17 Dec 2015

## A Hypothetical Discussion About Employer Wage Policy

It is late October. The boss of a group of office workers makes an announcement regarding their paychecks for the rest of the year. Specifically, he announces that in addition to their base pay, all employees will receive a bonus of \$1,000 added to the November paycheck and \$700 added to the December paycheck. The following dialog is between the two brightest employees, both of whom studied economics in college.

BOB: Hey, this is pretty good news, huh? I could sure use some extra cash for the holidays.

DAVID: What jerks! I can’t believe management is slashing our pay in December.

BOB: Wha– what do you mean? They just announced we’re getting more money than we originally expected. This announcement signifies a generous wage policy.

DAVID: Are you daft? Before the announcement, I expected my paycheck in December to equal my paycheck in November. Now, I’m expecting a \$300 fall in my paycheck, going into December. Just like ol’ management, sticking us with a tight wage policy at Christmas.

QUESTION #1: In the above dispute, who is making more sense–Bob or David?

QUESTION #2: Why did I choose these names?

#### 17 Responses to “A Hypothetical Discussion About Employer Wage Policy”

1. Transformer says:

Bob is making more sense but then Paul Krugman (sometimes) makes sense when he tries to be a populist.

What if the boss had said 2 years ago “OK, I know we have 2% inflation – I will give a bonus each month to compensate for it , which will increase over time as the price level rises ” and for 2 years he increased the bonus each month. Then he announces “All employees will receive a bonus of \$1,000 added to the November paycheck and \$700 added to the December paycheck. “. You can see why they would be surprised/annoyed. From a macroeconomic perspective, you might predict (if your name was David) that thier spending might fall and create some macroeconomic problems (unless your name in Bob and you’re a Rothbardian who thinks prices will fall instead).

• Bob Murphy says:

Transformer wrote:

Bob is making more sense but then Paul Krugman (sometimes) makes sense when he tries to be a populist.

Whoa whoa whoa. None of this under-your-breath approval. Yes or no, Transformer, in the dialog as presented in my OP, do you agree with Bob or David?

If you think this dialog has no relevance to my real-world argument with the Market Monetarists, fine, but I want to first be clear: You agree wholeheartedly with Bob in this scenario, and you realize David in this scenario is focusing on something that is irrelevant and misleading. Right?

• Transformer says:

Joking aside, the rest of my comment was meant to convey that you need context, and I tried to provide a scenario where even though at face value Bob appears to have common-sense on his side, when you see the big picture David may actually have had reasonable expectations about his December bonus which then failed to be realized.

• Bob Murphy says:

Transformer, this is important. The whole point of me doing this post is to start with something simple and then work our way up to the actual dispute between David and myself.

So yes or no: Do you agree that in the story I presented, Bob is totally right and David is totally wrong? And to save time, let me ask a further question, assuming your answer is “yes.”

==> What’s happening in the story I presented is that the men had expectations about what their pay would be in November and December. (Let’s say it’s \$10,000 just to make it simple.) Then the boss said actually, instead of getting the \$10,000 each month you originally expected, instead you’re going to get \$11,000 in November and \$10,700 in December.

Bob says that constitutes a generous wage policy, relative to the original, expected wages. Bob’s argument is that in both months, the men are receiving higher wages than they originally expected to be receiving in those months.

David says it constitutes a tight wage policy, relative to original expectations, because before they expected no change in wages between November and December, but now they expect wages to fall by \$300 from November to December. In other words, they are now expecting a future tightening, and hence the boss’ announcement should be interpreted as a shift to a tighter wage policy relative to what they thought before the announcement.

So Transformer: With whom do you agree, in this particular argument I’ve invented? You’re free to tell me anything else, like what you want for Christmas, but please don’t keep talking to me on this thread if you don’t definitively say that yes, you totally agree with the hypothetical Bob in the imaginary scenario I cooked up above.

• Transformer says:

I replied on the other post that given your assumptions , Bob is correct – looking forward to the next chapter!

• guest says:

“… but please don’t keep talking to me on this thread if you don’t definitively say that yes, you totally agree with the hypothetical Bob in the imaginary scenario I cooked up above.”

Wow! Heh.

I, for one, definitively *don’t* not totally agree with the hypothetical Bob.

😀

• Major.Freedom says:

When you spending might fall, do you mean fall from what would have been the spending on the basis of additional \$1000 in December, or fall outright from Nov wages plus \$1000 to Dec wages plus \$300, or did you mean fall from would have been the spending on no bonuses at all?

There is no good reason to predict spending will outright fall from Nov to Dec on the basis of a surprisingly lower than expected INCREASE in overall incomes. But that is what happened, and that is the point Bob is making.

No, Austrian theory does not predict or assert that the only activities that take place in the downward direction are falling prices. What Kool-Aid have you been drinking at LK’s blog? Falling spending is a cause of falling prices in Austrian theory. And that is what occurs. Just because it is not instantaneous, or quick enough for your liking, that doesn’t mean the theory is false. You just don’t like it that’s all. You aren’t proving it wrong.

• Major.Freedom says:

Metaphorically speaking the whole time, of course.

• Transformer says:

MF,

I meant that if the bonus had been going up over time to match inflation, and people’s spending had increased just enough each month so that spending in real terms stayed the same, then when the bonus in December fails to match inflation – spending in December is likely to increase at a slower rate than previously, which if prices still rise on trend. will mean a decline in real terms.

2. E. Harding says:

Q1: Murphy v. Beckworth
Q2: See Transformer’s comment.

BTW, Bob, my email address is being marked as spam again!

• Bob Murphy says:

You’re a modern day Job. I don’t know how you find the strength to continue with all that this blog does to you.

(BTW that Krugman thing on Reich was awesome. When I’m caught up with work I’ll trumpet it from the rooftops.)

3. Andrew_M_Garland says:

Bob is more reasonable as far as this goes. But, why the strange bonus policy?

Maybe the boss anticipates that another company will be expanding across the street. He is preemptively giving his employees an incentive not to apply there. The boss estimates that the other company will complete hiring by mid December. The threat of a mass exodus of talent from his company will be minimal by then.

So, this bonus policy should cause a smart employee to check the local job market.

• Major.Freedom says:

But no reason for the job market to decline in general on the basis of the lower than expected bonus, right?

• Andrew_M_Garland says:

I didn’t see either bonus as being expected.

In general, it seems to me, that when the boss offers raises or cuts in salary, he is estimating the market value of the particular employee in combination with the particular productivity of that employee.

If a policy doesn’t appear to be immediately rational, I become curious.

• RPLong says:

Best comment so far. I’m with Bob on the example, as well as in the real world, but you make a great point. Why would the employer divide the bonuses up this way?

• guest says:

“So, this bonus policy should cause a smart employee to check the local job market.”

I like this perspective because it shows that wage laborers can be entrepreneurial, too.

It’s totally in the employee’s interest to introduce competition for his labor.

4. Guest says:

As a general rule, don’t budget your bonus, instead use bonuses to pay down debt and save for 1 time purchases.