Alchian on Why Wages Adjust Slowly and Why It Matters

In my previous post, I reproduced a footnote from Armen Alchian’s classic article “Information Costs, Pricing and Resource Unemployment,” a footnote explaining the theoretical basis for Keynes’s somewhat tortured definition of involuntary unemployment. In this post, I offer another excerpt from Alchian’s article, elaborating on the microeconomic rationale for “slow” adjustments in wages. In an upcoming post, I will try to tie some threads together and discuss the issue of whether there might be, contrary to Alchian’s belief, a theoretical basis for wages to lag behind other prices, ata least during the initial stages of inflation. Herewith are the first four paragraphs of section II (Labor Markets) of Alchian’s paper.

Though most analyses of unemployment rely on wage conventions, restriction, and controls to retard wage adjustments above market-clearing levels, [J. R.] Hicks and [W. H.] Hutt penetrated deeper. Hicks suggested a solution consistent with conventional exchange theory. He stated that “knowledge of opportunities is imperfect” and that the time required to obtain that knowledge leads to unemployment and a delayed effect on wages. [fn. J. R. Hicks, The Theory of Wages, 2d ed. (London, 1963), 45, 58. And headed another type – "the unemployment of the man who gives up his job to look for a better."] It is precisely this enhanced significance that this paper seeks to develop, and which Hicks ignored when he immediately turned to different factors – unions and wage regulations, placing major blame on both for England’s heavy unemployment in the 1920s and 30s.

We digress to note that Keynes, in using a quantity-, instead of a price-, adjustment theory of exchange, merely postulated a “slow” reacting price without showing that slow price responses were consistent with utility or wealth-maximizing behavior in open, unconstrained markets. Keynes’s analysis was altered in the subsequent income-expenditure models where reliance was placed on “conventional” or “noncompetitive” wage rates. Modern “income-expenditure” theorists assumed “institutionally” or “irrationally” inflexible wages resulting from unions, money illusions, regulations, or factors allegedly idiosyncratic to labor. Keynes did not assume inflexibility for only wages. His theory rested on a more general scope of price inflexibility. [fn. For a thorough exposition and justification of these remarks on Keynes, see A. Leijonhufvud, On Keynesian Economics and the Economics of Keynes (Oxford, 1968).] The present paper may in part be viewed as an attempt to “justify” Keynes’s presumption about price response to disturbances in demand.

In 1939 W. H. Hutt exposed many of the fallacious interpretations of idleness and unemployment. Hutt applied the analysis suggested by Hicks but later ignored it when discussing Keynes’s analysis of involuntary unemployment and policies to alleviate it. [fn. W. H. Hutt, The Theory of Idle Resources (London, 1939), 165-69.] This is unfortunate, because Hutt’s analysis seems to be capable of explaining and accounting for a substantial portion of that unemployment.

If we follow the lead of Hicks and Hutt and develop the implications of “frictional” unemployment for both human and nonhuman goods, we can perceive conditions that will imply massive “frictional” unemployment and depressions in open, unrestricted, competitive markets with rational, utility maximizing, individual behavior.

So Alchian is telling us that it is at least possible to conceive of conditions in which massive unemployment and depressions are consistent with “open, unrestricted, competitive markets with rational, utility maximizing, individual behavior.” And presumably would be more going on in such periods of massive unemployment than the efficient substitution of leisure for work in periods of relatively low marginal labor productivity.

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10 Responses to “Alchian on Why Wages Adjust Slowly and Why It Matters”


  1. 1 Saturos June 14, 2012 at 9:57 am

    But is he denying that recessions are caused by lack of AD?

  2. 3 Luis June 14, 2012 at 10:49 am

    Well done, David.
    Is there any relación between Alchian view and that of New Keynesian?

  3. 4 JoeMac June 14, 2012 at 1:20 pm

    David,

    Are your discussions concerning Alchian’s macro views related to the disequilibrium economics movement of the 70s of Clower, Howitt, Leijonhufvud, Barro, Grossman, etc.?

  4. 5 Julian Janssen June 14, 2012 at 5:55 pm

    Very interesting post. What do you make of the generally positive “trajectory” of the S&P and the DJIA? Or is the recent dip the thing to look at?

  5. 6 Tas von Gleichen June 15, 2012 at 4:02 am

    Free Markets (Open) = low unemployment. What we have now is high unemployment because of governments interventions, high taxes, low entrepreneurship, big corporations (not hiring), crony-capitalism, and etc.

  6. 7 David Glasner June 16, 2012 at 8:56 pm

    Luis, Yes, at least indirectly. Unfortunately, in my view, New Keynesians got became too enamored with DSGE models of the type introduced by real business cycle theorists. Buying into the rational expectations equilibrium framework was a terrible mistake.

    JoeMac, Yes, Leijonhufvud was Clower’s student before he came to UCLA. I believe Leijonhufvud worte his book on Keynes as his doctoral dissertation under Clower at Northwestern. He came to UCLA before finishing the book and it evolved under Alchian’s influence. Clower later joined the UCLA department in the early 1970s. I think Howitt was also close to Clower, but I don’t remember what the connection is. Where Barro and Grossman fit in I don’t know.

    Julian, Good question. I think it is mainly wishful thinking by the markets expecting a change in Fed policy. Hope springs eternal.

    Tas, Do we have more regulation and more intervention and more crony capitalism than China and India? Are taxes in the US higher now than they were in 1982 when the recovery started from the 1981-82 recession? Reagan cut taxes in 1981 when the recession started, but raised taxes several times during the recovery. So, I think that there other causes of our weak economy than just government intervention and high taxes.

  7. 8 Luis June 17, 2012 at 10:03 am

    Thanks, David. i agree. Another question. I had the Luck of enjoing “the Alchian & Allen” in me thirth course of economics. Do you think that Alchian is the pioneer in information costs and markets frictions?

  8. 9 David Glasner June 19, 2012 at 10:22 am

    Luis, You are fortunate, indeed. Undoubtedly Alchian was a pioneer in that field as in the study of property rights, the relation of cost to output, evolutionary economics, you name it.


  1. 1 My Paper (co-authored with Paul Zimmerman) on Hayek and Sraffa « Uneasy Money Trackback on February 20, 2013 at 9:17 pm

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About Me

David Glasner
Washington, DC

I am an economist at the Federal Trade Commission. Nothing that you read on this blog necessarily reflects the views of the FTC or the individual commissioners. Although I work at the FTC as an antitrust economist, most of my research and writing has been on monetary economics and policy and the history of monetary theory. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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