does slow down worker movement a little bit, but it also has its advantages. For example, it can substitute for unemployment insurance for some time and it can insure against wage loss in reemployment. This is good, especially if moral hazard or administrative costs in these programs are high.

What is so strange about the arts labor market?

Why are people drawn to work as an artist? This kind of job seems to have all the characteristics that one would like to avoid for a typical career: very low pay, usually the need to supplement income with another job, the most unequal distribution of income of any field, and with all this a chronic oversupply of labor. One may argue that one should set Economics aside for the arts labor market, but I do not believe that the love of arts can be the only explanation for this uncharacteristic labor market. People need to live, and if they love the arts they can always do this as a hobby.

Milenko Popović and Kruna Ratković find a better explanation. An artist's productivity is a function of accumulated art-specific human capital. If artists are forward-looking and they can cope with very low income during their formative years, it can then make sense to get into such a career. The issue is the uncertainty whether one's artistic career will actually pan out. This is where the oversupply comes in: many people start an artistic career to see how it works out, but eventually drop out. While all this makes intuitive sense this last part about uncertainty is largely hand-waved by the authors and should be subject to some serious quantitative exercise to see whether it can hold water with data, though. Thus, I am still not letting my children get into such careers.

Some pitfalls in establishing the impact of minimum wage hikes

The debates on whether to, depending on the country, introduce, repeal, increase or lower the minimum wage are never going to cease because empirical studies have not been able to give a definitive answer about the impact of the minimum wage on employment. The issue is first that good data is difficult to come by, second that there are many confounding effects and unobservables that may vary from one labor market to the other in significant ways, and third that the true effect may actually be small.

Sylvia Allegretto, Arindrajit Dube, Michael Reich and Ben Zipperer analyze a common way to study minimum wage hikes (to be distinguished from their introduction), cross-state regressions for the US, as US states have the option to set a higher minimum wage than the federally mandated one. They use six techniques employed in the literature to compare outcomes with four datasets. The reason why you want to try so many methods is that a simple regression does not cut it. The level of the minimum wage, for example, is associated with different business cycle characteristics, that is, setting a minimum wage at a particular amount is endogenous with all sorts of things that can be associated with the labor market. Still, no matter how they look at the data, the authors find that the effect of minimum wage hikes on employment is small, if there is any. This increases the odds that the effect is actually small.

Are wages posted or bargained?

Modeling the labor market, we tend to postulate that wages are either posted by employers or negotiated, typically by Nash bargaining. This is especially true of search and matching models, which often study business cycles. Results depend to some degree on this assumption, thus it should be a good idea to check against the empirical evidence how wages are determined in the matching process.

Hanna Brenzel, Hermann Gartner and Claus Schnabel use employer data from Germany and find that it is a mixed bag. But how wages are set in not random. To quote from their abstract:

Wage posting dominates in the public sector, in larger firms, in firms covered by collective agreements, and in part-time and fixed-term contracts. Job-seekers who are unemployed, out of the labor force or just finished their apprenticeship are also less likely to get a chance of negotiating. Wage bargaining is more likely for more-educated applicants and in jobs with special requirements as well as in tight regional labor markets.

This implies in particular that the mix may change over the business cycle (as labor-market tightness changes), and that models that assume that one must be unemployed to apply for jobs and then get Nash bargaining are inconsistent with the data, at least in Germany.

Child labor and fertility

Child labor has often been described as a vicious circle. Parents have too little income to feed their family and require their children to work. Children do not get educated and end up earning too little to sustain their own family. One may then question why they decide to have children in the first place.

Simone D’Alessandro and Tamara Fioroni build a model of human capital and fertility with child labor. At least in theory, they highlight that destitute parents find it relatively advantageous to have children: they are less costly as they can work. If their net contribution is positive, they want to have many children. And this mechanism can be self-reinforcing if the gap between skilled and unskilled wages is large. This is an amplified quantity/quality trade-off that increases child labor and leads to more wage inequality. The only way out is to make it more attractive for unskilled parents to have fewer children and not have them work. Legislating child labor away will not help, as already demonstrated many times. One example was discussed here, and some was to get one of the vicious circle as well: 1, 2, 3.

Do child laborers learn less?

Child labor is frowned upon because going to school is deemed essential to the development of every child, especially in terms of giving her the essential tools to do well as an adult. It is generally recognized that parents do not want to keep their child away from school (excluding those who insist on home schooling), but that sometimes economic hardship forces them to have children help with current expenses to the detriment of their future earnings. But child labor is not a black and white outcome. It may happen that children work and go to school. To what extend does this have an impact of academic outcomes?

Patrick Emerson, Vladimir Ponczek and André Portela Souza got their hands on excellent data from the municipal schools in São Paulo, where they can track students across several years, know whether they work outside the home, what their study habits are as well as a few socio-economic characteristics of the family. They find that transitioning into child labor leads to a decline in test scores for mathematics and Portuguese in the order of 6% to 10% of a standard deviation. That may not look like much, but this adds up to a quarter to a full year of education by the time they are done with school. However, one may argue that they also learn some useful skills for the labor market while working, so one can wonder how it look like in terms of adult outcomes.

The impact of testosterone on wages

Men earn more than women, this is still rue despite much effort over the past decades. The difference in wages, of course, needs to be measured ceteribus paribus, which means we need to take into account any observable characteristic so that we really compare men and women with the same characteristics doing the same job. This could mean that there is some unobservable characteristic that still matters. Men have more testosterone, and maybe this brings an increase in productivity they are rewarded for. But we typically do not measure that in labor force surveys.

Anne Gielen, Jessica Holmes and Caitlin Myers find a way around this difficulty by looking at twins. Indeed, females with a male twin have been exposed to more testosterone than all-female twin pairs. And males with a female twin got less. Using administrative data from the Netherlands with 80,000 twins, they find that this proxy for testosterone levels has a positive impact on hourly wages for males, but not for females. This new "observable" allows thus to better explain wage dispersion among males, but cannot explain the still remaining male-female wage gap.

About exploding offers

The academic job market is characterized by much uncertainty about the job candidates, at least in Economics where students who have yet to publish anything (in most cases) and have not even completed their studies are hired. The fact that they are supposed to be at the research frontier and that very few people, if any, can evaluate their potential makes it no surprise that recruiting committees stick to signals: who the dissertation adviser is, where the degree is from, and always glowing recommendation letters. When a recruiter has managed to identify a particularly good candidate, it does not want to let others benefit from this discovery. To avoid the job candidate from continuing to shop around, the typical strategy is to make an exploding offer: The offer letter is valid for, say, a week, and thereafter becomes void. This is quite frustrating for a candidate who may still be waiting for a preferred department to make its move, but this is well proven strategy for recruiting departments.

Mark Armstrong and Jidong Zhou show that this does not necessarily have to be so. Other options are to let candidates make a down-payment to keep a job offer alive or offer a bonus if they sign quickly (I am reinterpreting the papers results for my example). Yet, I do not think I have ever seen this happen, even a signing bonus. The model, which is actually about a seller who may offer a buy-now discount, ask for a deposit or make an exploding offer, highlights that the uncertainty about the outside options of the buyer (or the job candidate) is crucial. The search wants to deter the buyer from looking elsewhere. How much the uncertainty affects the buyer determines which strategy is best. In the case of the academic market, I guess this means that job candidates are very risk averse, thus the exploding offer strategy is optimal for the recruiters.

How smoking hurts you on the labor market

Smoking not only is bad for your health, it also lowers your wage. Of course, this may not come from the mere fact that you are smoking, but from various characteristics that are typically associated with smokers. Once you have taken into account the latter, what is the true drop in wages that you suffer from smoking? Does the number of cigarettes a day then matter?

Julie Hotchkiss and Melinda Pitts answer there two questions by looking at data from the Current Population Survey. They find that about 16 percentages points of the 24% wage loss of smokers come from their common characteristics, such as lower education. The rest is from smoking itself, and the number of cigarettes does not matter, the first one is enough. One more reason not to take on smoking!

Ethnic ghettos and unemployment

Both in Europe and the United States, minorities face significantly higher unemployment rates. In addition, they live in places that are farther from work than others, or at least their commuting options make it more difficult to get to work. Are the two linked? Obviously, if you do not live where the jobs are, unemployment gets more prevalent. But one could also move, and this may be more difficult for minorities, for various reasons. But before going there, one needs to determine how much of the unemployment rate is due to this spatial mismatch.

Laurent Gobillon, Peter Rupert and Etienne Wasmer pick up on a previous paper of the latter two, which I discussed here. In this spatial search-and-matching model, commuting time acts as a friction, but can only explain a fraction of the unemployment rate gap between "majorities" and "minorities". So other factors are clearly at play. The fact that minorities are de facto confined to particular areas certainly plays a role here.