Wednesday, March 18, 2009

Get Your Sticky Wages Off My Health Care.

When you have six kids encountering something sticky is a daily occurrence. But in economics the phenomenon of sticky wages (and prices) has very different implications.

Basically, when things are sticky, they can't adjust as quickly as the surrounding conditions. This results in periods of time when the real world doesn't quite match the charts that the graduate students spent all that time on. I would call this a time when things are out of whack. Professional economists call it a disequilibrium.

The confluence of sticky wages, health care costs, and the competitiveness (or lack thereof) of the US auto industry reared its head recently on the blog of Harvard professor Greg Mankiw.

Mankiw quotes representatives (and personal friends) from two different agencies from the federal alphabet soup as follows (the red text is Mankiw's):
NEC: Our ability to produce competitively in the United States will be enhanced if we contain healthcare costs

when firms provide health insurance, wages and other forms of compensation are lower (by a corresponding amount) than they otherwise would be. As a result, the costs of providing health insurance to their workers are not a competitive disadvantage for U.S.-based firms.
This debate is more than academic, especially in Michigan. Do health care costs put GM at a disadvantage? Mankiw answers no:
Ultimately, what matters to firms is the compensation they pay workers. The composition of compensation between cash wages and fringe benefits like healthcare does not matter for the firms' costs of production. In short run when cash wages are sticky, the cost of healthcare may affect competitiveness: Lower costs of fringe benefits would reduce compensation and thus reduce firms' cost of production. But in the long run, compensation is set by supply and demand in labor markets. If more compensation is paid in the form of fringe benefits like healthcare, less is paid in the form of cash. And if less is paid in fringes, more is paid in wages.
OK, I'll agree that total compensation is the critical factor, not the cost of a single component of compensation.

But Mankiw specifically mentions workers. Does the calculus change when thinking about retirees? I suppose pensions can be adjusted through negotiation, no different than cash wages. But what about the fact that these people are no longer producing anything.

As Americans live longer, GM pensioners live longer, so every Chevy now has to cover the cost of the men and women that are currently producing the cars, and the health care and pensions of the men and women that produced Chevy's that have long since found their way to the scrap heap.

What about the fact that, during their working years, the productivity of current retirees was limited to the technology that was then available; but the health care they consume today is limited by today's standards. That is to say they worked at 1965 productivity levels, but GM has to pay for health care at 2005 levels. (This is not to say GM doesn't owe this to the workers, I am just wondering if this is more of a problem than Mankiw's brief analysis allows.)

Admittedly, both of these items have to do with legacy costs, but there may be some problems that are driven by the here and now as well.

Mankiw notes that in the long run cash and fringes will vary in order to stabilize total compensation. But certainly there must be some bottom limit beyond which cash wages cannot fall or people won't work - even though the cost of the fringe benefits to the company represent a level of compensation at which people would otherwise choose to work. (I mean would people have to be hospitalized so that they could eat a meal which would then be covered by their employer provided health insurance?)

Finally, what if a firm faces a rapid and steep increase in the cost of compensation coupled with a rapid and steep decline in demand for the products it makes? This seems to be what we have now. In this case, maybe there is no long run during which wages and fringe benefits can recalibrate to keep the firm competitive. Basically a firm could go under for want of a long run, or for want of a loan to make it through the short run. (Anyone still think functioning credit markets aren't important?)

Anyway, no doubt someone of Mankiw's caliber could put all my questions to rest with a few professorial pronouncements. (If only it were that easy!).

His post, for me at least, raised more questions than it answered. As far as I can tell he doesn't have an email or comments on his blog, so I am posting this reaction here.

I suppose I could send him a letter, care of the ivory tower of course! (Now why did I do that, I just marred an otherwise thoughtful post with a silly populist jab. Shame on me. )

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