Thursday, February 13, 2014

13/2/2014: Sticky Wages, Job Effort and Jobless Recoveries

In two posts earlier I discussed some new studies relating to the problem of a jobless recovery ( and the ICT-driven displacement of workers ( Here is another recent study dealing with labour markets outcomes in the case of a recessionary shock.

Here is another paper on employment adjustments, this time looking at cyclical shocks and wages rigidity: "HOW STICKY WAGES IN EXISTING JOBS CAN AFFECT HIRING" by Mark Bils, Yongsung Chang, Sun-Bin Kim (NBER Working Paper 19821:, January 2014).

There is much evidence that wages are sticky within employment matches, so that incumbent workers face wages that do not adjust significantly fast downward in the downturns, thus creating a wage mis-match with entry of new workers. "For instance, Barattieri, Basu, and Gottschalk (2014) estimate a quarterly frequency of nominal wage change, based on the Survey of Income and Program Participation (SIPP), of less than 0.2, implying an expected duration for nominal wages greater than a year."

"On the other hand, wages earned by new hires show considerably greater  flexibility. Pissarides (2009) cites eleven studies that distinguish between wage cyclicality for workers in continuing jobs versus those in new matches, seven based on U.S. data and four on European. All these studies find that wages for workers in new matches are more pro-cyclical than for those in continuing jobs."

"Consider a negative shock to aggregate productivity. If existing jobs exhibit sticky wages, then firms will ask more of these workers. In turn this lowers the marginal value of adding labor, lowering the rate of vacancy creation and new hires. Note this impact on hiring does not reflect the price of new hires, but is instead entirely a general equilibrium phenomenon. By moving the economy along a downward sloping aggregate labor demand schedule, the increased effort of current workers reduces the demand for new hires.

The result of this mechanism of adjustment is that "wage stickiness acts to raise productivity in a recession, relative to a flexible or standard sticky wage model. Thus it helps to understand why labor productivity shows so little pro-cyclicality, especially for the past 25 plus years (e.g., Van Zandweghe, 2010)."

The authors set up two versions of the model for such an adjustment.

First model allows firms "to require different effort levels across workers of all vintages… During a recession the efficient contract for new hires dictates low effort at a low wage, while matched workers, whose wages have not adjusted downward, work at an elevated pace."

In the scone variant of the model, authors "impose a technological constraint that workers of differing vintages must operate at a similar pace. For instance, it might not be plausible to have an assembly line that operates at different speeds for new versus older hires."

The study finds that the second model "generates considerable wage inertia and greater employment volatility." In other words, if contracts do not allow firms to impose greater effort requirement on new hires against incumbent workers, there will be more shocks to unemployment and stickier wages for incumbents. Or in other words, there will be a more jobless recovery.

The authors provide an example: "Again consider a negative shock to productivity, where the sticky wage prevents wage declines for past hires. The firm has the ability and incentive to require higher effort from its past hires, in lieu of any decline in their sticky wages. But, if new hires must work at
that same pace, this implies high effort for new hires as well. For reasonable parameter values we find that firms will choose to distort the contract for new hires, rather than give rents (high wages without high effort) to its current workers. This produces a great deal of aggregate wage stickiness. The sticky wage for past hires drives up their effort and thereby the effort of new hires. But, because high effort is required of new hires, their bargained wage, though flexible, will be higher as well. In subsequent periods this dynamic will continue. High effort for new hires drives up their wage, driving up their effort in subsequent periods, driving up effort and wages for the next cohort of new hires, and so forth. By generating (counter)cyclicality in effort, this model can make vacancies and new hires considerably more cyclical." (Or put differently, it creates more unemployment at the shock and retains more unemployment in the adjustment period.

Now onto empirical evidence: "There is only sparse direct evidence on cyclicality of worker effort. Anger (2011) studies paid and unpaid overtime hours in Germany for 1984 to 2004. She finds that unpaid overtime (extra) hours are highly countercyclical. This is in sharp contrast to cyclicality in
paid overtime hours. Quoting the paper: "Unpaid hours show behavior that is exactly the opposite of the movement of paid overtime." Lazear, Shaw, and Stanton (2012) examine data on productivity of individual workers at a large (20,000 workers) service company for the period June 2006 to May 2010, bracketing the Great Recession. At this company a computer keeps track of worker productivity. They find that effort is highly countercyclical, with an increase in the local unemployment rate of 5 percentage points associated with an increase in effort of 3.75%."

The authors use their model to "show that sticky wages for current matches exacerbates cyclicality of hiring when effort responds. In particular, for our benchmark calibration with common effort, the effort response markedly increases the relative cyclical response of unemployment to measured productivity. It does so by increasing the response of unemployment to productivity, but also by making measured productivity less cyclical than the underlying shock."

The authors then look at the data to see if their "model is consistent with wage productivity patterns across industries, especially the cyclical behavior of productivity in industries with more versus less flexible wages. We measure stickiness of wages by industry based on panels of workers from the Survey of Income and Program Participation for 1990 to 2011."

The study finds that 

  • "productivity (TFP) is more procyclical in industries with more flexible wages"; and 
  • "this impact is much greater for industries where labor is especially important as a factor of production. 
  • "However, we do not see that wages are more procyclical for industries with flexible wages, suggesting that frequency of wage change may not capture wage flexibility particularly well."

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