Like all New Keynesians, I believe two things that are apparently contradictory:
1. We each get paid too much; 2. Because of 1, we all get paid too little.
It only makes sense if you understand fallacies of composition. What is true of each part isn't necessarily true of the whole.
It's a very Hobbesian perspective. It's not a war of Us against Them; it's a war of All against All. Those who can only think in an Us against Them perspective will have the hardest time grasping it. You have to think in a Hobbesian perspective. Or representative agent model, as we call it nowadays. The distinction between the individual and the collective good is what's at issue, not the distinction between the good of one group of individuals and another group of individuals.
I have been thinking like this since I was 18, but I only understood it vaguely back then. I understood it better when I was 30, and started building macro models with monopolistic competition.
Each individual faces a downward-sloping demand curve. Taking other individuals' prices as given, the higher I set my price the lower the quantity I can sell. That's because we are not all identical. Nobody is a perfect substitute for anybody else. So we are not in perfect competition. So each individual faces a trade-off between price and quantity.
Microeconomists are with me so far; here's where I'm in danger of losing them.
But the demand curve facing all of us is horizontal. There is no trade-off between relative price and quantity at the aggregate level. The price of everything relative to everything must be one. And because the trade-off facing each individual is different from the trade-off facing all of us, each individual will choose a point on the trade-off that is bad for all individuals.
OK, let's go back and round up the stray microeconomists (and probably a few macroeconomists as well).
Every microeconomist knows that it's relative prices that should be on the vertical axis of demand curves. Suppose one individual wanted to sell more. Unless he is a perfect substitute for other individuals, he will need to lower his price relative to other individuals' prices. But if all individuals want to sell more, and all lower their prices, the average relative price does not change. If we aggregate up over individuals' downward-sloping demand curves, we get an Aggregate Demand curve, with the average relative price on the vertical axis, that is horizontal at one.
And now I've lost some macroeconomists too. Because I've drawn an AD curve with relative price on the axis, rather than the nominal price level. But don't worry. Remember that the AD curve is an equilibrium locus. It's a set of points at which output equals output demanded. We can ask what happens to the nominal price level as we move along that set of points, and that's the normal AD curve. But we can also ask what happens to relative prices as we move along that set of points, and that's the AD curve I'm talking about here.
When we talk about being paid too much, we should always understand this in real terms. What matters is not how many dollars we get paid; it's how much we can buy with those dollars we get paid. It's the relative price, not the nominal price that matters.
Because each individual faces a downward-sloping demand curve, but all individuals together face a horizontal aggregate demand curve, each individual will choose a price that is too high and a quantity that is too low. Because one individual's selling price is another individual's buying price, all would be better off if all cut prices and increased quantity. Prisoner's dilemma. The attempt by each individual to raise his own real income above the competitive equilibrium results in a lower real income for all.
If all prices are sticky, then an expansionary monetary policy, which increases aggregate demand, increases output and makes everyone better off. That's why booms are good, because it brings the economy closer to the competitive equilibrium. And why recessions are bad, because they take the economy further away from the competitive equilibrium.
And cartels, like labour unions, just make the problem worse. Because by joining together with similar sellers into a group, the demand curve facing the group is steeper than the demand curve facing the individual, since members of the group no longer compete against each other for buyers. So there is an even bigger difference between the downward-sloping trade-off facing the group of sellers and the horizontal trade-off facing us all.
Unions are bad for the very same reason that recessions are bad.
All New Keynesian macroeconomists have understood the above for the last 20 years. Which is why all New Keynesian macroeconomists are fundamentally opposed to cartels, labour unions, minimum wage laws, etc.. OK. It's why they should be opposed to such things.
Worthwhile Canadian Initiative 
And monopolistic competitors too, right? They are also a source of lumps in the stream, especially when they become big enough to be true monopolies.
Who is “we”, white man? 🙂
The rich are just as overpaid as much as the middle class? Are capital returns too high or is it just that labor costs are too high? They are both equally too high? All factor inputs equally cost too much? And there is no gain available from equalizing the amount by which people are overpaid?
Take a gander at the BLS paper “The compensation productivity gap: A visual essay”.
What bothers me is that you are taking a highly stylized model that ignores dynamics, investment, heterogeneity, finance, the endogeneity of productivity, and concluding that you “know” that “people” are overpaid.
All you know is that if the hypothesis hold, then the conclusions hold.
“If A, then B”.
But in this post, you forgot A, and then determined that you know B applies in our world, where A is manifestly false. And if your post is to be believed, then sometime in your 30s you decided to disassociate hypothesis from conclusion and just started making blanket statements about the world rather than making “if, then” statements:
“All New Keynesian macroeconomists have understood the above for the last 20 years. Which is why all New Keynesian macroeconomists are fundamentally opposed to cartels, labour unions, minimum wage laws, etc..”
There wasn’t a single “if” anywhere in there.
No conditions under which these conclusions held, because the conditions are so absurd that no one would believe the conclusions as being remotely applicable to our economy.
But given the overwhelming data that a majority of the people are underpaid, one would want to go back to his hypothesis and try to change them to see if he could create a model that could predict the compensation gap, as well as recurring asset bubbles.
I’m sure that many are doing that — I’m not slamming the profession (or you).
I’m slamming this particular post, in which you know, despite all the overwhelming evidence of stagnant wages, that people are being overpaid. And more over, you assert, that all other economists — even the ones who prefer to stick to “if, then” statements — must share your policy position vis-a-vis our actual economy.
You are sticking to your guns, to what you have known for 20 years. FYI, 30 years ago this compensation-productivity gap took off. Perhaps 20 years ago you were right in describing the world in the post-war era to about 1980. Perhaps at that time, unions were too strong, or the fantastical hypothesis that you rely on were, just by accident, not too harmful to the applicability of the conclusions reached.
But that’s not the economy that we live in today.
Can’t really argue against the logic, as far as it goes.
I’d second what Lord said and add that the C-suite clique is a de facto union if ever there was one, and far more destructive than anything a group of teachers.
Given the experience in the US over the last 20 or 30 years, I have to wonder if it’s really so simple: bust the unions and we’re all better off? Really? And in practice it seems to me the focus (and vitriol) is always on some group of working shlubs – teachers for example – whose wages collectively represent a tiny, tiny, tiny fraction of the rents extracted by the likes of Jamie Dimon or the high rollers at AIG FP who damn near blew-up the world economy. If we’re going to run around distortion busting, it seems to me that there are bigger fish to fry than unions of teachers and gov’t clerks whose lifetime earnings are collectively probably less than the bonuses at GS in a single year. Of all the distortions in the economy, at present unions seems to be low on the list of major problems.
For once I agree with everything RSJ said. I’m with RSJ.
From the individualist perspective, isn’t any corporation or partnership a cartel? How do you determine whether corporations or unions are worse for efficiency?
“The distinction between the individual and the collective good is what’s at issue, not the distinction between the good of one group of individuals and another group of individuals.”
Maybe I’m not reading the post correctly, but are you arguing that distribution of income doesn’t matter? Inequality doesn’t matter? Without even the “compensate the losers” argument?
I have to agree with the other commenters, I think.
Hmmm.
Suppose that we have two players. A zero sum game has a value, but trade is non-zero. So trade is a win-win. OTOH, I do not see how we can determine that both are paid too little or too much.
Now suppose that we add a third player. That introduces the factor of competition. IIUC, the claim now is that, if the players are comparable in ability and resources, the general welfare increases by more than 50%, unless two players form a coalition against the other. Then the gain of the two from the coalition is less than the loss to the odd man out. The increase in general welfare is plausible, but not the overall loss from coalition forming.
Now humans form coalitions, friendships, partnerships, associations, etc. But relative advantage is not the only reason for doing so. They also form communities. Focus on only trade may lead to a conclusion that you do not draw, that competition is more beneficial than cooperation.
The negatives of competition are obvious, reflected in sayings like, “It’s a jungle out there,” “It’s a dog eat dog world,” and “It’s a rat race.” Yet these negatives do not seem to be included in your equations. Nor do I see any evidence of the positive cooperative values of coalition building.
Now let us look at the three player case with inequality, where one person commands more material resources than the others. Can we really say that the general welfare is reduced if the other two form a coalition? If they compete with each other, the third has an even greater advantage than his natural material advantage, but if they cooperate, they can offset that advantage to some extent. Because they have relatively little to start with, their material gain from the coalition is plausibly greater than the loss to the third. (As with the moral value of money.) Furthermore, from the aspect of the three as a community, the one benefits from a certain minimal welfare of the two. (And probably more than he thinks. The temptation of a master-slave relationship can blind a person to the reciprocal value of the general welfare.)
Finally, an example I found amusing in real life: Three persons with inequality where one has a relative material disadvantage, and the other two are roughly equal. The two top dogs are in perpetual competition with each other. The materially weak one not only benefited from their competition, he was able to form temporary coalitions with one or the other, and so wielded real power. 😉
Correction:
I wrote: “their material gain from the coalition is plausibly greater than the loss to the third.”
I meant, “the value of their material gain from the coalition is plausibly greater than the value of the loss to the third.”
I wonder how the idea would look like if you make the -plausible- assumption that firms have some monopsony power.
I say plausible because the same microfoundations that apply to justify monpoly power, usually apply on the other side of the market- search frictions, heterogeinity, etc…
Thought this post might raise a few hackles!
I’m waiting for the New Keynesian macroeconomists to chime in. They will agree with everything, except the title (which is obviously false), and the conclusion.
For example: RSJ: “What bothers me is that you are taking a highly stylized model that ignores dynamics, investment, heterogeneity, finance, the endogeneity of productivity, and concluding that you “know” that “people” are overpaid.”
And it’s exactly the same stylised model, which assumes that each individual is overpaid, that New Keynesian macroeconomists use to explain why monetary policy has real effects, and why booms are good and recessions are bad. And they don’t complain about these same assumptions when they are used to draw conclusions they like. But all of a sudden, when you get a conclusion you don’t like, these assumptions are problematic.
You missed the point of the post. Or don’t want to see it.
cives: “I wonder how the idea would look like if you make the -plausible- assumption that firms have some monopsony power.”
I built a model like that once, and actually published it somewhere. I realised afterwards that it was wildly implausible. Because the model predicts there will be zero unemployment. All firms will be trying to hire more workers all the time. Any unemployed worker would immediately receive multiple job offers. Monopolists always want to sell more at the current price (wage). Monopsonists always want to buy more at the current price (wage). Which of the two assumptions looks more plausible? Monopoly, clearly.
jeffreyY: “From the individualist perspective, isn’t any corporation or partnership a cartel? How do you determine whether corporations or unions are worse for efficiency?”
Some corporations and partnerships are cartels. They exist in order to increase market power. How do I determine whether unions or other cartels are worse for efficiency? I don’t. They are both bad for efficiency.
Very interesting. The basic idea (one you have discussed here before, I think) is that when a monopolistically competitive supplier lowers her relative prices, the consumer faces a relaxed income constraint and can buy more from other suppliers, thus increasing their profits. But AIUI the aggregate demand curve is not perfectly horizontal, because some of the increased demand will “leak” into input costs, rather than markups. (e.g., perfectly competitve goods, etc.)
What is the monetary authorites’ best tradeoff here? Clearly you can’t have a “surprise” monetary expansion all the time, but what if you expect to have one with low probability, and have a slightly tighter policy at all other times? Do the negatives outweigh the positives?
anon; thanks.
here are two thought-experiments I find helpful (maybe one or both will work for you):
1. Cournot. Nash equilibrium with each person setting a quantity, taking others’ quantities as given. Starting in Nash equilibrium, if one person increases quantity the loss in that person’s utlility will be second order of smalls (since she is starting at the utility-maximising point and the objective function is smooth). But everyone else will consume more of her output and so will have a first order of smalls gain in utility.
2. Bertrand. Nash equilibrium with each person setting a money price, taking each other person’s price as given. We have to think of a monetary exchange economy here, because there are n players and so n prices, but only n-1 relative prices. And so we have to bring in the monetary policy reaction function. Assume it’s a price-level targeting central bank. Starting in Nash equilibrium, if one person lowers her money price (second order of smalls loss for her), the price level falls, and so the central bank will loosen monetary policy to increase AD, so real output expands, and all gain.
There is no hope for a policy of surprise monetary policy, under RE. The usual implication is to avoid surprises to AD, by offsetting other shocks.
Min: in a standard NK model, a coalition of the whole will make everyone better off. It’s very Hobbesian like that. Each agrees to give up his own monopoly power, in exchange for others doing the same. “One Big Union” will try to force all the individual unions to lower wages/prices. “Corporatism” is how it’s usually described (notwithstanding the fascist echoes). IIRC, something like this happened in Ireland (and elsewhere) in the 1980’s? Can’t remember the details. But the main ingredients are a “social compact” where the central union tries to prevent wages rising, and the central bank expands monetary policy to increase output and employment with no need to worry about inflation.
“Min: in a standard NK model, a coalition of the whole will make everyone better off. It’s very Hobbesian like that … ‘Corporatism’ is how it’s usually described (notwithstanding the fascist echoes). IIRC, something like this happened in Ireland (and elsewhere) in the 1980’s?”
It happens in Western Europe and the PRC as well. Depending on who you ask, it’s referred to as either “market socialist economy”, or “socialism with Chinese characteristics”.
Devil’s advocate, eh?
Cartels ain’t going away. Governments seem devoted to promoting bigger ones, and the press to ignoring them.
Corporatist wage restraint is common in western Europe. The srongest example at the moment are the Netherlands. Ireland social pacts are a rather weak one. Half Europe had such pacts, most had limited impact. In the past, Austria was the most corporatist one. They had some pushback since the neolib (FPÖ) gained more and more power up to the point where they were in government for 8 of the last 10 years. Corporatism worked very good against unemployment in the 70ths during the oil crisis.
The new competitive corporatism had less stellar result. Very recently it looks like countries with more centraliced wage bargaining came much better through the financial crisis. This is important political context.
Nick Rowe: “in a standard NK model, a coalition of the whole will make everyone better off.”
Yes, that seemed to follow.
Nick: “Each agrees to give up his own monopoly power, in exchange for others doing the same. “One Big Union” will try to force all the individual unions to lower wages/prices.”
Or One Big Gov’t?
The point of lower wages/prices is to spur output, right? More goods and services for you and me?
Nick: ” “Corporatism” is how it’s usually described (notwithstanding the fascist echoes). IIRC, something like this happened in Ireland (and elsewhere) in the 1980’s?”
I am reminded of Japan when I was young. The Japanese web of responsibility took care of output. People wanted to be good worker bees. (My American viewpoint is showing. ;)) Corporations were quite loyal to their workers, even providing sinecures. No need for union featherbedding. Underperforming workers were not regarded as shirkers, as indeed, they were not. (With some exceptions, OC.) Even if you could not afford to join a country club, you could use the company driving range on the roof or, on occasion, play on the company membership. As an American, the whole thing struck me as rather feudal.
Thanks, Nick. 🙂
Another thing:
Nick Rowe: “in a standard NK model, a coalition of the whole will make everyone better off.”
So then from that perspective the problem with the minimum wage is that it does not cover everybody? E. g., it will cause some unemployment. An answer to that might be Bill Mitchell’s Job Guarantee? You don’t need a minimum wage because it is implicit in the guaranteed jobs.
The model makes perfect sense to me, and I like it. I have two concerns, though:
1. Unions make everybody worse off in that we can consume fewer goods. But the tradeoff is more leisure, as our work is less demanded, is it not? Personally, I’ll take the leisure–more time to learn economics!
2. What about situations like the 19th century, when the owners of capital had a disproportionate share of income? I agree that unions reduced output. I also agree that unions reduced investment in factories as they reduced the ROI. I would even accept that the huge ROI on factories would have eventually forced a rise in workers’ salaries as factory workers became scarcer. I also accept that many of these problems were the result of really bad protectionist policy (i.e. The corn laws). I would also accept that a better solution would have been a GAI. But living conditions were atrocious, the government was unsympathetic, and unions forced a dramatic improvement in the lives of the poor. Long term increases were coming but far off, and the conditions needed ameliorating immediately. A reduction in overall consumption and efficiency was worth it.
“And it’s exactly the same stylised model, which assumes that each individual is overpaid, that New Keynesian macroeconomists use to explain why monetary policy has real effects, and why booms are good and recessions are bad. And they don’t complain about these same assumptions when they are used to draw conclusions they like. But all of a sudden, when you get a conclusion you don’t like, these assumptions are problematic.”
Hmm, no, I disagree about the potency of monetary policy, too, and have complained about it to the point of ridicule, on several occasions. I’m not trying to debate all the money multiplier stuff now, but you did mention corporatism, and a good example of that is the Wassenaar agreement, which was a (successful) attempt at disinflation without a central bank induced credit crunch.
Anyways, I understand the point — it’s a very simple point, and a nice argument. I just don’t think it has much to do with booms or busts in our economy, nor with whether or not people are overpaid or underpaid; one reason for that is the BLS study I cited — I’m really curious as to how you reconcile that study with your model.
If you would have just made the coordination failure argument as a way to think about monopolistic competition or to illustrate certain types of games, then it would be a great educational post. And a different economist would tell the exact same story, with the same educational value, and then point out how it contradicts the wage-productivity relationship we see, and list that as a limitation of the model. We have data about how much people are paid and how much they produce. Even though this data is imperfect, it doesn’t correspond well to the story you tell.
It’s possible to see that and at the same time understand the story.
professor rowe:
its a very good thing i come here so rarely
my affection for abstraction always suffers
btw
are you ever both relevant and right
err ….while still “doing economics ” ??
this mind gaming
never exceeds
the boys with toys level
and of the most pocket protector variety
“since 18 ”
indeed
duels with plastic pistols
Japan is considered a corporatist country (Schmitter definiton, not Ron Paul definition) by some, albeit an unusual special case – corporatism without labor.
So there is nothing wrong with your model other than it does not accord well with the world. Firms exist for presumably some efficiency reason that may also apply to unions, etc., like Krugman’s post on the glories of central planning.
Nick,
When you say “paid too much” and “paid too little” are you referring to wage rates, aggregate income, per capita aggregate income in proportion of effort expended or to some vague floating notion of getting paid that can refer to one thing at one time and another in some other circumstance? If you start out from a vague enough notion of getting paid, all the subsequent cosmetics and costume changes don’t contribute any clarity or precision, only deeper obfuscation.
There are not one but at least two plausible interpretations of your “coalition of the whole.” One of them would follow John Maurice Clark’s analysis of social overhead costs toward a holistic, social-accounting model. The other subscribes to a dualistic “consumer sovereignty” principle, as enunciated by William H. Hutt. The former integrates consumers and producers into a unified complex whole, the latter explicitly subordinates “the producer” to “the consumer,” without distinguishing between labour and capital in the role of producer — presumably they are both equally subservient to the will of the consumer.
The consumer sovereignty position is grounded in very basic accounting errors, some of which appear suspiciously like deliberate evasions.
very good, indeed.
Nick, is not there a problem of imperfect information? that is, is not the prisioner´s dilemma a problem of lack of information? I mean, is not always a problem of incompleted information in all markets?
Is not that the nuclear reason for:
“If all prices are sticky, then an expansionary monetary policy, which increases aggregate demand, increases output and makes everyone better off. That’s why booms are good, because it brings the economy closer to the competitive equilibrium. And why recessions are bad, because they take the economy further away from the competitive equilibrium.”
If everybody would know the reaction of the neighbors, everyone would search the equilibrum wage.
But never everyone will know that: it´s literally imposible (a joke that Hayek was one of the first in talk about the impossibility of complete information in each and everyone).
I mean: is lack of information is = All against All?
Sorry:
(a joke that Hayek was one of the first in talkING about the impossibility of complete information in each and everyone)
Sandwichman: “Devil’s advocate, eh?” I’m not sure of exactly the right words, but I don’t think I’m playing devil’s advocate here. “Irony” seems to be closer to the mark. The post title, being obviously false, is clearly ironical. What I’m doing is pointing out a prime facie internal inconsistency in the belief system of many New Keynesians, who are nevertheless pro-union. I’m wondering how they reconcile their pro-union stance with their New Keynesianism. (Not that it’s impossible, for any theorist with enough ingenuity; but there is a definite theoretical tension there.) I’m thinking especially of some of the cousins, and their views on Wisconsin. European “corporatists” seem more consistently New Keynesian.
miep: thanks. That’s exactly the sort of examples I had in mind, but couldn’t remember clearly enough. The logic of the NK model drives you either to a corporatist solution, with centralised wage (and price?) setting, or to trying to weaken the power of individual unions. One extreme or the other. And the centralised wage-setter in a NK model would try to keep wages down — below the level that individual unions would seek in Nash equilibrium — because one union’s wage increase is another union’s cost increase.
Min: “So then from that perspective the problem with the minimum wage is that it does not cover everybody? E. g., it will cause some unemployment.”
No, the problem is that it is a minimum wage. What is needed (according to the model) is a maximum wage (or price), that covers everyone. You need a maximum wage to reduce unemployment. And it would have to be individually-tailored (according to demand and supply for each different type of worker) so that it was binding everywhere. The government would lower the maximum wage for any type of labour that was in excess supply (that had positive unemployment). That’s the logic of the model.
(Bill Mitchell’s proposal is like a gold standard system, except labour replaces gold. And the (only?) problem with Bill’s proposal is that gold is homogenous, while labour is heterogenous. So in equilibrium only the very worst labour would be employed in Bill’s projects. Which is a pity, because Bill’s proposal is very neat theoretically. A closer analogy would be a gold standard, in a country where unemployed workers could pan for gold.)
Danial: Thanks. “1. Unions make everybody worse off in that we can consume fewer goods. But the tradeoff is more leisure, as our work is less demanded, is it not? Personally, I’ll take the leisure–more time to learn economics!”
The logic of the model is that demand prices will be above supply prices everywhere, because of monopolistic power (market power of sellers). Which means the value of “leisure”, at the margin, is less than the value of the goods it could produce. And remember, the “leisure” we are talking about is typically the “leisure” of unemployed workers. The extra leisure is not shared around equally; it’s “enjoyed” by the outsiders — the involuntarily unemployed, who would much rather have less leisure and more consumption.
2. You could be a NK and still defend unions by arguing that unions improve the distribution of income, despite the aggregate loss. But, to be consistent, you could only defend unions for those with below average incomes. (My guess is that the Wisconsin teachers everybody down south is so riled about have above average incomes?) And yes, some sort of GAI would presumably be both more fair and more efficient.
RSJ: “Hmm, no, I disagree about the potency of monetary policy, too,…” this point is really orthogonal to the question of the relative efficacy of monetary and fiscal policy. Most NK models have only monetary policy. But I could replace my words “monetary policy” with “monetary and/or fiscal policy”, or simply “AD policy”, and what I said about NK models would still be true.
I may have a look at that wage productivity link later. Maybe it does or does not count as evidence against the NK model. But this post is really about whether those who believe in the NK model of booms and busts, and at the same time are pro-union, can reconcile their beliefs. (I’m teasing them just a little, and so far none have bitten, but maybe they will. Just hope they don’t bite me too hard!)
paine:
Sometimes,
just sometimes,
you have a point
that is
both understandable
and good.
But not
today.
Pity.
Lord: maybe unions, like firms, create some efficiency benefits. But Paul Krugman also believes, like me, that the world we live in is one of generalised excess supply, for most goods (including labour) most of the time. The demand side of the market is the short side of the market. Sellers have market power in most markets. If you believe that, as we both do, and you accept the NK view of booms being good and recessions being bad, as we both do, then it’s not easy to reconclie that view with one that wants to strengthen the market power of labour unions.
Sandwichman: “When you say “paid too much” and “paid too little” are you referring to wage rates, aggregate income,….”
Good point. I wasn’t sufficiently clear.
At the individual level, each individual sets price (wage) too high, and has income too high. By setting his relative price above the competitive equilibrium, he increases his own real income, at others’ expense.
At the aggregate level, relative prices are not too high (mathematically they can’t be, since they must be one on average), but real incomes are too low.
You lost me on your second point. In a macromodel, everyone is both producer and consumer.
Luis: in an NK model in full equilibrium, the underlying problem is not imperfect information per se, but imperfect competition. (Though the imperfect competition might in part be magnified by imperfect information, if buyers are unaware of competing suppliers, but this is not in the NK model). Sticky prices don’t really come from imperfect information either, in NK models. It’s just assumed that it’s costly to change prices. (Though, again, there may be some underlying imperfect information story of those costs, but it’s not in the model).
Nick, is there any particular reason you single out unions for mention as an example of how reducing price elasticity is A Bad Thing? I’m frequently struck these days by how much effort is expended (via loyalty programs, “bundling” discounts, non-transferability of contracts, niche-marketing, efforts to build “brand loyalty”, etc.) to make the demand for goods and services less elastic at the level of the individual firm.
Do you think union power is a bigger macroeconomic problem? Or am I reading too much into a simple example?
Simon: you are maybe reading too much into it. I’m against all those frequent flyer scams too. There is nothing theoretically special about unions in reducing price elasticity. Maybe economically more important in some countries, since labour, and unemployed labour, is so economically important.
My main reason for singling out unions is that that’s where some people’s views become inconsistent. I can’t think of any New Keynesian macroeconomists who strongly support other “loyalty programs” like trading stamps and frequent flyer points.
Memo to self: someday I must finish writing this post. Unions etc. are really just epiphenomena. At the root is a distinction between buyers and sellers. Sellers have market power; buyers don’t. But that very distinction makes no sense in a barter economy. In barter, when you sell something you buy something at the same time. Bertrand competition only makes sense in a monetary exchange economy, because there are only n-1 relative prices to set. Because money is homogenous, each seller of money is in perfect competition with every other seller of money.
Dont think there is any meaningfull example for centraliced price seting anymore. Switzerland has some weird milk cartell that might be considered a sector corporatist system. Austria abolished centalicediced price setting long ago.
” One extreme or the other.” Its called the hump shape hypothesis. Tálos suggests this meta paper refutes the thesis (p27):
Click to access 0120.pdf
“You lost me on your second point. In a macromodel, everyone is both producer and consumer.”
My second point is that there is more than one way to be “both producer and consumer”. Are the two roles integrated or is one of them subordinated to the other? If the model in question equates the “leisure” of the unemployed person to the marginal value of leisure of the employed, then I would describe that model as non-integrative (if not outright absurd).
It’s possible to have both high-wage and low-wage versions of the non-integrative model. The two versions foster the semblance of a “debate,” which nevertheless excludes the social overhead cost perspective of Clark (and Veblen).
Nick: ” “Corporatism” is how it’s usually described (notwithstanding the fascist echoes). IIRC, something like this happened in Ireland (and elsewhere) in the 1980’s?”
Australia’s Prices and Incomes Accord is another example. According to John Quiggin in Zombie Economics, the Netherlands also had an agreement of this sort at the same time.
I am trying to figure out why you’re description seems so different than Krugman’s. Perhaps, because he’s (partially)abandoned the Rep Agent model?
http://krugman.blogs.nytimes.com/2011/01/16/wages-and-employment-again-wonkish/
Also, what if some people are perfectly competitive price takers, say migrant grape pickers, Wal-mart employees, and so on, while some others like Econ professors are monopolistically competitive? Which seems more realistic (not that that has much to do with modeling). Would unionization have some social benefits then?
“I built a model like that once, and actually published it somewhere. I realised afterwards that it was wildly implausible. Because the model predicts there will be zero unemployment. All firms will be trying to hire more workers all the time. Any unemployed worker would immediately receive multiple job offers. Monopolists always want to sell more at the current price (wage). Monopsonists always want to buy more at the current price (wage).”
Nick- I found this paper, though Sciencedirect is down for maintenance, so I can’t read it yet.
I don’t get intuitively why this scenario would cause zero unemployment. Employers have monopsony power in labor markets over workers. The employers offer fewer vacancies than the equilibrium level as this reduces the wage. Yes, employers would prefer to sell more at this level, just like any monopolist would. But they can’t, they would need to raise their wages to hire more. Workers would not get multiple offers, the number of offers would be much smaller than the equilibrium level of offers in a competitive market.
I think your model assumes a totally elastic labor supply curve at the monopsonist wage equilibrium. I dont’ see how else you get to zero unemployment with monopsonies. Obviously there can’t be zero equilibrium in a monopsony- the equilibrium labor supply is lower than a competitive market, so if the competitive market has non-negative unemployment, a monopsonistic one must as well. Countervailing the bargaining power of management would move the market closer to equilibrium and thus increase total output.
It depends on how you define a New Keynesian, I suppose. The aggregate demand externality due to monopolistic competition may be the critical feature of New Keynesian models, but most New Keynesians are interested in models that have other important features as well, and some of those features may look better for unions. For example, Delong and Summers argued that wage and price flexibility could be destabilizing due the effect of anticipated deflation on the real interest rate. And then there is the recent Eggertsson-Krugman paper which makes a similar argument via the debt-deflation mechanism.
RSJ’s BLS article highlights an interesting point: “dual realities”, aka the difference between the GDP Deflator and the CPI Index. I think this throws an interesting wrench into your argument, Nick.
Any thoughts?
Andy Harless, shouldn’t expected deflation be seen as a monetary problem and not a real one?
Perhaps wage/price flexibility makes incomes more volatile and defaults more likely, so the second paper still applies. But the straightforward solution is to index debt contracts on overall economic conditions, so that relief is available in bad times. AFAICT, there is no externality here, so this is at least as effective as the obvious government solution (mandated debt forgiveness).
Following up on RSJ – different models are good for different purposes. A macro model written to study the impact of financial intermediation is probably not suitable for understanding the impact of migration. Every model needs to make assumptions and in order to be parsimonious the typical approach is to assume away complexities on dimensions that are not directly related to the question being addressed. It appears to me that standard New Keynesian models are good for studying monetary policy but not so good for studying issues related to inequality, bargaining power, endogenous productivity, etc.
I believe that the preference ordering of economics models depends critically on the specifics of the question being addressed. To apply the same model or, more specifically, to make the same assumptions in order to answer every question is obsessive/close-minded.
I have learned as much from your blog posts (thank you!) as I have from reading textbooks and journal articles. I also agree that unions maybe sub-optimal. However, your attempt to use the NK model to answer this question seems far-fetched.
On a separate note could you in a future post discuss the role of the fundamental theorems of welfare in new keynesian (or even RBC and new monetarist) models? How critical is the complete markets assumption? How does it relate to the representative agent framework? How is welfare defined in heterogeneous-agent models (are we still alluding to the pareto-optimality of CE)? In typical models are we just adding the utilities of different groups? What does it really mean to say that the planners problem with transfers can be implemented as CE if lump-sum taxes and transfers are politically impossible (or endogenous). I have seen various descriptions, but I would really value your lucid and intuitive explanation (and I can learn not only from your post but also from the comments it generates). And thank you again for all that you’ve taught me.
I meant to say following up on Andy Harless (not RSJ).
My impression was that NK models tended to presume that labor markets clear, even in the short run, and despite the presence of labor wage contracts – e.g., here is the New Keynesian Greg Mankiw describing this presumption as an advantage:
Very unambiguous. This was in 1988, of course, and it may be that NK modelers have stopped presuming competitive labor. But my impression is that invocations of the canonical NK model still do generally incorporate flexible labor markets.
If you wish to be cynical, you can read a political quid pro quo into it – the economist right stopped screaming about excessively high wages, and the economist left stopped screaming about redistributive effects of macro policies 😉
Okay, so reading the comments again, it is clear that your impression of NK models tend to have sticky wages as a major element. Do you have citations for this? Isn’t the canonical three-equation NK model just have staggered Calvo price-setting with expectations (to generate the expectations-augmented Phillips curve), an IS curve, and a central-bank reaction function? There’s no wage-setting in there. Where did that impression come from?
There are, of course, prominent New Keynesians who don’t adopt pro-union views (Summers, Mankiw, etc.). And there are New Keynesians who do adopt pro-union views. This is completely unsurprising, since New Keynesian economics does not hold short-run wage stickiness or wage distribution as key canonical elements, which are exactly the issues involve unions, so the NK umbrella can cover pro- and anti-union thinkers.
There’s no need to believe that unions bargain the aggregate wage level above efficient levels to support or oppose unions, of course; on the pro- side one could claim that they redistribute wages from high earners to low earners, or that they increase long-run efficiency by reducing turnover/labor monopsony/etc. These sorts of arguments seem common among the Yglesias-type crowd. I trust you already know the anti- arguments.
Nick,
“I built a model like that once, and actually published it somewhere. I realised afterwards that it was wildly implausible. Because the model predicts there will be zero unemployment.”
You don’t need to think in terms of monopsony. Productivity is only (objectively) defined for the the industry or firm, not for the occupation — which is why the BLS doesn’t publish occupation productivity data:
“There are also conceptual obstacles to disaggregating these national measures. For example, the output of a factory may require both white-collar and blue-collar inputs, and it is therefore unclear how to allocate the output to the two groups separately.”
And in this ambiguity rests the power struggles among the occupations, which are carried out by unions, management and professional organizations. Unions have historically been occupation-based. In an environment with specialization of labor, one occupation is not substitutable for another, and so the production function, in terms of occupations, looks like min(A, B), and so the relative labor share of each occupation is undefined — it is left to power relationships and bargaining. Now you cannot argue that ideal state will be “no power”, as someone needs to decide on the distribution of payouts for each occupational input.
A decrease in the wage share of one occupation matched by an increase in the wage of another wont cause an increase in hiring.
The firm will not be able to hire more workers because that would drive the MPK below the market rate.
As an example, think of universities hiring fewer tenured track professors and a larger number of adjuncts. The adjuncts are paid much less, but tuition does not fall. If we assume output does not fall either, then what is happening is just an intra-firm shift.
If the adjuncts were to form a union and gain in power, then they could take back some of the salary gains experienced by the top professors while keeping overall university costs and output the same.
You don’t see these effects in a simple exchange model of production that doesn’t have occupations or that assumes that each occupation has a well defined marginal product.
I’m not even aware of a macro model in which “management” is listed as a factor of production. Of course those models don’t get unions right, as they can’t even model what unions do, let alone determine whether what they do is helpful or hurtful.
BTW, this theme is prominent in this blog entry at Crooked Timber, in the context of professional sports: http://crookedtimber.org/2011/02/27/fair-play/#more-19101
Strong occupation based unions are not the norm across the world. Industry based unions usually do better for society as a whole, less walkouts, lower wage differentials, less danger to be destroyed altogether.
OGT: “I am trying to figure out why you’re description seems so different than Krugman’s. Perhaps, because he’s (partially)abandoned the Rep Agent model?”
Because in that post, PK is assuming the economy is stuck in a liquidity trap, and that monetary policy can’t work to increase AD. He’s talking about a very special case of the same model. I’m talking about the general case, where monetary and/or fiscal policy can be used to shift the AD curve, and so the constraint is inflation.
Andy: same response. If there’s a problem with shifting the AD curve, then we are in a special case of the model, where the effects of falling wages and prices may be different, because they can’t be offset by monetary policy.
liberal-usa and david:
Draw a standard supply and demand curve diagram. Consider 2 cases:
1. The price is above the competitive equilibrium. Sellers have market power. Monopoly. Quantity actually sold is demand-determined. There is excess supply. Buyers are buying as much as they want at that price. Sellers would always like to sell more at the going price, but can’t find a willing buyer. If the price is sticky, then fluctuations in demand will cause equivalent fluctuations in quantity sold. Fluctuations in supply have zero effect on quantity sold, and only change the amount of excess supply.
2. The price is below the competitive equilibrium. Buyers have market power. Monopsony. Quantity actually sold is supply-determined. There is excess demand. Sellers are selling as much as they want at that price. Buyers would always like to buy more at that price, but can’t find a willing seller. If the price is sticky, then fluctuations in supply will cause equivalent fluctuations in quantity sold. Fluctuations in demand have zero effect on quantity sold, and only change the amount of excess demand.
Ask yourself whether 1 or 2 best describes the world we live in? The key insight of NK macro is that 1 best describes the world we live in. It best describes the market for widgets; it best describes the market for labour.
Yes, you can always build a fake NK model in which the market for widgets is like 1, but the market for labour is like 2. (As I did once). But doing so is both wildly implausible, and totally violates the whole insight of NK macro. Since labour is, 70% (whatever) of GDP, you can’t build a NK model where 70% of the model violates 1 above, and still call it NK. The aggregate labour demand curve is approximately horizontal. Non-human capital, and land, and the resultant diminishing marginal product of labour, are small beer.
In fact, my preferred NK model is a yeoman farmer economy. There are people, selling the fruits of their labour and land and capital (human and non-human), and money. Firms are a minor complication.
RSJ: you are still thinking in terms of the Us vs Them struggle for revenue shares within each factory. The factory as a whole faces a downward-sloping demand curve for its output. Now think about the struggle of All factories against All other factories. That’s the NK vision.
If the individual factory has a horizontal LR MC curve, and a demand curve with constant elasticity, it can and will pass on any cost increase with an equivalent percentage increase in its relative output price. But factories as a whole cannot do this, because the aggregate relative price is always one.