Labour skills and sticky wages: Is the problem worse now?

The mass unemployment in the 1930’s has sometimes been put down to “stick wages”. Fundamentally, the value of labour fell but the price didn’t – leading firms to cut back on employment at a faster rate than would have been socially optimal.

Since then, wage stickiness appears to have eased to some degree: Unions are less powerful than they were, and employees have a greater level of understanding about why firms may have to cut nominal wages – leading to less of a psychological impact (Note: These statements are just conjecture – if you don’t agree with them feel free to state in the comments, we could really do another post on it 🙂 ).

However, does that mean that the underlying issue of labour market adjustment has abated? The short answer is no.

Just listen to this quote from a post by Greg Mankiw:

And there’s an assumption out there that construction workers are interchangeable between residential and highway projects. But a carpenter isn’t a whole lot of help in building a road

This indicates that the specialisation of labour actually reduces labour’s ability to adjust to structural changes in the economy. These are what James Hamilton calls technological frictions (ht Econlog).

In this case, the fact that individuals have invested in specific skills means that their capital investment is stranded in the face of a sudden, permanent, economic shock. Individuals then need to reinvest in human capital which is valued in the current environment – a process that is costly, risky, and fraught with genuine uncertainty.

If we face a permanent shock and unemployment is rising it may be preferable for government to help ease the transition between skills rather than arbitrarily throwing money at the economy.  Furthermore, even in the absense of a shock there could be a role for government to “reduce the uncertainty” surrounding skills in order to promote investment in human capital.

In the short term, we may in fact be facing a situation where real wages are not too high, but where the requirement of specific skills in the labour market makes transitions more difficult – increasing structural unemployment in the short term.  If the relative price of labour can now change (which it is often assumed that it couldn’t in the GD) there will be signals for people to invest in skills.

Rather than prescribing policy that was assumed to be successful in the Great Depression we should be looking at, and prescribing policies based on, our knowledge of the current labour market.