Think about a model where prices are determined by relative bargaining power. The buyer wants to do the deal, but wants a lower price. The seller wants to do the deal, but wants a higher price. Each threatens to walk away from the deal if the other side refuses to budge on the price. The better his alternative opportunities relative to this deal, and the easier it is to walk away from this deal, the more credible his threat, and the stronger his bargaining power.
You can think of the perfectly competitive model, where prices are determined by demand and supply curves, as just the limiting case of this sort of bargaining model. The demand and supply curves cross at P*. If P is just a fraction above P*, all buyers can find willing sellers, but some sellers can't find willing buyers. So the buyers have bargaining power, because they can credibly walk away from the deal and find another seller who can't find a buyer; and the sellers have no bargaining power, because they can't credibly walk away from the deal and find another buyer who can't find a seller. So the price falls back to P*. Vice versa if P is less than P*.
Now add monetary exchange to the model. All goods are bought and sold for money. Buyers of goods are sellers of money. Sellers of goods are buyers of money.
Start in equilibrium where buyers and sellers have exactly the right relative bargaining power that prices stay the same.
Now suppose something changes, so that people want to hold more money. People want to buy more money and want to sell less money. This reduces the bargaining power of buyers of money and increases the bargaining power of sellers of money. These are the same people of course, because we all both buy and sell money. That's what money is.
In the market for apples, sellers of money (buyers of apples) have more bargaining power; and buyers of money (sellers of apples) have less bargaining power. It is easier for buyers of apples to find willing sellers and harder for sellers of apples to find willing buyers. The quantity of apples traded would fall, because trade requires both a willing buyer and a willing seller who can find each other. If the price of apples eventually fell, the relative bargaining powers of buyers and sellers would eventually fall back to its original equilibrium.
The same would be true in the market for bananas.
The same would be true in the market for labour.
What we call a "recession" is a reduction in the volume of trade, one that is associated with an increase in the bargaining power of sellers of money and a fall in the bargaining power of buyers of money.
So when Paul Krugman says that recessions weaken workers' bargaining power, my response is that he has correctly noted one symptom but has misdiagnosed the disease. It's a partial equilibrium description of a monetary/general equilibrium disease.
It is buyers of money whose bargaining power is weakened. And sellers of money whose bargaining power has strengthened. And all buyers of money are also sellers of money. We are weaker when we try to buy money and stronger when we try to sell money. Just like in Paul's favourite babysitters coop model.
Is labour any different from, say, apples?
Well yes. Labour is different in one very important respect:
Suppose a competing seller of apples offered me a better deal than my current seller of apples. If my current seller refused to cut his price, I would feel free to walk away from the deal and buy apples from the competing seller.
Suppose a competing seller of labour offered me a better deal than my current seller of labour. If my current seller refused to cut his price, would I feel equally free to walk away from the deal and buy labour from the competing seller? Nope.
Suppose a competing buyer of labour offered me a better deal than my current buyer of labour. If my current buyer refused to raise his price, would I feel equally free to walk away from the deal and sell labour to the competing buyer? Yes.
There is a taboo against buyers of labour switching to a competing seller who offers a better deal.
There is no taboo against sellers of labour switching to a competing buyer who offers a better deal.
That asymmetry of taboos strengthens the bargaining power of the seller of labour and weakens the bargaining power of the buyer of labour, ceteris paribus. Because it makes it harder for the buyer of labour to walk away from the deal. So something else needs to adjust to restore equilibrium in relative bargaining power so that ceteris is not paribus. That something else might be unemployment.
Nick's Law of Relative Bargaining Power: any exogenous change in relative bargaining power will cause some change in the market that restores the original level of relative bargaining power. If there is a taboo against employers quitting workers but no taboo against workers quitting employers, and if people fear breaking taboos, then something else will change that re-equilibrates the fear.
Normal people, even economists, don't like talking about taboos. It's taboo to question taboos. Normal people don't even notice anything strange about them. "Of course it's wrong to fire your existing worker and replace him with a lower wage worker! Of course it's right to fire your existing employer and replace him with a higher wage employer!"
Normal people will get mad at me for even talking about this taboo, and calling it a taboo. But normal people are wrong. It's our job, as economists, to be a bit autistic about things like that.
Here's Paul:
"Some people would have you believe that employment relations are just like any other market transaction; workers have something to sell, employers want to buy what they offer, and they simply make a deal. But anyone who has ever held a job in the real world — or, for that matter, seen a Dilbert cartoon — knows that it’s not like that.
The fact is that employment generally involves a power relationship: you have a boss, who tells you what to do, and if you refuse, you may be fired. This doesn’t have to be a bad thing. If employers value their workers, they won’t make unreasonable demands. But it’s not a simple transaction. There’s a country music classic titled “Take This Job and Shove It.” There isn’t and won’t be a song titled “Take This Consumer Durable and Shove It.” "
If you really want to see why employment relations are different from any other market transaction, and if you really want to talk about power relationships, you first have to recognise that asymmetry of taboos. Then you have to ask what effects that asymmetry of taboos will have. Will it create an offsetting asymmetry in the new equilibrium?
Of course there isn't a song titled "Take This Consumer Durable and Shove it". We do that the whole time, when we walk away from one car dealership to get a better price at a second car dealership. There is no taboo against walking away from a seller of cars and buying from another seller instead.
Now, here's the real question: why isn't there a song, sung from the POV of an employer, titled "Take This Worker and Shove him"? That song would be taboo. There is a taboo against walking away from a seller of labour and buying from another seller instead.
Worthwhile Canadian Initiative 
1 obviously.
In 2 the fired worker is left without a job and an income. He might be unable to pay his rent/mortgage or provide for his family.
In 1 the employer still has his business and his money as before.
People would be more likely to see 2 as worse because it is considered to be more harmful, for obvious reasons. Not because of an irrational taboo.
Philippe: “In 1 the employer still has his business and his money as before.”
No he does not. He has lost his employee.
The fact that you simply cannot see it the other way around, from the other’s perspective, shows how deep-seated this taboo, and this bias, really is.
“No he does not. He has lost his employee.”
If, by quitting, an employee caused his employer to lose his business and income, I think most people would see that as bad. Indeed it is seen as ‘taboo’ to just quit without giving your employer any warning or time to find a replacement.
As I said there’s a general taboo against harming people, treating people badly, exploiting people, etc. People will object to either firing workers to replace them with cheaper workers, or quitting for higher pay, if they think either of these involves harming people, treating people badly or exploiting people.
In general people object to the former more because they see it as being more harmful. Not just in theory, but based on the evidence.
Nick,
Yes, I think the first equilibrium is unstable. It would only be stable if workers were infinitely substitutable – which clearly they are not. Adjusting pay alone only works for unskilled jobs. For everything else you have to adjust skills as well, which takes time, costs money and may in some cases be simply impossible. So skills shortages, gluts and mismatches all inevitably exist, and that means that not all workers can be certain of walking straight into another job, and not all jobs can immediately be filled if a key worker leaves. Unemployment is therefore inevitable. But it’s maybe less clear why the taboo is also inevitable. I think you touched on it in your reply to Philippe. It is to do with the cost to employers of losing key staff.
The lengths to which employers will go to retain key staff suggests that losing workers they can’t easily replace is a very significant cost to them. The worker’s right to leave is another valuable “safe asset” whose price is positively correlated with the employability of the worker. This time it is the worker, not the employer, who has the put option: we could say that the worker’s implied threat to leave disciplines the employer who can’t easily replace him in much the same way as the implied threat of dismissal disciplines lower-skill workers who face unemployment. The more “in demand” the worker is, the more likely it is he will leave and the more difficult the employer will find it to replace him. So whereas the workers are very happy with their freedom to change jobs whenever they want, employers will constantly try to reduce the elasticity of their skilled workforce. Therefore an employer who dismisses key staff on a whim is not acting in the best interests of the business. In fact he is possibly certifiably insane. Hence the taboo.
Conversely, in low-skill jobs where workers are far more substitutable, employers want elasticity, but the workers don’t. If employers get what they want, it has untoward economic effects because of the extreme uncertainty faced by their workers. People who think they are going to lose their job any moment and have no idea when, or if, they will get another one don’t plan for the future and don’t make spending commitments. They may spend – sometimes rather a lot – but it’s ad-hoc. If a large proportion of the workforce are living like this, demand is volatile (I’m not sure if that makes sense but I can’t think of a better way of putting it).
So when the labour market (high AND low skill) is highly elastic, the pattern of behaviour from both employers and workers is driven by extreme uncertainty and the risk of negative shocks: it’s volatile and reactive. That doesn’t make for a stable economy, I’d suggest.
There is some support for this argument from a surprising place. Researchers at the ECB produced a paper a while ago which among other things found a positive correlation between highly elastic workforces and both frequency and intensity of financial crises. The paper itself is here: http://www.ecb.europa.eu/pub/pdf/scpwps/ecbwp1514.pdf. It’s flawed but fascinating. The relevant bit about elastic workforces is on p.40, but the whole paper is well worth a read.
“Well yes. Labour is different in one very important respect…”
Oh?
What you’re doing here, Nick, is tacitly assuming that labour-power is a “normal” commodity and then explicitly pointing out one rather minor anomaly to that (supposedly) normal commodity’s normality. However, if you took a broader view, you would note that, to begin with, the seller of the commodity, labour-power is constrained from disposing of a life-time supply all at once. That’s just one aspect but it should provide you with a hint of the peculiarity of labour-power, aside from any rhetorical pronouncements from the U.S. Congress (Clayton Anti-trust Act), the Treaty of Versaille or the International Labour Organization that “labor is not a commodity or an article of commerce.”
Of course the “fictional” status of labor as a commodity is one of the pillars of Karl Polanyi’s critique of economic liberalism. One overlooks the beams of Polanyi, Marx, Veblen, Keynes, Kalecki, John Maurice Clark, Marshall, Pigou and Hicks (to name a few) and beholds your mote of a “taboo” only at the risk of falling afoul of Matthew 7,5: “Thou hypocrite, first cast out the beam out of thine own eye; and then shalt thou see clearly to cast out the mote out of thy brother’s eye.”
Sandwichman: when I go to my hairdressers, what am I buying? Am I buying a haircut, or am I buying her labour? Yes, she owns her own tools. So do most auto-mechanics.
I would take your Matthew 7,5 more seriously if followers of Marx, when they actually get into power, weren’t the biggest offenders. That is a whole forest of beams.
Frances: re the risks to employers of losing key staff. That reminds me of one efficiency wage theory of unemployment. Because quits are costly, employers will pay above-market wages to reduce turnover, because a workers will be very unwilling to quit if he gets a higher wage in his current job than he could get elsewhere. When all employers do this the result is unemployment, and unemployment deters workers from quitting, so no individual firm tries to pay wages above the wages paid by other firms. If it were taboo for workers to quit, there would be no unemployment (in this model).
Philippe: “In general people object to the former more because they see it as being more harmful. Not just in theory, but based on the evidence.”
But see above: “Nick’s Law of Relative Bargaining Power: any exogenous change in relative bargaining power will cause some change in the market that restores the original level of relative bargaining power. If there is a taboo against employers quitting workers but no taboo against workers quitting employers, and if people fear breaking taboos, then something else will change that re-equilibrates the fear.”
If the asymmetry of taboos causes unemployment, then it will be more costly for an employer to quit an employee than for an employee to quit an employer.
The assymmetry of taboos creates the conditions for its own justification. See my discussions with Frances and Andy above.
Nick: “if followers of Marx, when they actually get into power, weren’t the biggest offenders.”
Nick, aside from your omission of Polanyi, Veblen, Keynes, Kalecki, John Maurice Clark, Marshall, Pigou and Hicks, your assertion about “followers of Marx” is an unwarranted red herring. Harold Rosenberg argued that, “no one is a Marxist who, in the interest of working-class liberation, consents to serve the powers of the new other world created by Marxist totalitarianism.” Whether one is a Marxist or not, one can also distinguish between Marx’s critique of political economy and his historico-political imagination. That is to say, one doesn’t have to believe that the proletariat is the revolutionary subject of history to acknowledge the contribution of Marx’s analysis of labour power’s peculiarity as a commodity.
But forget Marx. What about Polanyi’s critique? On what grounds do you hold up “one very important respect” in which labour is different from apples or bananas and disregard the myriad fundamental ways that labour has been shown by Polanyi et al. to be different? Might not your “taboo” have somewhat of the character of a consolation prize or even a “booby prize”? Taboo or tabooby?
Sanwichman: “On what grounds do you hold up “one very important respect” in which labour is different from apples or bananas…”
The answer is obvious from my post. Because that difference is directly relevant to Paul Krugman’s post about bargaining power of workers in a recession. Which is what my post is about.
As a general rule, remember this: my posts are usually not about the things you want them to be about and want to talk about.
“Because that difference is directly relevant to Paul Krugman’s post about bargaining power of workers in a recession.”
And you’re saying that John Maurice Clark’s analysis of the overhead costs of labour and social cost-shifting is not???? I fully understand that you don’t want to talk about the things I want you to talk about. You seem to think that’s because what I want you to talk about is irrelevant to what you’re talking about. I think you don’t want to talk about what I want you to talk about precisely because it is relevant. As a general rule.
S: You are not very good at commenting on blogs. Remember how I once explained to you how to write a good comment? I don’t have the patience to keep on explaining it.
Nick, “Man is born ignorant; he is not born a fool; and it is not even without labour that he is made one.” — Helvetius
Very good Sandwichman. But not a good comment. Now please go away.
An interesting comment thread. Perhaps now desirable to try remodeling the previous post this sprang from.
So basically, you are not giving up on defining the labor market using ‘taboo,’ an anthropological word that entered English about the time Smith, Ricardo, and both Malthuses, were working, and up until the spin you are putting on it here, for the most part derogatory. That the word’s usage has changed is not at all a problem. Today we tend to respect, or at least tolerate, others’ taboos, though the litany of ethnic insults my superego is holding per-conscious says otherwise. So, I’m suggesting, the conversation would be better-off back to, the ‘efficiency wage’ discussion. We really should not be limited to the behavioral models put forward by major discussants. Not that most are wrong, just incomplete. Most employers, at least those taught in business schools, use well-worked applications in the efficiency strain. So much so, it is remarkable that straight-line labor supply curves across the population are still utilized. The word I used before, bifurcation, that of dual labor markets, has tendrils of great historical depth.
A lot of issues in your question about whether Malthusian constraints impact labor markets. Firstly, most historical societies have endured Malthusian pressures; but by no means predominately lived at subsistence level. Secondly, the advanced countries of this millennium are still enduring them. Just, today we call it population pressure.
The reality is that labor markets were differentiated in the most ancient civilizations we know about. Labor relations have really not changed a lot. The words we use are different, but what they describe is not.
So, how do we get from there to ‘efficiency’ when constrained to think of labor as a commodity? The labor market has rules. In Aristotle’s “Economics,” we find,
“Of workers there are two kinds; those in positions of trust, and the laborers.”
Aristotle goes on to describe the inducements of various types, applicable to either. Your discussion is about trusted workers. There is a lot more herding when it comes to laborers, a lot of pretending that laborers are ‘trusted,’ for appeasement’s sake, and laughter when the pretense is broken. That’s in this world, complicated as hell, but certainly an economic formation, many markets rather than a single market, and quite determinate.
So, the answer is that the wage adjustment process is only marginally involved with bargaining during transactions. It is much more about roles, and the bargaining that does take place is really at the political level. At best, there might be multiple price/quantity equilibria, as politics determines.
Let me pull a Sagan on you. If familiar with the name Sapolsky, please nod. The socioeconomic gradient of health stretches back into the mammalian lineage, and likely further. So, I guess we’d like to talk about the curvature of that; but if you are serious about us being different from 99% of history, then we are the 1 percent. A better approximation, given, say, just 10 million years as alpha, beta and gamma monkeys, would have today’s advanced country citizens as the 1/1000th percent, not really a credible divergence.
Apologies, I don’t know if you intended that pangloss, but your remark about wages anywhere between W2 and Wmax in the last post was rather beyond the pale.
Nick,
I’ve been thinking about that efficiency wage model. I don’t think it works in the bifurcated labour market we have (implicitly) been discussing.
Firms increasing wages to retain workers they would have difficulty replacing doesn’t cause unemployment among those workers: it does among other workers, but that doesn’t affect the behaviour of firms or workers in the scarce-skills sector. Making it taboo for those workers to quit kills the wage spiral, but it also ossifies the scarce-skills labour market. But actually you end up with an ossified labour market anyway, whether or not there is a taboo on quitting.
If the wage spiral is allowed to run its course, eventually all jobs requiring those skills will be filled, and all workers with those skills will have jobs and will earn about the same. They will probably stay in the same job until they retire, too, since if this high-skill sector is sclerotic others are likely to be too, so career paths will be virtually non-existent. There is no unemployment among this cohort, though there might be quite a lot of frustration at their lack of opportunity for advancement (when I worked in banking we called this “dead men’s shoes” – you couldn’t be promoted until someone more senior left). Admittedly, if someone did leave he would find it very difficult indeed to get another job. But I don’t think it is primarily the threat of unemployment that forces these workers to stay. It’s the lack of opportunity. They aren’t going to find a better job anywhere else.
But there are impossibly high barriers to entry for younger people with similar skills but less experience. Those younger people have a choice between remaining unemployed until the older cohort retires, retraining for other skilled jobs (though the same situation is likely to exist in those too), or accepting less skilled, lower paid and more insecure jobs. The result is a bifurcated labour market – a secure, highly paid and highly skilled older cohort and a far less secure, poorly paid and eventually less skilled (because of hysteresis effects) younger cohort. It is that younger cohort that experiences unemployment, not among the more skilled people but among the genuinely unskilled, who now have to compete with higher skilled people and inevitably lose out even for jobs they are perfectly capable of doing. (Actually the generational split is not as clear-cut as this. Unskilled older people also lose out, particularly men in their 50s.)
Of course, if the economy grows, then there should be increased need for the higher-skill jobs, which creates opportunities for skilled youngsters without dislodging incumbent workers. But if the economy stagnates, as it has in Japan, there may be no more need for higher-skill jobs. In which case, as the older cohort retires, skills gaps emerge which affect productivity and output. In the long run, bifurcated (dual) labour markets are not good for the economy.
To me, it’s not at all clear that employers would pay higher wages (leading to involuntary unemployment) if workers are free to quit. They may simply pay lower-than-market wages at the start of the worker’s tenure, with the understanding that this portion of the compensation would be recouped later in the worker’s career. Though, this might fail (and “efficiency wages” in the conventional sense would then come back into play) if the employer cannot be trusted to “fairly” compensate the worker later in her career, i.e. there is moral hazard on the employer’s part.
nemi’s post said: “Too much Fed: “I’d say in a recession people want to hold the highest yielding asset that won’t go down in value or default.”
I agree.”
Thanks! Hardly anyone agrees with me here.
Squeeky Wheel said: “I’m not sure I entirely believe the labor supply curves as usually drawn. Roughly, employers (some of them, and individually) won’t demand more labor just because wages fall. In software, it’s well recognized that low-skill and new-to-company (Brooke’s law) are negative in productivity. Dropping the cost of software engineers does not entice me to hire much more of them – they aren’t fungible. On the other end of the spectrum, a MacD outlet faced with a 50% cut in labor costs does not hire many more front line employees – there’s no work for them.”
I agree.
This is a beautiful post. I was thinking about your “recession is lack of trade” idea many times but I did not have a look at it from bargaining power point of view. You may have just “microfounded” your theory 🙂 Now all we need is young economists to go through sectors with a lot of differences in bargaining power and take a look at what happens during recession. Maybe this may explain what is going on with real estate – why do we sometimes see whole newly built neighborhoods being leveled by bulldozers after years of vacancy instead of being sold for a cheaper price?
Nothing more to add, your thoughts about “taboos” seems right to me and that there are some people who do not agree was expected. Anyways this discussion reminded me an article from Bryan Caplan about a poll among employers by Truman Bewley that I bookmarked for later review. I did not read the book itself, but Bryan’s article contains enough information or a good teaser.
Frances C (I must call you “Frances C”, because Frances Woolley is the only “Frances” on this blog 🙂 )
“But I don’t think it is primarily the threat of unemployment that forces these workers to stay. It’s the lack of opportunity. They aren’t going to find a better job anywhere else.”
Yep. There are two types of efficiency wage model:
1. Where efficiency wages apply to all jobs, so you either get an efficiency wage job or you are unemployed. It’s a theory of unemployment.
2. Where efficiency wages apply to some jobs but not others, so you either get an efficiency wage job or a regular low wage job. It’s a theory of wage differentials.
You can always blend the two, and get a model where low wage jobs are about as good as unemployment.
anon: Yep. A problem for most efficiency wage models is “Why don’t employers require new workers to post a bond?” The standard answer is that that creates moral hazard on the employer’s part, to fire the worker just to grab the bond. A rising wage profile, where you get paid less than your market value initially, and more when older (or a company pension) is like posting a bond.
JV: thanks! I’m not sure if it’s really all there though, in terms of microfoundations.