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"In a recession, a bigger increase in unemployment rates for lower quality workers is exactly what we would expect from sticky wages. It's an observation that confirms the theory of sticky wages."

Except for the circular reasoning, that is spot on! ;)

Sorry, that's not the only problem. There is also the assumption that quality is one-dimensional. :)

Nick, it is exactly what I see around me.

I'm not quite sure what you mean by "quality in the eyes of potential employers". One's ability to market oneself is not necessarily the same as one's ability to perform the necessary tasks effectively.

Min, Leo: "quality" is whatever it is that causes employers to prefer to hire you, rather than the next person in line, and be willing to pay you higher wages, if that's what it takes to hire you. "Quality" is whatever it is that is reflected in the equilibrium wage distribution. If marketing skills is what gets you the job and higher wages, then that's what it is.

Simplicity in theories is a virtue, not a vice.

All theories are false; there is only theory.

What circularity? I start with some assumptions, derive some conclusions, those conclusions match what we see.

Luis: where? Spain? Unemployment in Spain has always been very high, a legacy of General Franco's "pro-labour" laws, right? Doubly ironic. "Pro-labour" laws, by a fascist, that harm labour. (I drove across Spain in 1973, when he was still in power; I haven't had the chance to visit since; no doubt it has changed much.)

Thinking of which: can this sort of theory also explain why lower quality workers always tend to have higher unemployment rates? Yes, I think so. Even if the labour market on average is in equilibrium, there are always relative declines in labour demand in some sectors and regions, and so excess supplies of workers to some firms, which will hire the highest quality workers first.

Canadian economist Dick Lipsey had an early theory of the Phillips curve along these lines. His mistake (as he acknowledged a little later) was to fail to distinguish real from nominal wages. Add in that distinction, and you easily get a theory of the natural rate from his theory. It would imply that lower quality workers would tend to have a higher natural rate of unemployment.

Nick Rowe: "What circularity? I start with some assumptions, derive some conclusions, those conclusions match what we see."

What you see is that lower quality workers remain unemployed. How do you know that they are lower quality workers? The fact that they remain unemployed. There is the circularity.

Nick: "quality" is whatever it is that causes employers to prefer to hire you, rather than the next person in line, and be willing to pay you higher wages, if that's what it takes to hire you."

Given that definition of quality, let's rewrite your conclusion:

In a recession, a bigger increase in unemployment rates for **workers whom employers do not prefer to hire** is exactly what we would expect from sticky wages. It's an observation that confirms the theory of sticky wages.

I think Min's got you dead to rights, Nick. And I would add that what you see often depends heavily on what you have already made up your mind you are going to see.

Now "Quality" in real life is a word with a commonly accepted meaning, which one can even look up on the internet. And that meaning is NOT "what employers like". If you are willing to redefine words you can "prove" anything you want. But calling a tail a leg doesn't make it into a leg, remember?


Yes Nick, we have changed a lot, except in labor market. I would say we have wosened. Reason? Unions & left governments. In Spain is dificult to change so ingrained misconceptions. And the last reform jus been passed is no panacea.
So, what I said before is that my relatives with a good "quality in the eyes of potential employers"(exactly: I applaud this expresion; it´s very accurated)have had no problem to work, in spite of a 20% of unemployment rate.

Oh Nick, you've rather messed up with your response to Min. What you wanted to say, provided it's true, is something like "based on observable measures of quality, like education and pay in last job, it appears to be confirmed in the data that lower quality workers do spend longer durations unemployed".

Adam: Yep. It was late (for me), on a Saturday night.

What you have is very close to what I think it should be. What about "based on observable measures of *what we might plausibly believe employers perceive as* quality, like education and pay in last job, it appears to be confirmed in the data that lower quality workers do spend longer durations unemployed"?

Because there is always the possibility that, for example, employers believe a PhD is lower quality than an MA, which is lower quality than a BA, etc.. Or even that pay in last job, which would have reflected perceived quality in the past, may inversely reflect perceived quality today. Which would reverse the observable predictions of the theory. Possible, but implausible.

All hypotheses require subsidiary hypotheses before they can be tested. In this case, the subsidiary hypothesis is that observable things like education, and pay in last job, are correlated with current quality as perceived by employers. I find that subsidiary hypothesis very plausible.

Popper, Kuhn, etc., when we test a theory we are nearly always testing a joint hypothesis: the theory itself, plus the subsidiary hypothesis that observable phenomenon are indeed good indices of the theoretical concepts in the model. And we can always save a theory from falsification by reversing one of those subsidiary hypotheses. "What Stascan calls 'consumption' is in fact inversely related to 'true' consumption".

Yep, if you believe that education and pay in last job is inversely related to quality as perceived by employers, then observing lower unemployment rates among the educated and those with higher pay in last job would falsify this theory of unemployment rate differentials.

I think there is a distinction (actually probably more than just 1) that needs to made between private and public sector employment

(1) In the public sector (or union sector) quality has no definition, there is only seniority and broadly defined skills that are recognized. Ontario Teachers, for example, who have no university degree (they still exist btw) have, by nature of the timing of their OCT certification, higher salaries and job security than their more educated, more highly motivated, younger counterparts today provided they are willing to complete additional qualifications that have a 100% pass rate (apparently everyone is of the same quality and you get better as you age). There is a direct counter example to your theory.

(2) In the private sector, which is dominated by consumption and service, there is little use for quality (more educated or skilled) workers because the distinction in "quality" skills is minimal across the spectrum of "quality" workers due to the vocational nature of what is involved in their jobs i.e. learning how to write a 2 week schedule is something that everyone is capable of... with or without a high measure of "quality". This argument goes for engineers, most of which spend days reading computer printouts and resetting machines, managers, who write schedules and deposit money, and most other jobs you can think of. As jobs become more vocational "quality" of employees has dropped across the board and the surplus of "qualified" individuals to fill jobs has made it possible to reduce salaries.

If this is the case recessions give excuses for companies to reduce wages and "stick prices lower".... the same is never true in the reverse because their is no real need for "quality workers"..... this is a policy issue for federal governments as we move away from production and manufacturing and the need for new research and development of the sciences where "quality" is most appreciated.

I would argue that employers are always trying to reduce wages for all workers regardless of "quality"; during recessions economists get a chance to redefine "quality" to suit there supply side bias and it happens all the time.

Theory from a non-economist:
Of course, in the case of either lower wages OR unemployment, we create a reinforcing and recursive drop in aggregate demand (which then leads to still lower wages or employment) until the capital efficiency of production (fixed costs are fixed) at the lower level of capacity utilization falls to a new equilibrium (offset by the increased level of labor productivity due to lower wages or higher average quality workers, and by reduced variable costs as production declines), where production and demand match. This assumes a fixed level of real debt service, if debt is also contracting (absent default) the new equilibrium will be lower still. Default or lower interest rates reduce debt service and allow a higher equilibrium. In the absence of sufficient quantities of one or the other, the gavernment must act to increase aggregate demand.

The level of consumer spending as a fraction of the economy will determine (among other factors) how much contraction in aggregate demand will result from layoffs or reduced wages. An economy with a higher rate of savings, and broader portion of the populace with a significant net worth (a middle class) will have reduced sensitivity to downturns, since less aggregate demand contraction will occur. If consumer spending prior to the downturn is credit dependent (due to a low savings rate) and credit contracts, the aggregate demand contraction will be further exacerbated.

Long story short: Commercial leverage means higher booms, and deeper busts. Lower relative levels of income and net worth for the bottom 95% mean deeper busts. Higher levels of consumption and lower levels of savings mean deeper busts.

What the government can do to increase aggregate demand without taking on additional debt (they should but that's another story):
Reduce interest rates on mortgages and consumer debt. Immediately cap all existing mortgage debt and outstanding consumer debt at 6% until the Fed rate is raised above the zero bound. Allow cramdown in bankruptcy. Repeal the 2005 bankruptcy "reform." Cap ATM fees and credit card fees at 112% of actual cost.

Rick,

I think you understate the significance of quality in the service sector. In fact, you're dead wrong.

Take the legal profession, about which I know something. There are significant differences in the quality of lawyers out there, notwithstanding that they all have, more or less, the same formal qualifications. If you're a creditor in a multi-billion dollar bankruptcy, you're probably not going to hire Jimmy the Grunt to represent you, you're going to hire a lawyer at one of the Bay Street law firms (and believe me, there is an appreciable different in quality between the people who work there and the Jimmy the Grunts of the world - which differences are reflected in their billing rates). Similarly, if you're charged with murder, you're not going to rely on the dude trolling for clients in bail court, you're going to hire Clay Ruby or Eddie Greenspan or one of the heavy hitters of the criminal bar (always assuming you can afford them).

Now, maybe this is unique to the legal profession and quality doesn't matter in any other sector of the economy, but I have trouble believing that. Everyone, for example, has experienced good waiters and bad waiters. With the former, you're served promptly, any problems are addressed quickly, questions are answered and you leave with a smile on your face (and tip them handsomely). With the latter, they take forever to take your order, are surly or rude when you ask questions, they mess up your order and blame you, and as often as not you leave vowing never to come back again. Now you say the distinction in skills is minimal, and one level you're right. Both waiters have the skills to deliver food to customers. But clearly the "good" waiter is far better at being a waiter than the "bad" one. There is a meaningful different in quality between the two and a difference which is likely to be valued by a successful restauranteur.

And that's true in a lot of different areas in the economy. Go work for a telemarking company and watch how they try to retain that "good" employees (i.e., the ones who are successful at selling junk to gullible consumers), while getting rid of the "bad" employees (people who are bad salespersons or who just have a conscience). Go work in sales, where compensation is typically tied to "quality" (in the form of commissions), and tell me that there aren't quality differences between employees that are appreciable to employers. When times get tough, and businesses start cutting back on staff, they know, with some degree of accuracy who the "quality" employees are and they're the ones who are kept on, at least to the extent possible for that reason.

Well Bob, if you know something about the legal profession you know that most creditors (banks) are institutional clients of bay street firms because of size, not quality.... and if you think that Jimmy the Grunt isn't working on your file anyway with a name tag that says articling student--you're crazy...actually the legal profession illustrates my point perfectly.

If you are a "quality" FSE lawyer, which is a specialization that didn't necessarily exist 60 years ago, you have no choice but to work for a Bay street firm as an associate who does the grunt work for the partners who bring in the business. You work longer hours and get paid less without ever getting the opportunity to meet the clients face to face. You cannot compete on your own regardless of your "quality" which is not marketed by skills, its maketed by brand name.

Further FSE does great during recessions so its a poor example, but if there were an issue, who would go first? The partner who makes $500,000 and hasn't done any research in 7 or 8 years or 5 bright young "quality" first year associates making $100,000 each? You're kidding yourself if you don't think the 5 1st year associates will be replaced by articling students and if the downturn was severe enough their workload eventually outsourced the research to India.....

And as for Waiters, there are just as many bad waiters as good waiters, independent of recessions. But that isn't even the point most restaurants are franchises and the waiter is just rehearsing lines that are standard to the franchise. The whole idea behind the model is that you get the same service regardless of the person, there is no idividual "quality" to speak of, just the "quality" of the brand. That's why servers get paid less than minimum wage and you still pay $14.95 for a Caesar salad....

Direct sales is different, but show me a telemarketer and that makes 6 figures and I'll sign you up for a show in Vegas :)

Rick: "I would argue that employers are always trying to reduce wages for all workers regardless of "quality"; during recessions economists get a chance to redefine "quality" to suit there supply side bias and it happens all the time."

Sure. Buyers are always trying to get the lowest price they can, given quality of the goods they buy (as they perceive it). Or the highest quality they can, given the price. And sellers are always trying to get the highest price they can, given the cost of producing extra quality. Or trying to sell the cheapest quality they can, given the price. And if prices are flexible, and there's many buyers and sellers, supply and demand take those competing desires and determine equilibrium prices, quantities, and qualities.

And if demand falls, and price can't fall (for whatever reason), then quantity will fall, and quality will rise for any given price.

What sort of "quality" is it that you think employers are looking for? Do you think that "low-quality" workers (as you think employers define quality) suffer worse increases in unemployment during a recession?

Damn! I'm having difficulties commenting!?

Rick,

Saying that bay street firms hire "grunts" in the form of articling students misses the point and therefore quality doesn't matter. That's like saying that scoring ability doesn't matter to hockey players because teams hire people who don't score a lot of goals. Firms, like hockey teams, hire different people (at different levels of seniority and different prices) to fulfill different roles.

Nevertheless, within each role, quality matters. There is an enormous difference, for example, between a real estate practioner working in suburban Toronto and a real estate practioner working at a bay street law firm. Heck, there's even an appreciable difference, in general (though there are always exceptions) between articling students working in bay street law firms and those working in less prominent firms (which differences are reflected in price tags).

Moreover, your understanding of how Bay street law firms work is really a caricature of reality. Granted, "face time" with firm clients varies from firm to firm (though, in general, its far greater at Canadian firms than in the US), but even a young lawyer who never speaks to a client, still has "clients" of his own, namely the senior lawyers who he or she work for. And if you think "quality" is either unnoticeable or unimportant to them, you're kidding yourself - they're the ones on the hook if that lawyer screws up, and they're the ones who have to explain his or her bills to their clients ("it took you X hours to do THAT?") or else write them off.


And yes, during the reccession lots of young lawyers got fired (in part beacuse it's a lot easier to fire employees than to cut partners - though in point of fact, a number of firms thinned the herd with partners as well), but doesn't mean that quality doesn't matter. Quite the contrary, if you look at the lawyers who were cut first, invariably they were the ones who firms identified as being "lower" quality.

As for waiters, nothing you said undermines my point that quality matters. That a restaurant is a franchise or not is really not here or there. We've all experienced good waiters at franchised restaurants and we've experienced bad ones. If anything, you might think that quality matters more at a franchised restaurant, since the franchisor has an incentive to protect their brand - a bad experience at one restaurant might make you unwilling to go to other restaurants in that chain.

Finally, I can think of all sorts of people in sales who make 6 figure salaries - real estate agents, stock brokers, investment bankers, car salesman (though probably not recently). In any event, how much they make isn't at issue, the question is whether quality matters - clearly it does.

Lets face it, for some jobs people are fungible. Anyone with a couple of days of training can do it. The employers want credentials just to reduce the size of the resume pile.

Other jobs definitely need quality people, I'm thinking of lawyers, surgeons, nuclear engineers, software developers. That's why you see some software developers making $100/hr and some making $50/hr. I these type of "creative" as opposed to manual jobs, quality is observable and employers have to pay the price. Sometimes they get away with paying less for quality people if the seller of the service is unaware of the going rate or unaware of their true value.

Bob: I asked you to show me a telemarketer making 6 figures; of course sales people have the ability to do well, so long as they are the ones that have the ability to broker their own deals. And in your examples, those salesmen work solely on commission so their jobs are secure during a recession, its their paycheck that is not - remember we are talking about who will be cut by firms, not those who suffer wage cuts.

If you were to say that "clearly quality matters" in waiters, and only quality waiters are kept during a recession you would expect to get better service in a recession than during a period of growth. I would be interested to take a quick survey, but I suspect there would be no reported difference in service "quality" over the last 4 years, but since it is impossible to verify lets leave it as agreeing to disagree; however, next time your out on a date and you get bad service I better not hear you complain because according to you wait service is only going to get worse as we start to recover :)

But as for comparing law firms hiring articling students to NHL teams drafting players...that makes you sound crazy when you compare things that are so obviously not related to illustrate a point.

The NHL has an entry draft where players rights are drafted by teams independent of market share. Their salaries are dependent on draft position, which is evaluated on performance against other players in the draft (Taylor Hall was drafted first because he outperformed all the other players in the draft through actual head to head competition). Teams fight over players because the teams need the players to get better, better players = better teams = more fans.

On Bay street there is no draft, the larger firms have large enough market share that smaller firms are unable to compete against head to head, so "players" i.e. articling students have no choice but to fight to get hired at Bay Street firms because even if small firms get the best players, those players are not able to solicit the same institutional clients and make the firm stronger, this means that the smaller firms do not have the incentive to pay the premier lawyers, because the premier lawyers have no ability to increase their market share (so if your comparing the Edmonton Oilers to a smaller boutique law firm, that firm could draft Taylor Hall, but they couldn't pay him what he's worth, the larger firms know this, so rather than pay him the salary he deserves they can get away with paying him just above what the smaller firm could offer).

Their salaries are not decided by performance in that case, they are decided by what that firm wants to offer, knowing full well that they have leverage because the articling student has few other options to work at a comparable salary. Further, the key distinction between newly drafted NHL players and articling students is that while the NHL can objectively determine quality, articling students are hired based on highly subjective criteria. They never compete against each other and have no accumulated stats other that GPA, which I'm sure is very comparable on the B curve from University to University. So where does the broad difference in "quality" come from? Perhaps capriciously to fit whatever argument a supply side advocate has chosen to put forth - hardly an academic endeavour.

And not to be confrontational, but adopting the talking point that young lawyers have clients, just not "real" clients, or that somehow partners are "real" clients, is analogous to saying that a secretary to an agent is actually an agent because the agent is a client of the secretary. It might make it easier to get her to do your laundry, or lie to your wife, but its certainly not going to make you want to give her a portion of the commission or put her name on the business cards. And if she ever questions the structure, regardless of how good she is at being an "agent" or rather a secretary - depending on how you look at it - it's not going to stop you from replacing her with someone who is a little more gullible, a little more cute, and willing to work for less. Just call it what it is, exercising a power imbalance, don't call it economic fundamentals.

Nick:
I know your argument, its the rhetoric that gets preached in the context of this discussion. Theoretically supply and demand meet at an appropriate price, it's a seemingly sound argument. But the problem is that although sellers are trying to get the highest price for their service, there is such a huge imbalance in power, information, market share (whatever you want to call it - due to an effective monopoly), sellers, namely young people looking for jobs, will probably never get paid even close to what they would be worth if that imbalance didn't exist.

It's up to policymakers to ensure that things like a 20% youth unemployment rate for University graduates doesn't happen, it's up to policymakers to encourage new business development, it's up to policymakers to encourage development of new technologies and bottom up growth of the economy through effective corporate taxation and transfers. It's not appropriate for policymakers to encourage monopolistic practices that result in the opposite. And it's certainly not appropriate for economists as esteemed as you to give them excuses like unemployed people are somehow of less quality than employed people, so as to justify policymakers inaction as being natural, rather than being a policy choice itself.

I would argue that for every unemployed worker (maybe not every, but many) there is another employed worker with a skill set that is indistinguishable. Further, for every unemployed worker there is an employed worker with an indistinguishable skill set who is doing the same job for less wage than the unemployed workers previous salary, and more importantly, there is someone else in that same company that makes far more for doing far less...

Rick: Yep. All the power seems to be on the side of the buyer of labour, not the seller.

But when you follow that reasoning through to its conclusion, you get hit by a really weird contradiction with what we see around us.

1. If there are lots of small buyers and sellers, none has much power in the marketplace, and any power there is is roughly balanced, so you should be somewhere near the competitive equilibrium, where demand equals supply.

2. If there's a few big powerful sellers (monopoly), they would have the power to push prices above the competitive equilibrium, so supply is greater than demand.

3. If there's a few big powerful buyers (monopsony), they would have the power to push prices below the competitive equilibrium, so demand is greater than supply.

Of those 3 cases, which one best represents the typical labour market, in Canada say?

Case 3, you say, because the employers are normally bigger and more powerful than the individual workers. But then Case 2 looks better, because there's usually unemployment, so supply is usually greater than demand.

Something is very wrong with this story.

No Nick,

Actually what I'm saying is that through governmnet legislation, or through direct government spending or through government's fiscal policies, monopolistic firms- firms that may or may not have dominated market share naturally over time (I would guess though the later) are created, unnaturally, to handle the large scale of government "business" activity. The government has legislated competition (weak, but better than nothing) into the market place that prevents an out right monopoly on services, but not enough to prevent a collective, or residual labour monopsony for the firms that benefit from the "business" our government solicits. Nobody employed loses per se, but you get less people working (higher uneployment) at lower wages than you would expect with that level of unemployment...

I would actually like to get back to the bay street example because it illustrates the issue perfectly, I just don't have the time.... I may come back to this when my meeting is over.... if it ever ends...

I think you loose information by talking about *the* labour market. There really isn't one labour market because most labour isn't fungible. I suspect most labour markets are case 2 to a small degree - competent skilled labour is available, but not always easy to find. Some are case 3 (low skill labour), and a very few are case 1.

Rick: in a monopsonistic labour market, wages are low, and employment is low. But there is the exact opposite of unemployment, in the sense of an excess supply of labour, who want to work but can't find work at prevailing wages. On the contrary, since Wage is less than the Marginal Revenue Product of labour, firms are hungry for extra workers. The only reason they don't increase employment is because they know they would have to increase wages in order to persuade an additional worker to accept a job. It just doesn't fit the facts very well.

Patrick: yes, you are right. But I think the exceptions tend to prove the rule, first because labour shortages are so newsworthy they must be rare ("man bites dog"), and second because it is in those cases where bargaining power is weaker (except of course the threat to quit for a better job which I can find easily if you don't raise my wages).

Nick
I'm not using a textbook definition, and the only reason I used monopsony in the first place is to relate with your language in the hopes you could understand what I'm talking about.....? I guess it didn't work :(

Regardless, are you saying that in real life "Canada" we have low employment, but the opposite of unemployment? Firms are hungry for workers, but cannot afford to pay them? What are the facts? and where did they come from?

You lost me....

What I'm arguing is that firms are saturated with employees. Business is (in a dynamic way) still available, but is restricted to a certain number of large firms (call it inefficient distribution of resources), there is excess demand for goods and service, but a lack of supply in jobs and thus an effective demand shortage (not a real one). I believe this is because there are entry barriers, in the form of poor policy and legislation, that prevent smaller firms, or start ups, from getting into the market and competing. Those employees who would have run or contributed to those companies never get the chance; instead are forced (out of practicality) to strive for the best job available, not the one they would be best at, or the one that is best for the economy as a whole-that's summarized by the argument that the best minds did finance, not physics or engineering over the past decade because the incentives were skewed.

In this case "Quality" employees are prevented from utilizing their real quality in a competitive way. If those barriers were lifted, or smaller companies were given an opportunity to overcome those barriers, across all market sectors, you'd get more people employed. Average wage might not rise or fall, but entry wages would increase, incentives to take risks would rise as would employment. More firms making less money total (still enough to be worthwhile), but more people who run the firms would actually be working and producing; because they have to. That's what happens when it's the quality of their work that matters, not the size of their firm. Too many smart people are doing jobs that produce nothing, even the prestigious jobs have become vocational and the distinction in "quality" has become non-existent.

Rick: It worked. "Monopsony" is the right word, and it's close enough.

What I'm saying is that there's a genuine puzzle here. The imbalance of power in the labour market (one big employer, lots of little workers) seem to fit the assumptions of monopsony (not exactly, but close enough). But when we look at the predictions of monopsony, they don't fit the facts. Because monopsony predicts firms will be hungry for workers, while what we usually observe is that workers are hungry for jobs.

My solution to this puzzle is to reject the monopsony model. It doesn't seem to fit the facts. And to say that, despite appearances, the market power in the labour market must be tilted towards the workers. Why???!!!

Easy, when you think about it. It's very easy for a worker to split from a firm ("sorry, I quit, because another firm has given me a better offer"), but not so easy for a firm to split from a worker ("sorry, you're fired, because another worker has given me a better offer"). Think about the balance of power in marriage if men could easily divorce women, but women couldn't easily divorce men (or vice versa).

Nick.

Interesting, employers don't really have the ability to cut employees loose, at least without a financial penalty-even the least "quality" ones. Actually I never thought of it like that, at least in this context.

But on the flip side, most firms don't really care because they are big enough to be profitable no matter the "quality" of the employees that they have. They also retain a monopoly on services so the have the ability to hire a bunch of employees without distinguishing "quality" and count on 1 or 2 of them being good and making money for the firm, the others just can't lose them more money than the good ones make. So they continually undervalue new hires in sort of a resultant (not deliberate) statistical fashion; knowing full well they are paying some too much and some too little, it's almost a conscious decision to ignore "quality" it saves them money and effort in the long run; the problem is that it hurts the economy as a whole.

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