- Email: [email protected]
Comment on the Donald Gordon paper
Comment Or! the Donald Gordon Paper E. S. Phelps Columbia University Professor Gordon has thought about "job rationing" and the corresponding "invohmtary unemployment" of workers - in tile everyday sense of the word "involuntary", unlike Keynes's sense for which a better term might be ~ "pathologicar' - as much as anyone, so this contribution by him is very welcome. The comment his paper deserves is at least half the length of the paper itself. I shall limit myself to a few renrarks about it. 1. As Gordon eventually concedes, his own quasi-contract notion entirely fits the search-type theory of unemployment. His untenured workers are certainly searching, desperately at times, and even his tenured workers may quit to search for better Iemlre. Gordon's model belongs to one of tw_._&otypes of search model. 2. In the first type of search model, wage rates are imagined to be market clearing at each factory gate. There is a local auction, at whatever discontinuous moments one or more new applicants turn up, for jobs a t that site in the spatial labor nrarket. Aside from the fact that this very postulate is consciously counterfactual, like many postulates we commonly make for the sake of argument and analysis, the resultiug model of this type suffers from the empirical implication that the quit rate is counter-cyclical when the fact is that the quit rate is procyclical, high during boom times. 1 I would not agree with Gordon, however, that it is "contradictory" of the search theory to postulate that workers believe in a long-run tendency toward a common, universal wage while hypothesizing that workers will seize the shortterm advantage of an above-market perceived wage when an employer is discovered who is short of labor and wants to enlarge his work force. A worse contradiction appearing in some models of disequilibrium search unemployment - I think here of the post-1970 work of R. E. Lucas - is that the commodity price level, by hypothesis a known variable each period, may serve as a good proxy for the average money-wage level prevailing in the economy at large; therefore, savvy workers should not be fooled into accepting commonplace jobs by unexpected commodity inflation. Yet too many mathema.tical economists are too easiiy traumatized every time they are struck by such a pseudo-contradiction. Walrasian llneidentally, this flaw in the Mottensen-type model of unemployment has long been noted. It is cited on page 10 of the volume, Microeconomie Foundations of Employment and Inflation Theory cited by Gordon
123
economics supposes a costless auctioneer and self-enforcing contracts in a world where labor is scarce and no resources are allocated to detect or deter cheating. But we do not reject Walras outright, we only try to improve on him. 3. In the second type of search model, there is an effort to explain why even in normal times many an unemployed worker encounters "not hiring" signs and why, in depression, those lucky enough to have kept their jobs lmve not had to accept real-wage cuts down to the point that would eliminate the queue at tile factory gate. Akerlof has reminded us of what every consumer economist knows, namely that people appraise quality by price when it comes to unfamiliar products. A mau who offers Iris services for peanuts will be supposed to be worth peanuts. Similarly, hiring an over-qualified worker for a low-run job may be uneconomical in view of tile greater believed risks of his quitting. The labor ecouomists remind us that a person's self-esteem aud resulting morale on the job are tied up with Iris perception of Iris relative wage and employment status. Hence replacing an expensive, proud worker by a cheap, hostile worker may be a false economy. What these observations reflect is tile point that the typical finn likes to employ persons who it knows (believes) to be reliable in carrying out the firm's business. Consequently, the firm is willing to pay a premium to those workers who enjoy the firm's confidence. This premium creates an excess demand for jobs by those unemployed persons who are not old hands or known quantities. Of course, if each firm knew the supply price of each worker at each moment, these premia would be individualized and sometimes of epsilon magnitude. Bnt the firm does not have that intimate a knowledge of its employees. And tile tasks to be performed may be so heterogeneous that the firm cannot employ tile law of large numbers to much use. If I may quote Microeconomic Foundations: "...it may be advantageous to the finn to pay its workers wage rates that frequently exceed the "bids" for those jobs by unemployed (or other) workers if the employer faces a stochastic supply of labor. When the employer is not sure, at each wage, how many workers, and which workers will seek and accept jobs, he may find it expected-present-value maximizing to reduce the risk of a loss of workers by paying wage rates that, most of tile time, are unnecessarily high for generating tile average employment level the firm would like to have." (p. 14) And in Inflation Policy and Unemployment Theory; "One reason we do not observe such nice determinations of the wage scale [tile example was Dutch auctions of secretarial positiousl is that the employer faces a stochastically fluctuating supply of serviccs...As a consequence the employer is not sure, at each wage, how many workers and which workers
124
will quit tomorrow and how many unemployed workers in the various (job) categories will seek and accept jobs at the firm. To reduce tile risk of losing critical workers through occasional undersetting of wage scales, the firm may be willing ill normal times to pay wage rates in tile various categories that are, intermittently and perhaps most of the time, nnnecessarily high for generating the average employment levels that the firm likes to have ..... At the same time, such a firm may very well lmve what it aptly calls job vacancies in a significant number of its job categories." (p. 18) That was where matters stood, or where I thought they stood, in the Spring of 1968 when I wrote the first passage and in the Spring of 1970 when I wrote its paraphrase. Whether the thought quoted above was uniquely my idea, or was everyone's idea, I cannot say. But the irony is that I got the idea from reading the Gordon/Hynes paper in Microeconomic Foundations. It is a little disconcerting, then, for me to read in Gordon's paper the suggestion that we lack a search model of unemployment and disequilibrium having the real-life features of job rationiug and everyday "involuntary" nuemployment. I had thought we lind the rudiments of such a model and that the theory was one in which he played a seminal part. 4. The aforementioned theory of job rationing appealed to the incentive of employers to pay the price of a higher relative wage in return f o r greater stability in file supply of dependable labor services. Tile new theory offered by Gordon, and developed simultaneously by Martin Baily the Younger, is that the workers are willing to pay the price of a lower relative wage in return for greater stability in the demand for their labor services. In the old theory, it was implicitly supposed that firms needed to pay a wage premium to existing workers in order to obtain the extra stability of their work forces. In the new theory, the point is that the firms may need only to give assurances, and demonstrate their willingness to abide by those assurances, that the tenured workers will be able to enjoy a pecuniary premium over the labor services supplied by temporaries. The new theory thus enriches the old theory. Its novel element is tile postulate that firms have less risk aversion than workers, owing to the greater imperfectness of the market for "human" as against non-human capital goods. I think it should be said that job rationing is by itself not an explanation of the lnomentary Phillips Curve and the associated proposition that the onset of a deficiency in aggregate demand tends, at least temporarily, to produce a recession with decreased enllfloyment. The essence of that story is not rigidity of anyone's real wage or anyone's wage relative to the known average wage paid elsewhere. The essence of the story involves ignorance of what wages elsewhere are and how they are drifting. If labor-market information about wage rates of each sort were 125
costless, one could have "quasi-contract job rationing and employment stability" andhave at the same time a vertical momentary Phillips Curve, all prices and money wages adjusting illstantaneously to fluctuations of aggregate demand. What Gordon and others have in mind when they talk about quasi-contracts for labor expressed in terms of real wages or else relative wages is projections or estimates of these ratios which tend to be so sluggish as to produce a certain amount of money wage stickiness. 5. Is it socially desirable - Pareto optimal or Bergson optimal - that the labor market should respond to uncertainty with the devices of job rationing and quasi-contracts? R. E. Hall has argued that job rationing and wage premia artificially stimulate an excess of search unemployment in stochastic general equilibriunl. In Inflation Policy it is argued that job rationing may create queues and congestion phenomena which drive a wedge between private and social returns to quitting and searching. Gordon evidently argues that labor markets leave room for improvement. He envisions a role for controls on relative wages of some sort. We ought to think more about the welfare-economics side of labor markets to insure that positive-theorizing on this stlbject stays on useful tracks.
126
123
economics supposes a costless auctioneer and self-enforcing contracts in a world where labor is scarce and no resources are allocated to detect or deter cheating. But we do not reject Walras outright, we only try to improve on him. 3. In the second type of search model, there is an effort to explain why even in normal times many an unemployed worker encounters "not hiring" signs and why, in depression, those lucky enough to have kept their jobs lmve not had to accept real-wage cuts down to the point that would eliminate the queue at tile factory gate. Akerlof has reminded us of what every consumer economist knows, namely that people appraise quality by price when it comes to unfamiliar products. A mau who offers Iris services for peanuts will be supposed to be worth peanuts. Similarly, hiring an over-qualified worker for a low-run job may be uneconomical in view of tile greater believed risks of his quitting. The labor ecouomists remind us that a person's self-esteem aud resulting morale on the job are tied up with Iris perception of Iris relative wage and employment status. Hence replacing an expensive, proud worker by a cheap, hostile worker may be a false economy. What these observations reflect is tile point that the typical finn likes to employ persons who it knows (believes) to be reliable in carrying out the firm's business. Consequently, the firm is willing to pay a premium to those workers who enjoy the firm's confidence. This premium creates an excess demand for jobs by those unemployed persons who are not old hands or known quantities. Of course, if each firm knew the supply price of each worker at each moment, these premia would be individualized and sometimes of epsilon magnitude. Bnt the firm does not have that intimate a knowledge of its employees. And tile tasks to be performed may be so heterogeneous that the firm cannot employ tile law of large numbers to much use. If I may quote Microeconomic Foundations: "...it may be advantageous to the finn to pay its workers wage rates that frequently exceed the "bids" for those jobs by unemployed (or other) workers if the employer faces a stochastic supply of labor. When the employer is not sure, at each wage, how many workers, and which workers will seek and accept jobs, he may find it expected-present-value maximizing to reduce the risk of a loss of workers by paying wage rates that, most of tile time, are unnecessarily high for generating tile average employment level the firm would like to have." (p. 14) And in Inflation Policy and Unemployment Theory; "One reason we do not observe such nice determinations of the wage scale [tile example was Dutch auctions of secretarial positiousl is that the employer faces a stochastically fluctuating supply of serviccs...As a consequence the employer is not sure, at each wage, how many workers and which workers
124
will quit tomorrow and how many unemployed workers in the various (job) categories will seek and accept jobs at the firm. To reduce tile risk of losing critical workers through occasional undersetting of wage scales, the firm may be willing ill normal times to pay wage rates in tile various categories that are, intermittently and perhaps most of the time, nnnecessarily high for generating the average employment levels that the firm likes to have ..... At the same time, such a firm may very well lmve what it aptly calls job vacancies in a significant number of its job categories." (p. 18) That was where matters stood, or where I thought they stood, in the Spring of 1968 when I wrote the first passage and in the Spring of 1970 when I wrote its paraphrase. Whether the thought quoted above was uniquely my idea, or was everyone's idea, I cannot say. But the irony is that I got the idea from reading the Gordon/Hynes paper in Microeconomic Foundations. It is a little disconcerting, then, for me to read in Gordon's paper the suggestion that we lack a search model of unemployment and disequilibrium having the real-life features of job rationiug and everyday "involuntary" nuemployment. I had thought we lind the rudiments of such a model and that the theory was one in which he played a seminal part. 4. The aforementioned theory of job rationing appealed to the incentive of employers to pay the price of a higher relative wage in return f o r greater stability in file supply of dependable labor services. Tile new theory offered by Gordon, and developed simultaneously by Martin Baily the Younger, is that the workers are willing to pay the price of a lower relative wage in return for greater stability in the demand for their labor services. In the old theory, it was implicitly supposed that firms needed to pay a wage premium to existing workers in order to obtain the extra stability of their work forces. In the new theory, the point is that the firms may need only to give assurances, and demonstrate their willingness to abide by those assurances, that the tenured workers will be able to enjoy a pecuniary premium over the labor services supplied by temporaries. The new theory thus enriches the old theory. Its novel element is tile postulate that firms have less risk aversion than workers, owing to the greater imperfectness of the market for "human" as against non-human capital goods. I think it should be said that job rationing is by itself not an explanation of the lnomentary Phillips Curve and the associated proposition that the onset of a deficiency in aggregate demand tends, at least temporarily, to produce a recession with decreased enllfloyment. The essence of that story is not rigidity of anyone's real wage or anyone's wage relative to the known average wage paid elsewhere. The essence of the story involves ignorance of what wages elsewhere are and how they are drifting. If labor-market information about wage rates of each sort were 125
costless, one could have "quasi-contract job rationing and employment stability" andhave at the same time a vertical momentary Phillips Curve, all prices and money wages adjusting illstantaneously to fluctuations of aggregate demand. What Gordon and others have in mind when they talk about quasi-contracts for labor expressed in terms of real wages or else relative wages is projections or estimates of these ratios which tend to be so sluggish as to produce a certain amount of money wage stickiness. 5. Is it socially desirable - Pareto optimal or Bergson optimal - that the labor market should respond to uncertainty with the devices of job rationing and quasi-contracts? R. E. Hall has argued that job rationing and wage premia artificially stimulate an excess of search unemployment in stochastic general equilibriunl. In Inflation Policy it is argued that job rationing may create queues and congestion phenomena which drive a wedge between private and social returns to quitting and searching. Gordon evidently argues that labor markets leave room for improvement. He envisions a role for controls on relative wages of some sort. We ought to think more about the welfare-economics side of labor markets to insure that positive-theorizing on this stlbject stays on useful tracks.
126