Sunday, December 21, 2008

Sticky Wages, Flexible Labor Costs?

The version of the "textbook" Keynesian model that I teach my students relies on "sticky" wages, set in advance. One of the less-satisfying features of the story is that the large gains to adjusting wages are left on the table. And yet, my students mostly find it plausible, because it seems consistent with observed behavior. In last week's Times column, David Leonhardt explored the issue:
Jobs are disappearing, bonuses are shrinking and raises will be hard to come by. But the drop in prices, which isn’t over yet, will make life easier on millions of people. It’s possible, in fact, that the current recession will do less harm to the typical family’s income than it does to many other parts of the economy.

The reason is something called the sticky-wage theory. Economists have long been puzzled by the fact that most businesses simply will not cut their workers’ pay, even in a downturn. Businesses routinely lay off 10 percent of their workers to cut costs. They almost never cut pay by 10 percent across the board.

Traditional economic theory doesn’t do a good job of explaining this. During a recession, the price of hamburgers, shirts, cars and airline tickets falls. But the price of labor does not. It’s sticky.

In the 1990s, a Yale economist named Truman Bewley set out to solve this riddle by interviewing hundreds of executives, union officials and consultants. He emerged believing there was only one good explanation.

“Reducing the pay of existing employees was nearly unthinkable because of the impact of worker attitudes,” he wrote in his book “Why Wages Don’t Fall During a Recession,” summarizing the view of a typical executive he interviewed. “The advantage of layoffs over pay reduction was that they ‘get the misery out the door.’ ”

However, there are other margins to adjust, and its far from obvious (to me, at least) that layoffs are less damaging to worker morale than pay cuts. That's why I found the examples of non-wage adjustments in this Times story interesting:

A growing number of employers, hoping to avoid or limit layoffs, are introducing four-day workweeks, unpaid vacations and voluntary or enforced furloughs, along with wage freezes, pension cuts and flexible work schedules. These employers are still cutting labor costs, but hanging onto the labor.

And in some cases, workers are even buying in. Witness the unusual suggestion made in early December by the chairman of the faculty senate at Brandeis University, who proposed that the school’s 300 professors and instructors give up 1 percent of their pay.

“What we are doing is a symbolic gesture that has real consequences — it can save a few jobs,” said William Flesch, the senate chairman and an English professor.

He says more than 30 percent have volunteered for the pay cut, which could save at least $100,000 and prevent layoffs for at least several employees. “It’s not painless, but it is relatively painless and it could help some people,” he said....

At some companies, employees are supporting the indirect wage cuts — at least for now. The downturn hit so hard, with its toll felt so widely through hits on pensions and 401(k) retirement plans and with the future so murky, that employers and even some employees say it is better to accept minor cuts than risk more draconian steps.

The rolls of companies nipping at labor costs with measures less drastic than wholesale layoffs include Dell (extended unpaid holiday), Cisco (four-day year-end shutdown), Motorola (salary cuts), Nevada casinos (four-day workweek), Honda (voluntary unpaid vacation time) and The Seattle Times (plans to save $1 million with a week of unpaid furlough for 500 workers). There are also many midsize and small companies trying such tactics.

To be sure, these efforts are far less widespread than layoffs, and outright pay cuts still appear to be rare. Over all, the average hourly pay of rank-and-file workers — who make up about four-fifths of the work force — rose 3.7 percent from November 2007 to last month, according to the latest Labor Department data.


The magnanimous feeling will probably pass, said Truman Bewley, an economics professor at Yale University who has studied what happens to wages during a recession. If the sacrifices look as though they are going to continue for many months, he said, some workers will grow frustrated, want their full compensation back and may well prefer a layoff that creates a new permanence.

“These are feel-good, temporary measures,” he said.
Update (12/31): Washington Post columnist Steven Pearlstein ponders the merits of sharing the pain through wage cuts.

Wednesday, December 17, 2008

The Cookie Also Un-Crumbles

I already got what I wanted for Christmas:
Lance, Inc. (Nasdaq: LNCE) today announced that the U.S. Bankruptcy Court for the District of Delaware has approved Lance's bid to purchase substantially all of the assets of snack food company Archway Cookies LLC ("Archway"). Under the terms of the Asset Purchase Agreement, Lance will acquire substantially all of the assets of Archway for approximately $30 million. The transaction is expected to close no later than December 15, 2008. Lance will use available liquidity under its current credit facilities to fund the acquisition.

"We're excited about this acquisition," commented David V. Singer, President and Chief Executive Officer of Lance, Inc. "Archway was founded in the 1930s, and has built solid market share in its niche of soft, home-style cookies. Archway is an excellent addition to our growing portfolio of consumer preferred niche brands. We are looking forward to reopening the Ashland, Ohio production facility, where we intend to produce Archway cookies. This facility will also provide the capacity to support growth in our existing business and capabilities that will broaden the products we can offer our Private Brands customers, thus supporting our growth goals for our non-branded business."

Thanks, Santa! U.S. Bankruptcy Court for the District of Delaware!

Saturday, December 13, 2008

The Serious Badness of the 1980's

Macroblog has kindly answered some comments about their comparison of the current recession with past episodes. In response to a comment I left, "considering the 1981-82 recession by itself, rather than in combination with its 1980 little brother, somewhat understates the 'badness' of that period," they say:
The 81–82 recession graphs include data from 12 months before the first day of the recession to 12 months after the last day of the recession, therefore the dates range from 7/1/1980 to 11/1/1983. The 1980 recession ended in July of 1980, so these time periods overlap each other by one month. Including this month does not “understate the ‘badness’ of the period” because the calculations are based solely on the recessionary period being examined. In other words, the time span has no effect in this case. The first day of the recession is set to one. The months before and after are normalized to the first day of the recession. If we were to remove the 1980 recession date and run the time span 10 months before the 1981 recession to 10 months after, the graph does not change in anyway apart from a shorter time span. This is because the data is scaled to 7/1/1981, the beginning of the recession.
That is correct, but it misses the point I was trying to make (so perhaps I didn't make it very clearly). What I was trying to say is: the two recessions, together, represent a very long period of elevated unemployment. There wasn't much "recovery" from the 1980 recession before the 1981-82 recession began. The unemployment rate was 6.0% in December 1979; it peaked at 7.8% in July 1980, before falling to 7.2% at the end of that year. In mid-1981 it began a new climb all the way to 10.8% at the end of 1982. The unemployment rate fell to 7.2% in 1984 (Morning in America*), but didn't make it all the way back down to 6% until August 1987!

I've plotted the BLS nonfarm payroll employment series around the NBER business cycle peak dates of November 1973, January 1980, July 1981 and December 2007. The yellow line illustrates what I was trying to say... in 1980, America was at the precipice of some hard times. Now that the NBER has made its call, we know that we are 12 months out from the last peak. I'd like to hope that our position is more like July 1982 than January 1981 (i.e., I'd rather be at 12 on the green line than the yellow one).

Of course, in the 1980's, we took a certain pride in being "Bad."

*By the unemployment rate, in 1984, people were better off than they were four years ago, but not five.

Saturday, December 6, 2008

Don't Call it a Comeback

The Times reports on Larry "The Harvard Lighning Rod" Summers' "Path to Renewal." Will he be the Oscar Madison in a White House of Felix Ungers?
The two men, who have forged their relationship in the tumult of the financial crisis, share a lot: Harvard, a love of debate, and firm convictions, like agreement on the need to narrow the gap between America’s most fortunate and everyone else. But they are also an odd couple: the serene, slender politician who seems to win people over effortlessly and the impatient, acerbic bear of a man who seems to offend them just as easily.

“Barack thinks with his mind open,” said Charles Ogletree, a law professor at Harvard. “Larry thinks with his mouth open.”

Friday, December 5, 2008

The Recession: "Mild" Down and "Bad" to Go?

At Macroblog, David Altig does wholesale what I've been doing piecemeal in several recent posts, comparing the current downturn with past recessions. He plots the recent movements in employment relative to both the "mild" recessions of 1991-92 and 2001 and the "bad" recessions of 1973-75 and 1981-82. Where we are still looks like a mild recession, but where we appear to be going looks like a bad one. The graphs are a good reminder of just how bad the bad ones were... we've still got a way to go before we get there. (Also, I think considering the 81-82 recession in isolation, rather than in combination with the 1980 recession somewhat understates the "badness" of that episode).

Update (12/6): See also the Times' recession comparison charts which predate the latest employment numbers (as Dean Baker rightly notes, the comparison of housing prices is somewhat deceptive since it is not adjusted for inflation).

Specter of '74

The November employment report from the BLS was not good. The unemployment rate is up to 6.7% (which is still lower than in most previous recessions). The Times reports:
The nation’s employers shed 533,000 jobs in November, the 11th consecutive monthly decline, the Bureau of Labor Statistics reported Friday. Not since December 1974, toward the end of a severe recession, have so many jobs disappeared in a single month, and the current recession appears to be just gathering steam.
Of course, the labor force is much bigger now than in 1974, so in percentage terms, the decline is considerably smaller. The November decrease was 0.4%; December 1974 was an 0.8% decrease, and there were declines of 0.5% in November 1974 and January and February 1975, as well as May 1980. There were also 0.4% decreases in March 1975, June 1980, and January and July 1982. Overall, the 1973-75 and 1980/81-82 recessions featured several months with decreases in employment comparable to or larger than November 2008. However, as David Leonhardt notes, the rise in the unemployment rate was made smaller by a large decrease in the labor force, which suggests that some people are giving up on finding a job. The labor force participation rate fell by 0.3 percentage points to 65.8%.

I see the FRED folks have added a shaded area...

Who is Beggar-ing Whose Neighbors?

The FT's Martin Wolf has an interesting column about global imbalances and the economic slump. He calls on the surplus countries to take responsibility for increasing global demand:

In normal times, current account surpluses of countries that are either structurally mercantilist – that is, have a chronic excess of output over spending, like Germany and Japan – or follow mercantilist policies – that is, keep exchange rates down through huge foreign currency intervention, like China – are even useful. In a crisis of deficient demand, however, they are dangerously contractionary.

Countries with large external surpluses import demand from the rest of the world. In a deep recession, this is a “beggar-my-neighbour” policy. It makes impossible the necessary combination of global rebalancing with sustained aggregate demand. John Maynard Keynes argued just this when negotiating the post-second world war order.

In short, if the world economy is to get through this crisis in reasonable shape, creditworthy surplus countries must expand domestic demand relative to potential output. How they achieve this outcome is up to them. But only in this way can the deficit countries realistically hope to avoid spending themselves into bankruptcy.

Some argue that an attempt by countries with external deficits to promote export-led growth, via exchange-rate depreciation, is a beggar-my-neighbour policy. This is the reverse of the truth. It is a policy aimed at returning to balance. The beggar-my-neighbour policy is for countries with huge external surpluses to allow a collapse in domestic demand. They are then exporting unemployment. If the countries with massive surpluses allow this to occur they cannot be surprised if deficit countries even resort to protectionist measures.

(For a similar argument by Michael Pettis, see this earlier post).

Dani Rodrik has a related worry, that America's propensity to import reduces the effectiveness of any stimulus because a significant portion of the spending will be on imported goods. That is, the marginal propensity to import reduces the simple spending multiplier (which he guestimates at 1.8):

Now suppose that we had a way to raise the multiplier by more than half, from 1.8 to 2.8. The same fiscal stimulus would now produce an increase in GDP of $2.8 trillion--quite a difference. Nice deal if you can get it.

In fact you can. It is pretty easy to increase the multiplier; just raise import tariffs by enough so that the marginal propensity to import out of income is reduced substantially (to zero if you want the multiplier to go all the way to 2.8). Yes, yes, import protection is inefficient and not a very neighborly thing to do--but should we really care if the alternative is significantly lower growth and higher unemployment? More to the point, will Obama and his advisers care?

Being the open economy that it is, I fear that the U.S. will have to confront this dilemma sooner or later. In an environment where the dollar has already appreciated against the Euro and even more significantly against emerging market currencies, fiscal stimulus here will produce an even larger current account deficit. If American consumers decide to spend 40 cents of a dollar of additional income on cheap imports from China and other foreign countries, the multiplier will be a mere 1.3. How long will it take before politicians of all stripes cry foul over the leakage through the trade account and the "gift to foreigners" that this represents? And they will have Keynesian logic on their side.

One would hope that a decline in the Dollar - though not too abruptly, please - could be an adjustment mechanism (even if panic-induced demand for US Treasuries has moved the Dollar in the other direction lately) but Chinn and Wei's finding that flexible exchange rates do not facilitate current account adjustment suggests otherwise. That's counter-intuitive, but I guess I shouldn't be too surprised; some of my own work has studied another aspect of the "exchange rate disconnect" puzzle.

Monday, December 1, 2008

Living in the Shaded Area (Probably)

The NBER's Business Cycle Dating Committee says the "peak" in the business cycle occurred in December:
A recession is a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in production, employment, real income, and other indicators. A recession begins when the economy reaches a peak of activity and ends when the economy reaches its trough. Between trough and peak, the economy is in an expansion.

Because a recession is a broad contraction of the economy, not confined to one sector, the committee emphasizes economy-wide measures of economic activity. The committee believes that domestic production and employment are the primary conceptual measures of economic activity.

The committee views the payroll employment measure, which is based on a large survey of employers, as the most reliable comprehensive estimate of employment. This series reached a peak in December 2007 and has declined every month since then.

The committee believes that the two most reliable comprehensive estimates of aggregate domestic production are normally the quarterly estimate of real Gross Domestic Product and the quarterly estimate of real Gross Domestic Income, both produced by the Bureau of Economic Analysis. In concept, the two should be the same, because sales of products generate income for producers and workers equal to the value of the sales. However, because the measurement on the product and income sides proceeds somewhat independently, the two actual measures differ by a statistical discrepancy. The product-side estimates fell slightly in 2007Q4, rose slightly in 2008Q1, rose again in 2008Q2, and fell slightly in 2008Q3. The income-side estimates reached their peak in 2007Q3, fell slightly in 2007Q4 and 2008Q1, rose slightly in 2008Q2 to a level below its peak in 2007Q3, and fell again in 2008Q3. Thus, the currently available estimates of quarterly aggregate real domestic production do not speak clearly about the date of a peak in activity.

Other series considered by the committee—including real personal income less transfer payments, real manufacturing and wholesale-retail trade sales, industrial production, and employment estimates based on the household survey—all reached peaks between November 2007 and June 2008.

The committee determined that the decline in economic activity in 2008 met the standard for a recession, as set forth in the second paragraph of this document. All evidence other than the ambiguous movements of the quarterly product-side measure of domestic production confirmed that conclusion. Many of these indicators, including monthly data on the largest component of GDP, consumption, have declined sharply in recent months.

The last time around, payroll employment peaked at 132.53 million in Feb. 2001 and bottomed out at 129.84 million in June 2003; the NBER's peak was March 2001 and the trough was November 2001; but employment was very slow to rebound. This one may be worse - the industrial production index sure looks scary, doesn't it?

The announcement should at least put an end to the tedious "are we technically in a recession" arguments. But if we want to be pedantic (and, really, who doesn't?) we might note that we don't know that the trough hasn't already occurred. I sure don't think it has, but the turning points usually are only clear in retrospect. So it would be a little premature for the folks at FRED to put in another "shaded area."

Update: I've removed the sentence where I mixed up the 2001 and 1990-91 recessions (d'oh!).