Sticky wages are impeding hiring in the U.S. economy

The supply/demand model suggests if there is a shortage in the supply of labor, the price of labor will rise until the shortage has been eliminated, arriving at equilibrium in the labor market. Yet we’re not seeing anything of the sort. By all accounts there appears to be no end in sight for the current labor shortage. 

COVID-19 emergency programs were blamed for putting downward pressure on labor supply, by providing many workers with income absent a job. Those programs have been expiring for nearly a year now, and we still don’t see labor supply keeping up with companies’ attempts to fill vacancies as consumer demand for goods and services returns to pre-pandemic levels. And economy-wide price inflation has meant that average cost of living has increased, and therefore workers’ need for income has only increased as well. One would think these factors would be driving workers back into the labor market if offered similar or higher wages compared to what they have received for similar work in the past. The wages on offer to these workers are similar to or higher than prior levels, but record staffing vacancies remain.

LONG TERM STRUCTURAL FACTORS

Millions who left the workforce in 2020-21 haven’t returned to it. Numerous surveys have been done of this group of workers, and they have consistently cited a variety of impediments to their ability to work which did not exist for them prior to the COVID-19 pandemic, among them being lack of childcare, emigration, hostile working conditions, and physical and mental disability due to declining public health.

Many millions more have changed jobs, leaving less desirable positions unfilled.

NEW NORMAL

And so we have to return to the supply/demand model of resource allocation in the economy. Microeconomic theory suggests that the U.S. labor shortage should have abated by now, as employers would have continued to raise wages until vacancies were filled. And clearly that hasn’t happened.

Short of changes to monetary or fiscal policy from the federal government, employers have been using every tool in their toolbox – as they absolutely should do and need to do – to improve their hiring rates, and in many cases to lower their quit rates as well. Every tool except for, in many cases, the hammer: Significant increases to wages and benefits.

STICKY WAGES AND THE CASE OF DOWNWARD WAGE RIGIDITY

Nearly a century ago, the economist John Maynard Keynes coined the term sticky wages. The worldwide Great Depression had set in seven years prior, yet high unemployment continued to persist. Keynes arrived at the concept of sticky wages after the failure of traditional neoclassical economics and its simple supply/demand model to explain the persistence in high unemployment. The old idea had been as follows – The business cycle would hit a recession, followed by a decrease in the demand for labor due to low demand for goods and services. This decrease in the demand for labor would trigger a fall in the price of labor (wages), in keeping with the basic logic of supply/demand. And finally, because wages had fallen, employers could now afford to expand their hiring, and levels of employment would return to equilibrium.

Except it didn’t happen that way. Keynes, his colleagues in economics, business owners, and workers all watched for seven years as this sequence of events failed to transpire.

Keynes observed that many workers were reluctant to accept wages which were lower – and in particular wages which were significantly lower – as payment for the same work, and understandably so. To describe this phenomenon he coined the term sticky wages, and made the case for why wages were displaying what he called downward wage rigidity. Because so many workers refused to accept lower wages for the same work, wages didn’t fall enough for the labor market to reach equilibrium, and sky high unemployment persisted. There’s no doubt arguments raged both in employers’ boardrooms and at workers’ family dinner tables over whether these workers were right or wrong to hold out for a higher wage. But that question was ultimately found to be irrelevant, as in either case, it wasn’t happening. There was only the question of where to go from here. Low consumer demand for goods and services meant employers had few spare profits on which to draw to maintain their prior wage levels, and workers refused to accept the indignity of doing the same (often physically strenuous) jobs for less pay. 

Precisely what ended this spiral has been long debated by economists and will continue to be, but there is a large degree of consensus that state intervention either through the New Deal, World War II, or both, was necessary to kickstart a rise in employment and bring America out of its Great Depression. 

UPWARD WAGE RIGIDITY

Just as economists had to modify their theories and look to empirical data in their quest for the return of economic growth and healthier levels of employment, today we too can use our eyes and our ears to face the reality and what needs to happen in order to mend the current, unrelentingly stubborn labor shortage. Unlike the situation employers faced during the Great Depression, or in economies which have displayed upward wage rigidity in the past, U.S. corporate profits are currently at an all time high. Countless hiring managers have been tasked with the impossible in some cases, to meet their hiring goals without flexibility to implement significant increases to employee pay and benefits. Companies are wise to be using nearly every tool at their disposal. But for many particularly stubborn employment crises in firms across the economy – especially those who have not already made increases to wages and benefits – they may need to reconsider their aversion to pay increases, and get out the hammer already.