Krugman: “Sticky Wages I Win, Flexible Wages You Lose”
I have pointed this out before, but it’s funny when Krugman shakes his head at the morons who dispute the sticky-wage case for Keynesianism (e.g. when he recently posted a chart about wage adjustments in Spain during the crisis), when he earlier had taken Casey Mulligan out to the woodshed for thinking sticky wages/prices had anything to do with Keynesianism during the crisis. Full details here. The conclusion:
(1) Krugman can’t believe the idiots who try to reject the Keynesian policy prescriptions by denying that there are sticky wages and prices. Just open your eyes, guys! Wages are clearly sticky and so the classical solutions fail; that’s why we need bigger government deficits.
(2) Krugman can’t believe the idiots who try to reject the Keynesian policy prescriptions by looking at the empirical relevance of sticky wages and prices. Try reading what the Keynesians are actually writing, you liars! If wages fell it would exacerbate nominal debt burdens; that’s why we need bigger government deficits.
(3) The empirical evidence for the need for bigger government deficits is overwhelming at this point. The Keynesian model came through this crisis with flying colors. Anyone who denies that is a knave or fool.
Bob, what is the contradiction in saying that both sticky wages and sticky debt prevent you from getting to full employment, so if you just eliminate one of those things, then you won’t get to full employment?
There isn’t necessarily a contradiction in believing
1. That wages are sticky
and
2. If they weren’t , and wages fell, it would cause employment to fall
Is there ?
(I agree that the chart on Spain is less clear-cut on sticky wages than Krugman presents it , though )
Keshav and Transformer,
It isn’t a contradiction in terms that is the issue. Murphy is referring to Krugman’s rhetorical tactic of justifying state intervention regardless of what happens to wages and attacking his opponents differently depending on which particular argument suits the day.
If someone says wage rates and prices are not sticky and thus state intervention is not justified, then Krugman will say “you fool!”, wage rates and prices are in fact sticky and that is why governments need to intervene and increase money and spending when spending would otherwise fall and cause unemployment.
But if someone then studies wage and price stickiness to learn the history of wage and price changes so as to test the New Keynesian justification for state intervention, then Krugman will say “You fool!”, it isn’t wage and price stickiness that is the problem, because if wages and prices fell, then bam, debt overhang will lead to insolvency and unemployment.
The point is that for wage stickiness per se, Krugman can’t lose. Sticky wages, Keynesian intervention justified. Flexible wages, Keynesian intervention justified.
In my own view, Krugman is demanding net lenders be beholden to, and indirectly subsidize, net debtors, at gunpoint. If enough Americans go into debt, and live beyond their means, then poof, I am forced to pay for it indirectly through inflation taxes. Indebted people who would otherwise take ownership of fewer resources if they went bankrupt, instead benefit at the expense of others when they receive inflation before them and redirect resources towards themselves instead.
The appeal to debt overhang is catering to the irresponsible, profligate individuals in society.
“The point is that for wage stickiness per se, Krugman can’t lose. Sticky wages, Keynesian intervention justified. Flexible wages, Keynesian intervention justified.” Well I think from Krugman’s perspective, it’s “if wages are sticky, Keynesian intervention is justified. If wages are not sticky but there is sticky debt, Keynesian intervention is justified. Only if there is neither can the free market get us to full employment on its own.”
Of course you can get to ‘full employment’ without intervention. How quickly this occurs is the question. Second, does intervention lead to asset malinvestment? If so are you not simply creating a bubble ( whether large or small ) by attempting to intervene?
Also what do we mean by ‘sticky’? How much time should pass for an asset ( and I suppose human labor is an asset ) to be reassessed for valuation? The concept of sticky is such a lose and vague term as to be almost meaningless and by creating devaluation via inflation is in many ways a cruel tool used by Government.
I have come to disagree with a perpetual inflationary policy above replacement value.
” Only if there is neither can the free market get us to full employment on its own.”
Keshav Srinivasan,
There are many other reasons why wage and price flexibility is not a reliable nor necessarily effective way to reduce involuntary unemployment and quickly end recessions. See
Keynes in Chapter 19 of the General Theory.
A free market is more reliable than state intervention, and it is certainly more effective in reducing wasteful employment and encouraging productive employment.
Not all employment makes people wealthier. Employment levels are not a proper metric for standards of living, and certainly not a proper metric for when it is justified to point guns at innocent people in order to force a more “flexible” income for special interest groups closest to the centralized counterfeiters.
A person is not made better off by being aggressed against so that others benefit at his expense.
What a free market cannot do as well as state intervention is trick people into setting suboptimal prices and interest rates given prevailing consumer preferences subject to strong private property rights protection. You got us there LK. The free market is really not dependable at all for that.
As for Keynes’ GT, as many economists have already shown, it is riddled with fallacies and errors. I think “gobbledygook” is the term most apropos.
The most glaring error is one that refutes Keynes’ entire analysis of lower wage rates and prices curing unemployment and depressions. That error is quite astounding, and few have ever even picked up on it.
Keynes’ theory of the ineffectiveness of a fall in wage rates and prices to cure depressions hinges on his MEC doctrine. It is here that Keynes’ error resides. Since his entire theory on wage rates, prices and employment depends on his use of the MEC, it means his whole attack on the free market is not only immoral, but logically completely bogus.
The error is that Keynes’ analysis of the effectiveness of a fall in wage rates and prices, in his discussion of the MEC, actually consists of an absence of a fall in wage rates and prices, indeed, it consists of a rise in prices.
It makes no sense to refute the effectiveness of a fall in wage rates and prices by presenting a counter-argument that presumes a rise in prices. But Keynes got away with doing just that.
I’m not making this up. Keynes’ reasoning for a falling MEC as net investment increases is as follows:
In the real world, lower prices and wage rates means lower unit costs of production. That is what lower wage rates achieve both directly and through bringing about lower prices of materials, machinery, and capital goods in general.
The use of the MEC totally contradicts this reality.
There you have it folks. Free markets can’t work because when net investment increases in response to, and fully dependent on falling prices, falling wage rates, and falling unit costs of production, recovery in employment cannot be achieved because…prices rise.
Keynes could not distinguish between an increase in the quantity of a good demanded that takes place in response to lower prices (think electronics as an example), and a rise in the demand for the good (think spending more money for the same supply of a good as an example).
It gets better. Keynes also wrote that with more net investment, there will be more capacity in place, and more capacity in place means lower selling prices of products, which, all else equal, means a fall in profitability. See the error? Again the argument of falling prices, which of course means falling unit costs, is totally contradicted, and here they are presumed as unchanged.
You know what sticky prices really are? Sticky brains, that’s what.
Oh it gets even better. Keynes then wrote that profits fall as net investment rises because of the law of diminishing returns. Yet diminishing returns have no bearing on the rate of profit. Even if it did, real returns would rise, not fall, as workers went back to work, as the supply of labor increased relative to the previously idle supply of capital. While the supply of capital does increase as workers go back to work, this increase is secondary. The primary change is the increase in labor relative to previously idle capital as workers go back to work.
Get it? It’s brilliant. Assume that “a fall in prices” means a rise in cost prices and a fall in final goods prices. Then demolish it! State violence FTW you ideologues!
—————
My personal favorite absurdity in the GT is the contradiction between Keynes’ MEC doctrine and his “multiplier” doctrine. When Keynes spoke of the MEC, he claimed profits fall in response to an increase in net investment. Yet when he spoke of the multiplier doctrine, he claimed that the effect of more net investment is a multiplied increase in aggregate demand. The additional net investment, Keynes tells us, brings about a series of diminishing consumption expenditures, which increases aggregate demand by a multiple of of the initial increase in net investment. Now I don’t know about you, but when someone says that aggregate demand has increased, then surely profits have increased. For aggregate profits are the difference between aggregate demand and aggregate costs. If aggregate costs rise by net investment, but aggregate demand rises by a multiple of that, then profits must mathematically rise.
So we’re told more net investment both decreases and increase profits. More state violence FTW!
Free markets don’t work kids, because something something up down left right in out look over there look over here. Razzle bedazzle, flippity floppity abracadabra…
The state’s function, nearly always and everywhere, is to create negative externalities. It’s proponents unwittingly admit this because they argue that the *benefit* of gov’t is that it concentrates benefits and disperses costs.
The ideology of statism is devoid of introspection.
The haters of free markets often use the doctrine of “pure and perfection competition”, whereby they set an impossible standard for free markets, and then claim because free markets cannot live up to the impossible standard, state intervention comes out of nowhere without any application of the same or similar principles on the state.
Have you ever heard of the “Pure and perfect government” theory? Me neither. The socialists never bothered to set an impossible standard for government and then advocate for free markets because of the perpetual failure of government to live up to that standard. They never bothered because their goal of using the pure and perfect competition is solely to attack the free market and justify state violence.
You don’t see free market advocates going around showing people a list of what constitutes pure and perfect government, and then say aha, they fail in all respects, so free markets are justified, and then not apply the same or similar principles to the free market.
Here is the list of perfect competition. Think of this list as a list of criteria for perfect government instead. Why not? If the socialists do it for markets, then we should do it for their own ideal.
1. A large number buyers and sellers – A large number of consumers with the willingness and ability to buy the product at a certain price, and a large number of producers with the willingness and ability to supply the product at a certain price.
2. No barriers of entry and exit – No entry and exit barriers makes it extremely easy to enter or exit a perfectly competitive market.
3. Perfect factor mobility – In the long run factors of production are perfectly mobile, allowing free long term adjustments to changing market conditions.
3. Perfect information – All consumers and producers are assumed to have perfect knowledge of price, utility, quality and production methods of products.
4. Zero transaction costs – Buyers and sellers do not incur costs in making an exchange of goods in a perfectly competitive market.
5. Profit maximization – Firms are assumed to sell where marginal costs meet marginal revenue, where the most profit is generated.
6. Homogeneous products – The products are perfect substitutes for each other;i.e-the qualities and characteristics of a market good or service do not vary between different suppliers.
7. Non-increasing returns to scale – The lack of increasing returns to scale (or economies of scale) ensures that there will always be a sufficient number of firms in the industry.
8. Property rights – Well defined property rights determine what may be sold, as well as what rights are conferred on the buyer.
9. Rational buyers – buyers capable of making rational purchases based on information given.
10. No externalities – costs or benefits of an activity do not affect third parties.
———
As you can see, real world governments deviate significantly from the above ideals. So if we were as inconsistent as the socialists, we would be saying free markets should run all governmental services because all real world governments deviate from all of the above criteria.
“It makes no sense to refute the effectiveness of a fall in wage rates and prices by presenting a counter-argument that presumes a rise in prices … etc, etc.”
A bizarre ignorant and irrelevant rant that refutes nothing I said, because Keynes’ analysis of why wage and price deflation is not an effective system of curing recessions is found in chapter 19, and MEC is not even part of the analysis there.
From Chap 19:
“Let us, then, apply our own method of analysis to answering the problem. It falls into two parts. (1) Does a reduction in money-wages have a direct tendency, cet. par., to increase employment, “cet. par.” being taken to mean that the propensity to consume, the schedule of the marginal efficiency of capital and the rate of interest are the same as before for the community as a whole? And (2) does a reduction in money-wages have a certain or probable tendency to affect employment in a particular direction through its certain or probable repercussions on these three factors?
” The first question we have already answered in the negative in the preceding chapters. For we have shown that the volume of employment is uniquely correlated with the volume of effective demand measured in wage-units, and that the effective demand, being the sum of the expected consumption and the expected investment, cannot change, if the propensity to consume, the schedule of marginal efficiency of capital and the rate of interest are all unchanged.”
Please don’t tell me you just CTRL-F’d for “MEC” and called it a day.
Supremely sloppy work LK!
And more from Chap 19:
“Thus the reduction in money-wages will have no lasting tendency to increase employment except by virtue of its repercussions either on the propensity to consume for the community as a whole, or on the schedule of marginal efficiencies of capital, or on the rate of interest. There is no method of analysing the effect of a reduction in money-wages, except by following up its possible effects on these three factors.”
[…]
“Since a special reduction of money-wages is always advantageous to an individual entrepreneur or industry, a general reduction (though its actual effects are different) may also produce an optimistic tone in the minds of entrepreneurs, which may break through a vicious circle of unduly pessimistic estimates of the marginal efficiency of capital and set things moving again on a more normal basis of expectation.”
As you can see, these passages in my two posts here are proof positive that Keynes’ critique of falling wages as cure for depressions depends on the MEC.
Since you have not challenged my critique of Keynes’ MEC doctrine, I will assume for now that you cannot disagree with it, and thus assume you will do the honest thing and reject Keynes’ critique of the classical treatment of wage rates and prices as cures for depressions to be fundamentally flawed, for ultimately Keynes did not even address falling wage rates and prices, but assumed a rise in them!
Yeah, three arrows:
[1] Raid piggy banks.
[2] Cut real wages.
[3] Use Gruber tactics to convince the same people you have made them better off.
Even after Krugman has done his nana on people who just don’t get it about sticky wages, he still will never front up to his followers and say, “The purpose of inflation is to devalue your wages”.
He just can’t bring himself to say that, keeps trying to pretend he is some born again defender of the working classes. That from a guy who never turned a spanner or lifted a spade in his life.
Rubbish. Krugman thinks the aggregate level of employment is a function of aggregate demand: he is not interested in cutting wages and doesn’t even think wages cuts (even real ones by inflation) are a reliable way of curing involuntary unemployment.
Too bad you know very little about Krugman or this economic theories, tel.
If aggregate level of employment is a function of aggregate demand then why are sticky wages significant at all? How can sticky wages cause involuntary unemployment, unless employers are sensitive to the price of labour?
Congratulations! You have just contradicted the very basis for Keynesian theory of depressions.
Well, there is no doubt that Krugman is a redistributionist. Even outside of a recession Krugman supports the use of taxation and government expenditure to that end – he doesn’t need sticky wages or fear of debt/deflation to justify that.
But does Krugman truly ” Demand net lenders be beholden to, and indirectly subsidize, net debtors, at gunpoint”? As long as borrowers and lenders have the same expectations of future inflation then there will be no redistribution between them if those expectations are met.. In the last few years, if anything, inflation has failed to meet people’s expectations (Bob’s anyway, j/k)
Could one not equally argue that a monetary policy that produces deflation , (or even inflation below expectations) leads to net borrowers indirectly subsidizing net savers ?
(1) there is no contradiction or problem in (1) pointing out that wage and price adjustment is a highly unreliable mechanism for reducing involuntary unemployment (Keynes showed exactly why in Keynes in Chapter 19 of the General Theory) and (2) also noting that even if it were that there are overwhelmingly strong downwards nominal price and wage rigidities in the world in which we live, and that the whole idea that this is how modern economies generally tend to “clear” is untrue..
The trend of general downwards nominal wage rigidity was already an empirical fact in the late 19th century when trade unions were weak and governments very hostile to labour. See Christopher Hanes 1993. “The Development of Nominal Wage Rigidity in the Late 19th Century,” The American Economic Review 83.4: 732–756. Even Alfred Marshall writing in 1879 noted it as an observable fact of the UK economy
“Indeed, the chart shows that around 5 percent or so of the labor force saw a one-year drop in wages between 5 and 10 percent. That’s a pretty big drop, for 5 percent of the labor force, when we’re talking about “sticky wages.””
Since “sticky wages” has always meant that nominal wages, **generally speaking**, tend to be inflexible downwards, and certainly the empirical evidence from country after country shows this, one can only marvel at how you seem to think this is some kind of substantive point in your favour, when it is a minor point but utterly consistent with what economists say about sticky wages.
“All in all, Krugman’s chart about Spain suggests to me that there’s nothing inherent in market economies per se that prevents nominal wages from falling. “
You need to read T. F. Bewley’s Why Wages Don’t Fall During a Recession (Harvard University Press, Cambridge, MA., 1999) ASAP. Of course, it’s unlikely you ever will. It is unlikely you’ll ever allow yourself to see or consider the empirical evidence that blows your fantasy view of market economies out of the water.
All in all, this post shows how irrelevant and dogmatic modern Austrian economics really is.
“All in all, this post shows how irrelevant and dogmatic modern Austrian economics really is.”
the kultist hath spoken
Wage rates don’t fall in state intervention economies?
The heck you say!
The problem, LK, is that you haven’t established whether this wage stickiness has any sort of causal or policy implications at a more disaggregated level. Doing that sort of analysis forces you to look at arguments like the one Bob makes here:
http://mises.org/library/putting-austrian-business-cycle-theory-test
I see! Very strong wage rigidity, when wage flexibility is the key element of Austrian ideas about how economies coordinate and eliminate unemployment, has no “causal or policy implications”! lol.
Also, there’s not even any discussion of wages in your link.
Good to see you hitting ZeroHedge, those guys really hate Krugman over there, and need to be reminded now and then of why.
Actually, there were a few insightful comments amongst the ZH’ers (ignoring the hothead trash talk for which that site is famous). One guy pointed out that people who lose their jobs take a 100% pay cut, and strangely the graph ignores those guys. Another guy pointed out that many people lose one job but get re-hired at lower pay… I tried to chase back the data as best I could and yeah, I believe the graph is only “job stayers”. I may have traced it wrong, but I think the source data is here:
http://dx.doi.org/10.1787/888933132089/
Note the label, “Percentage of full-time job stayers (aged 15-64) in the corresponding earnings tercile”.
Thus, Krugman is deliberately ignoring two fairly significant mechanisms of wage reduction (ending up unemployed and changing jobs). We could go one step further and point out that this is Spain, which is an economy with one serious problem, only a few bus tickets short of being the next Greece… so just perhaps there’s something special about this particular example. I mean, maybe that inflexibility is actually somehow linked to what’s going wrong in Spain, and might not be the best example of a general principle, or something.
But it gets more entertaining than that. Now Bob, this is basic research and although I’m both proud and honoured to be doing this work for you, the best time for research is before publication (just sayin’).
Inflation (CPI) Statistics for Spain:
Average 2007: 2.78 %
Average 2008: 4.09 %
Average 2009: -0.28 % DEFLATION
Average 2010: 1.80 %
Average 2011: 3.20 %
Average 2012: 2.44 %
Average 2013: 1.42 %
That’s right, the deflationary period (as measured by official CPI) happened in 2009 which is not even part of the statistics shown in the graph and when you look at 2007/2008 compared to 2011/2012 what you see is actually CPI is hardly different at all. Nowhere near that all important zero point where real wages can no longer be devalued by stealth.
How about that? Not only has Krugman cited statistics that are basically dishonest because they look at a selective piece of the micro picture, instead of the genuine macro picture… but they don’t even show what he pretends to show because in neither of the cited cases was there deflation, nor even a CPI near zero.
Grumble, grumble.
http://dx.doi.org/10.1787/888933132089
If the hypothesis is that wages will drop to establish full employment, then arguing that average wages have dropped due to the unemployed not earning anything doesn’t really help. That sounds pretty much like the definition of sticky wages – that the wages will not drop so you get unemployment.
Do you mean to tell me that when you all talk of a general wage stickiness or rigidity you have always meant within the population who stays employed? Or just that Krugman is doing so? Of course I expect no less from a demagogue like him, I assumed everyone here above this.
I have personally always rejected the idea because I work out in the productive sector , and when money gets tight and work slows down my bosses “cut the fat” and hire more young guys with less experience. Essentially the whole employment ladder is shifted up with minimal pay increases from previous levels of responsibility. Clearly this effectively combats sticky wages. Rarely does anyone ever take an actual paycut. In fact this practice goes on more or less all the time with severity dictated by the state of the market.
That was my initial impression as I looked at the graph.
That’s exactly the argument that was coming up on ZeroHedge.
Just to be clear about my own point of view, you have a micro situation where you study some particular business or some small group of workers, and within whatever context you like, the micro study means something, and it might even generalize but it might not.
Then you have macroscopic statistical aggregates like employment participation, or like the number of weeks on average someone spends looking for work. These are meaningful but in a different way. The average family might have 2.3 kids, but no real family has 2.3 kids. The global average temperature might be 58°F but since this averages Singapore with Antarctica, it tells you basically nothing about the temperature any real person is living at.
Statistical measures are highly sensitive to sampling bias, and to some extent this can be compensated (people do try) but you have to be very clear what you are trying to look at and why. If you want to know how many bankruptcies are likely to be triggered by the recession, you have to look at the options open to business to cut costs (by whatever means) and the options to open up new markets (could be various directions there). The statistic that is interesting to a business might not be particularly interesting to a worker who wants to know the chance of keeping his/her job.
Of course, if many businesses close their doors, this will also be the cause of workers losing their jobs, so the various metrics are interrelated… but not in such a direct way that you can just swap one for another any time it suits.
Thanks Tel. These are all good points except the unemployment one. Krugman would say, “Right, because wages can’t fall, it means people get laid off. That’s what we’re trying to explain: why does the unemployment rate shoot up, and stay up, during recessions?”
Two points in brief:
[1] Did the person leaving employment have an offer of lower wages and thus have a choice in the matter, or were they just asked to leave, end of story? It matters, because if they had a choice they are voluntarily out of work.
[2] What are the realistic chances of workers getting new jobs? How well aware are people of the job market situation? This makes a difference… suppose someone wants to change career and then discovers they need to spend six months and a lot of money getting a bunch of certificates, before they can get re-hired, that looks a lot like involuntary unemployment, but has nothing to do with sticky wages, and cranking inflation won’t do anything to fix it.
To go into a lot more detail, I’m following the theory that a large part of economic activity is information processing. Price discovery is part of that, but not the only part. When a recession happens (especially a sudden crash) some really important information has been revealed to the system and the impact of that is rippling out to the corners. In the case of 2008 we had a belief that the mortgage market was sound, and that CDO’s were a really neat idea… then those interest rate resets hit, lots of people failed to make payments, we suddenly discovered that a lot of rotten bad debt was spread around the system.
That at least would be the immediate trigger cause of the recession, I don’t have space to go into long term consideration about how things got to that, and we can argue all day about who to blame. Let’s ignore the historical side, and consider what happens next.
Clearly, something has to change, the system needs to digest the new information and adjust to that. Part of said adjustment is changing prices, so in the housing market the price of houses did fall (for example), in business you might have 50 people employed making widgets, the market price of widgets falls, the business drops wages to compensate and goes on making widgets same as before… problem is not everyone can just keep doing what they did before. In order to adapt to the new situation, someone has to change what they were doing.
That’s the restructuring, some business must grow, some must shrink, some inevitably just aren’t viable anymore. That cannot happen without people being out of work, for at least a time, and hopefully back into a job where they are more productive.
OK Tel with your elaborations I see maybe I rejected one of your points too quickly. I’m just explaining why Krugman would have scoffed at that one plank in your original comment.
Regarding “debt deflation” as yet another desperate plea to justify pointing guns at innocent people:
There is nothing permanently preventing individuals from borrowing less as a result of eliminating state coercion that raises nominal incomes which encourages lending and borrowing more. If I expected a higher income volatility going forward as an example, then there is nothing permanently preventing the lender from utilizing a higher risk premium and lending less money to me, so that my expected income is sufficiently high to cover the debt costs. We do not need socialist toilet paper money to ensure that we cover our debts. We can learn and adapt to ANY free market price trends. If volatility increases, then prices relative to money supply can be made lower. The incentive is there for lower prices in an environment of unfettered capitalism. Massive and prolonged unemployment is a state creation, not a free market one.