George Akerlof - Behavioral Macroeconomics and Macroeconomic Behavior (Part II : Involuntary Unemployment) lyrics

[II. Involuntary Unemployment] I once had an economist friend who said that he could not sell his house, a complaint that I reiterated sympathetically to one of his colleagues. The colleague responded that there was only one problem: the house was unreasonably priced. At a lower price the house would sell, perhaps instantly. New Cla**ical economics views involuntary unemployment as a logical impossibility, like my friend's inability to sell his house. Could not an unemployed worker obtain a job if only she were willing to reduce her reservation wage? The New Cla**ical answer is yes: unemployed workers are those searching for work (hence unemployed, rather than out of the labor force) but rejecting jobs that are available because they had expected better pay. The unemployed may be unhappy that they cannot sell their labor at the wage or salary that they would ideally like, but except for those affected by the minimum wage or union bargaining, they are voluntarily, not involuntarily, unemployed. Everyone can get a job at the market-clearing wage. In New Cla**ical theory, periods of declining employment—businesscycle downturns—may be caused by an unexpected decline in aggregate demand, which leaves workers mistakenly holding out for nominal wages that exceed the new market-clearing level. Alternatively, declining employment may be due to negative supply shocks, which cause workers to withdraw from the labor force and eschew the jobs which are available. Any account of the business cycle based on voluntary variations in job-taking faces a significant empirical difficulty—to explain why quits decline in cyclical downturns. If higher unemployment results from workers' rejection of the poor returns from work, quits should rise along with unemployment. But there are fewer quits, not more, when unemployment rises. The procyclic behavior of quits is indisputable. Instead of denying the very existence of involuntary unemployment, behavioral macroeconomists have provided coherent explanations. Efficiency wage theories, which first appeared in the 1970's and 1980's, make the concept of involuntary unemployment meaningful. These models posit that, for reasons such as morale, fairness, insider power, or asymmetric information, employers have strong motives to pay workers more than the minimum necessary to attract them. Such “efficiency wages” are above market clearing, so that jobs are rationed and some workers cannot obtain them. These workers are involuntarily unemployed. In the next section I will extend this reasoning to explain why involuntary unemployment varies cyclically. The pervasive empirical finding of a wide spread of earnings for seemingly similar workers is strongly suggestive of the near ubiquity of efficiency wages. Long before the efficiency wage was a gleam in the eye of macroeconomists, labor economists had documented wide dispersion in earnings across seemingly similar jobs and among workers with apparently iden-tical characteristics. an*lysis of panel data indicates that workers of the same quality receive different wages depending upon their place of work. Moreover, data show that workers who switch industries receive wage changes that are correlated with the respective wage differentials between the industries. Industries with higher pay (conditional on characteristics) also have lower quit rates, suggesting that pay differences are not simply compensating differentials due to different working conditions or benefits. It thus appears that there are “good jobs” and “bad jobs.” The existence of good jobs and bad jobs makes the concept of involuntary unemployment meaningful: unemployed workers are willing to accept, but cannot obtain, jobs identical to those currently held by workers with identical ability. At the same time, involuntarily unemployed workers may eschew the lowerpaying or lower-sk**ed jobs that are available. The definition of involuntary unemployment implicit in efficiency wage theory accords with the facts and agrees with commonly held perceptions. A meaningful concept of involuntary unemployment constitutes an important first step forward in rebuilding the foundations of Keynesian economics. But why do firms pay wages above rock bottom? In my view, psychological and sociological explanations for efficiency wages are empirically most convincing.20 Three important considerations are: reciprocity (gift exchange theory from anthropology), fairness (equity theory from psychology), and adherence to group norms (reference group theory in sociology and theory of group formation in psychology). In the earliest “sociological” version of efficiency wage theory based on gift exchange, firms give workers above market-clearing wages and workers reciprocate in their commitment to the firm. The payment of above-market-clearing wages may also be motivated by considerations of fairness: in accordance with the psychological theory of equity, workers may exert less effort insofar as their wage falls short of what is considered fair. Group norms typically determine the conceptions workers form about how gifts should be reciprocated and what constitutes a fair wage. In the laboratory, Ernst Fehr and his coauthors have established the importance both of reciprocal behavior and social norms for worker effort in experimental settings. My favorite version of efficiency wages is the insider-outsider model, whereby insider workers prevent the firm from hiring outsiders at a market-clearing wage lower than what the insiders are currently receiving. This theory implicitly a**umes that insiders have the ability to sabotage the inclusion of new workers into a firm. A detailed study by Donald Roy of an Illinois machine shop reveals the dynamics by which this may occur: In Roy's machine shop, insiders established group norms concerning effort and colluded to prevent the hiring of ratebusting outside workers. Workers who produced more than the level of output considered “fair” were ostracized by others. Collusion by insiders against outsiders is a compelling motive for many firms to pay wages that are above market clearing. An alternative version of efficiency wage theory, grounded in asymmetric information, views above-market-clearing wages as a disciplinary device. In the Shapiro-Stiglitz model, firms pay “high” wages to reduce the incentive of workers to shirk. The attempt of all firms to pay “above-average” wages, however, pushes the average level of wages above market clearing, creating unemployment. Unemployment serves as a disciplinary device, because workers who are caught shirking and fired for lack of effort can become reemployed only after a period of unemployment. The worker-discipline model fits the standard logic of economics more comfortably than approaches grounded in sociology and psychology. But sociological and psychological models, including the insider-outsider model, that rely on elements outside the standard economic box, probably yield a better overall explanation for involuntary unemployment. These behavioral models capture Keynes' emphasis, in the initial chapters of the General Theory, on equity and relative wage comparisons.