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Labor Economics #1 - Sticky Wages

Labor Economics #1 - Sticky Wages
by Alex Merced

The next few posts I'll be writing will be a series on some aspects of labor economics which will mainly center around wages and upward mobility. In this initial part of the series I'm going to address one of the main Keynesian buzzwords, "Sticky Wages".

 John Maynard Keyes (read "Where Keynes went Wrong") makes the admission that it's plausible that an economy can self correct by allowing all prices to adjust downwards if the money supply is reduced for whatever reasons, but contends that there is a problem cause wages are "sticky" so this would make it difficult for businesses to adjust their inventories and prices to maintain the current labor supply since wages won't fall in line with everything else so unemployment ensues. This unemployment will then cause further contraction of the monetary supply causing the economy to just spiral downwards as Keyenes expounds on ideas first proposed by Irving Fisher which really are just echoes of antiquated mercantilist thinking.

 What I contend is not to deny that wages move slower than the prices of consumer goods, but if anything this should be a reason to want deflation not inflation. First let's look at the structure of production to explore why wages would move slower in either direction.

Let's say my structure of production looks like so...

Labor+Materials+Tools = Consumer Good

Deflation Scenario

So if the Demand for the consumer good increases I have three choices on where I can costs in this simplified scenario. For many reasons I may try to cut costs as much as possible in Materials and Tools since they are homogenous instead of giving up my trained skilled labor which is heterogenous. I may still have to ask my labor to take some level of a cut in pay but only after I exausted my ability to lower the other prices. So essentially I may have been able to cut my costs enough to get a drop in price in the good of 10% yet from cutting costs elsewhere only had to cut labor costs by 5%.

So if this is going on across the economy essentially laborers will have gotten an effective pay raise cause goods have dropped in price more than their wages did. Given if you look at editorials in times like 1870's or late 1830's when you had this sort deflation without massive unemployment (actual growth in the 1870's) going on, yet psycoligically many people felt things were bad cause they saw the nominal numbers going down so there is something to be said for the psycological state of people.

Inflation Scenario

So let's say the demand for my goods has increased cause the money supply has grown for whatever reasons. Since demand is increasing all over the economy, the demand for the same materials and tools I use will increase over different industries and firms that use those same tools. This widespread demand increase will cause an increase in the price of my materials and tools which I'll have to pass on to the consumer yet this increase will be larger than any raise I may give to my laborers in a attempt to prevent too much of an increase in the final goods price that would effect it's demand.

So basically due to increases in costs primarily in capital goods the price of the good has gone up 10% and wages went up 5% which if this is a widepread phenomena results a pay cut for the laborer. Again, psycologically they feel good cause they see their nominal wages going up without realizing their real wages are going down. This is essentially the story in any bubble or boom, except due to problems with CPI calculations inflation is usually understated.


If sticky wages are a real phenomena then deflation would be the much better environment for real wages and for the laborer. Although what is usally proposed by Keynesians and other types of leftist is to push for more inflation which actually hurts real wages yet psycologically breeds consent of the labor class since they only think in nominal terms. In order to have the benefits of deflation yet without the psycological pessimism, it would be a proper use of an economic figurehead such as a president to explain this phenomena to manage expectations and sentiment.

Posted Aug 13 2010, 04:45 PM by Alex Merced


Jonathan M. F. Catalán wrote re: Labor Economics #1 - Sticky Wages
on Fri, Aug 13 2010 4:47 PM

Deflation between 1879 and 1893 was of a different kind than the one Keynes was referring to (although, I'm not sure Keynes recognized the differences fully).  The former was a product of an increase in productivity (the money supply still increased during that period, it just did not match the increase in productivity).  The deflation we are experiencing today is a product of a contracting money supply.

Nevertheless, the only reason there should be sticky wages is due to price floors on wages, or government-induced inflation of the costs of breaking labor contracts (the most likely reason, today).

david2viya wrote re: Labor Economics #1 - Sticky Wages
on Fri, Aug 13 2010 7:20 PM

In this post the writer has taken his notice to the labor economy.I myself appreciate his writing.

Alex Merced wrote re: Labor Economics #1 - Sticky Wages
on Sat, Aug 14 2010 7:42 AM

I agree with you Jonathan, what I'm trying to do in this paper is say IF the stick wage issue was a real issue I don't see why further inflation and government intervention would be prescribed. If wages are sticky then workers would benefit more from deflation from their real wage increase.

Although Having formerly owned a business and currently being in the room when decisions are made where i'm working now I can understand how labor costs usally move up and down last.

If things are good, my other costs rise as well so I won't give out as much of a raise as I would otherwise.

If things are bad, I'm going to cut everything else I can before I give a paycut whether out of not wanting to lose talent or out of pure empathy.

Prices have fallen faster than wages for example in the recession of 1920, and it didn't cause the spiral that Keyenes warns about which is the point I'm making, if wages are stick... it's not really a problem.

Although if there is a price floor it does limit the ability of an entrepeneur to adjust his prices during very large recessions which will cause further unemployment beyond the unemployment it causes all the time anyways.

Nadjeschda wrote re: Labor Economics #1 - Sticky Wages
on Mon, Nov 1 2010 11:49 AM

Even if wages where sticky unemployment can't be permanent. In an economic recession the environment usually starts regenerating. For example: If fishers cling to high wages these might surpass their labor productivity leading to unemployed. Given that the sea is overfished now, the fish stock has time to regenerate if fishers are layed of. Over time you will be able to catch more fish with less hours of work, the productivity of labor per hours hence rises until it becomes attractive to hire again. Since there is no steady state in environment there can't be a steady state of unemployment.