Fluctuations and Rigidities in Local Labor Markets. Part 1: Theory and Evidence

Abstract. Cyclical sensitivity in employment, wages, and hours worked are explored with reference to three industries and eleven US cities over the period 1972-1980. Conventional neoclassical discrete-exchange models of the labor market are shown to be inadequate because of marked rigidities in the patterns of short-run adjustment. Money wages are very stable, being dominated by a long-run trend, and firms tend to adjust hours worked and only then employment in the short run. There are, however, significant interregional variations in these patterns within the same industry. Spectral analysis and tests for periodicities in the patterns of residuals derived from trend-line estimates of money wages confirm a supposition that urban Phillips curves do not exist. The evidence supports the implicit notion of contract theory that continuous employer-worker relationships exist over the business cycle. The question of how useful, in general, this theory might be is left open for the present. 1 Introduction Imagine a firm is faced with a sudden and unanticipated decline in demand for its output. How is it likely to respond? Neoclassical models, based upon perfect competitive assumptions, suggest two possibilities. First, if the market price falls quickly enough, a compensating increase in demand could be induced via the bargain prices faced by consumers. Second, if prices do not adjust to fully compensate declining demand, or if there is a lag in response, the firm would be forced to reduce output and to lay off excess labor. As a consequence, with declining demand for labor relative to supply, wages should also fall. Only a minor modification to this second answer is required if money wages are sticky downwards. Phillips (1958), argued that although wages do not decline absolutely, their rate of increase does. What of workers' responses in this situation? Neoclassical models emphasize real wages as a key behavioral criterion. With declining commodity prices, a commensurate decline in money wages would be of little relevance because real wages would be maintained. A step further in this line of reasoning is to suggest that money wages vary according to workers' expectations of likely changes in prices (Grossman, 1980). Even if money wages are sticky downwards, neoclassical theory still implies a great deal of wage-rate inflation volatility over the short run. Studies of the dynamics of local labor markets have depended to a large extent on these types of propositions (Clark, 1980). In these analyses, short-run patterns of employment are typically linked to industry-specific demand patterns and the location of those industries, and local wage inflation models typically depend upon the Phillips curve and its implied neoclassical quantity and price adjustment mechanisms (Clark, 1981c). Essentially, the local labor market has been treated just like any other commodity market, albeit with the appropriate cautions regarding the significance of flexible versus fixed-price arrangements. Workers are not simply commodities. They can, and often do, enter into implicit and explicit contractual agreements with employers. Rather than supply and demand being the dominant means of setting wages, union and collective wage bargaining are key institutional characteristics of the labor market (Ross, 1948). In recent years Baily (1976) and Azariades (1975) have also shown that implicit contracts can