The economic outlook in the United States right now is remarkably positive according to many indicators; unemployment is at its lowest since the dot-com bubble, the stock market is at record highs, and inflation is relatively mild.
Wages, however, seem to be bucking the trend. Growth in nominal wage rates has remained modest despite a tight labor market, puzzling many commentators. The blame has been spread widely; China, robots, and Baby Boomers are the target of one recent article. However, the answer for this puzzling phenomenon could perhaps be found in the work of John Maynard Keynes.
One of the central tenets of Keynesian economics is the concept of ‘sticky wages;’ the belief that wages, more so than other prices, are inherently inflexible and rigid, particularly in the downward direction. This key plank of Keynes’ theory has often been used as an argument against deflation and as an impetus for monetary expansion in a recession. Although, these policy prescriptions have been dealt with countless times, what of the underlying claim?
It turns out that praxeology per se has very little to say about the existence, or non-existence, of sticky wages. Assuming that by ‘sticky’ all that is meant is that it takes a long time for wages to adjust to market pressures, the only judgment being made is a quantitative one. Mises constantly stressed throughout his work that the only judgments praxeology can make are strictly qualitative. For example, if there is an increase in the demand for labor, we know qualitatively that the wage for labor must rise, ceteris paribus. However, in the exact same sense that we cannot predict the magnitude of this increase in wage rate, we can never predict the time it will take for wages to increase.
How Markets can Encourage Sticky Wages
There are many reasons for expecting wage rates to be less flexible than other prices. Bob Murphy has gone as far as to suggest that flexible wages rates would no doubt be a “market failure.” This argument is simple; workers don’t like uncertainty if their wage rates fluctuated as freely as the price of a barrel of oil they would be forced to bear much more uncertainty. A long-term fixed-wage contract transfers the burden of bearing uncertainty from the laborer to the entrepreneur. By virtue of their position entrepreneurs are more apt to take on this kind of risk, likewise, laborers by a demonstrated preference of not being entrepreneurs clearly value reduced uncertainty. This function is no different to that served by future markets in transferring entrepreneurial risk from producers to speculators.
Government Mandated Stickiness vs. the Marketplace
Of course, not all of the ‘stickiness’ in wages can be attributed to the normal functioning of the market. It will come as no surprise that there is a long history of government intervention either purposely or inadvertently decreasing flexibility in the labor market. During the Great Depression, wages seemed to demonstrate a ‘stickiness’ of unprecedented proportions. In money terms, wages fell modestly, but, once you adjust for deflation and declines in productivity real wage rates actually rose significantly during the first few years of the Great Depression. It seems unlikely this remarkable ‘stickiness’ was a result of a change in worker preferences. In fact, Herbert Hoover instituted a whole host of measures designed to keep wage rates constant, repeatedly encouraging businesses to fix wages in order to save the economy.
Further analysis of the myriad of government policies of the last century reveals case after case of increased ‘stickiness;’ minimum wage laws have made downward wage adjustments illegal beyond a certain point, unemployment benefits reduce the incentive to accept a lower wage after losing one’s job, and repeated inflation has caused workers to expect a continuous rise in money wages, further exacerbating the psychological aversion to a lowering of wages. However, not all policies are one-sided in their effect. The bundling of healthcare with employment has made switching costs higher, as workers may be without health care if they lose their job, thus incentivizing longer-term employment contracts. Similarly, increased regulation has made the cost of employee training higher, incentivizing employers to desire longer-term contracts. Ultimately, there can be little doubt that these (and many other) policies have had a significant effect on the flexibility of labor markets.
But all this inflexibility isn’t inherently bad. The downside is that in a period of recovery, growth, or boom (whichever we are currently in) wages may be slow to keep pace with inflation and increases in output because the terms are often locked in. Any increases in wages can be expected to lag other indicators, even employment. Conversely, during the ‘bust’ phase of the business cycle, to correct for the malinvestment and overconsumption of the “boom,” requires that factors of production fall in price so that they can be reallocated to their most valuable stage of production. But if the price of labor is slow to fall in price, this adjustment period will take longer, and hence we will be stuck in a longer recession.
This does not mean that all improvements in labor market flexibility are desirable, as shown above a certain level of ‘stickiness’ is natural on the market and is highly valuable to workers. Instead the key distinction is between natural market stickiness and artificial government stickiness. The former is the outcome of the individual valuations regarding uncertainty, whereas the latter necessarily deviates from the preferences of the market.