How to Think About Aggregate Labor Markets
Peter Dorman at Econospeak takes a look at economics and models. (Re-posted with authors consent)
How to Think About Aggregate Labor Markets
The remarkable Tyler Cowen has me scratching my head again. Here he is at the beginning of a critique of minimum wage laws and sticky-price Keynesianism. (The latter is an oxymoron, as anyone who knows the history of Keynes’ dispute with the “Treasury view” knows, but we’ll let it pass.)
Let’s say your labor is worth $10 an hour but you won’t go back to work for less than $12, thereby leading to the unemployment of you.
In essence you are self-imposing a minimum wage on that market, but the employer is responding by leaving you jobless.
You can guess where this is headed.
The interesting thing is that Cowen apparently has no inkling that most people would find his opening sentence insulting. It implies that some significant portion of the unemployed are simply worth less than they think they are. Imagine going up to someone who’s been without a job for a while and saying, “I’m sorry, but have you considered the possibility that your abilities are really not very valuable, and your job search has failed because of this delusion?” If you insist on saying this, I’d advise doing it from a distance.
Now, of course some people have an inflated sense of self-worth, and others are too bashful. It might be an interesting research project to see whether the distribution of these types is correlated with employment status. I don’t have any priors about which would predominate where—do you?
What makes this interesting to an economist is that the popular perception of unemployment actually fits how we model the aggregate labor market pretty well. Let me explain. The view of most unemployed people, according to the interviews I’ve seen, goes something like this: “I’m looking for a job, and I’m willing to take something that’s worse than what I used to have, but I haven’t found anything yet.” The unemployed person hopes that the job is out there but that the connection hasn’t been made.
This formalizes to the now-standard model of search and matching, for which Peter Diamond and especially Dale Mortensen and Christopher Pissarides split a Nobel. Equilibrium in such models does not occur where the Beveridge curve crosses the 45-degree line, which it would if the criterion were supply equals demand, but depends on a larger array of factors. The model is used to explain why the ratio of unemployed workers to vacant jobs is typically greater than one, even in “full employment”.
This is how knowledgeable economists study aggregate labor markets today. Supply and demand, as deployed by Cowen, is a special and highly unlikely case that assumes away the complications that make the theory empirically relevant. If you see someone drawing supply and demand curves for labor and trying to explain unemployment as a result of too-high wages, you know they are employing outmoded methods.
What’s striking is that the more high-powered model actually conforms better to popular intuition. You have to have a rather uncharitable view of human behavior to believe that excess unemployment is due to people overestimating their true worth.
You can just create your own anecdotal data to contradict this by reviewing all the news stories about hundreds of people turning out for low paying job openings (such as McDonalds, or data entry jobs). If you were really research oriented, you could interview some of these hundreds and find out what they were getting paid previously, besides unemployment.
i don’t know about uncharitable. how about just wrong.
workers are not like rich people who can afford to turn their noses up if the pay is not to their liking. workers are always a few weeks away from destitution. and they will take what they can get.
if your “science” cannot discover this, then your science is not worth a damn.
fwiw the Cohen view is that of Paul – the real – Samuelson in about 1980 intro text. I thought it was ridiculous then. It continues to be ridiculous now. As is Cohen about almost everything he says.
in the world Cohen would like to see, workers would always “know” they were worth no more than what the owners were willing to pay. and unemployed PhD’s would be glad to take a job in a sawmill without waiting another week to see if “something better” turned up.
we are not talking economic efficiency here, much less human decency, just the convenience of those who regard “the help” as less than cattle. it’s “supply and demand” doncha know. the supreme law of the universe.
let me add
it is a peculiar thing that these epidemics of inflated self worth always turn up at just about the time the banks stop lending.
I would add that at the level of the labor economy I think the greater driver regarding one’s thought of their worth is need. If one need’s $12/hr to break even with their present living expenses then…that’s their preceived worth.
Add to this a contracting labor economy (depression economy) and the issue of one’s preceived worth means squat if you’re building a model other than maybe as a egg head debate.
“I would add that at the level of the labor economy I think the greater driver regarding one’s thought of their worth is need. If one need’s $12/hr to break even with their present living expenses then…that’s their perceived (sic) worth.”
Then people need to cut down on their living expenses, duh. As any CEO will tell you, a person can get by with just one personal jet. Don’t poor people understand economics?
Two words : “below cost.”
What is the cost of producing and maintaining human beings? Education, training, birth, growth and health, the cost of bringing a US citizen to working age is somewhere around $250,000. The minimum cost of maintaining him afterwards is a little over $8700 a year.
Minimum wage jobs, even at full time, pay around $13,000 after tax, or about enough to support him and his replacement (child.)
Only it isn’t. The government pays for schooling, minimal health care, and lots of other necessities for people living at minimum wage. It also supports those poor workers in old age, ill health and unemployment.
The long and short of it is that people working at minimum wage are being “supplied” to their employers below cost.
There are times, of course, when this is a good idea. The employers provide something in return (experience for the young, or services of value which can’t be sold at their true cost, like cultural institutions for instance.)
We have to ask ourselves which below-cost jobs people are doing and whether these jobs supply anything in return to justify the subsidy they are receiving and often demanding.