Last week the Boston Fed held a two day conference on the Implications of Behavioral Economics for Economic Policy (hat tip: Greg Mankiw). Amongst a number of interesting papers was one on labour markets by Ernst Fehr (University of Zurich), Lorenz Goette (Boston Fed), and Christian Zehnder (Harvard Business School). It doesn't break any new ground, but it does ably summarise a lot of research and presents it in a palatable way for mainstream grad economists. Here is the abstract for the draft paper, The Behavioral Economics of the Labor Market: Central Findings and their Policy Implications (PDF):
Many labor markets are characterized by long-term employment relations and incomplete labor contracts. The employees’ effort, in particular, is typically not contractible so that effort needs to be enforced endogenously in repeated interactions. Theory and evidence shows that under these conditions fairness concerns play an important role in affecting effort choices and wage setting, rendering wage levels and wages’ responsiveness to shocks rather rigid. In addition, loss aversion and money illusion interact with fairness concerns to generate downwards nominal wage rigidity and - in case of strong unions - downwards real wage rigidity.
Thus, key structural features of labor markets such and long-term relations and contractual incompleteness and the psychological forces of fairness concerns, loss aversion and
money illusion lead to substantial departures from the predictions of the standard competitive model, rendering this model problematic for policy prescriptions. We illustrate this claim for two policy domains - monetary policy and minimum wage legislation.
Or to put it more simply, workers are not simply commodities. Most jobs are based around long-term employment relations and incomplete contracts, where effort is difficult to monitor and enforce. Hence issues such as trust, fairness and loyalty matter. As a result, labour markets seldom behave the way a competitive spot market would.
Of course this isn't rocket science, nor is it new. Labour economists such as John Dunlop and John Commons made much the same points over half a century ago. They didn't dress it up in fancy behavioural economics language, but their arguments were similar. While it is good to see the economic mainstream is at last catching up with the institutionalists (just as they are rediscovering other fields, such as pyschology), I find it astonishing that the paper makes no reference to Dunlop or Commons - or even to the more recent May 1989 Monthly Labor Review article by Jack Barbash, John R. Commons: Pioneer of Labor Economics (PDF).
I can understand such ignorance from Goette and Zehnder, who both have recently acquired PhDs. But Fehr completed his Doctorate in Vienna back in 1986. Don't the Austrians study labour economics or the history of economics? Or is this simply another case of the curse of JSTOR - if it's not online, it doesn't exist.
There is plenty I like about economics, but the appalling ignorance of most recent gradautes about both economic history and the history of economics is hardly a strength. I heartily endorse Arnold Kling's recent call to reform PhD programmes:
I would be inclined to require a course in economic history. There is much to be learned from trying to understand events like the Industrial Revolution or the Great Depression. There is much to be learned from more detailed analysis of lesser issues, as well.