Interview with Mark Bils

Mark Bils, Hazel Fyfe Professor in Economics, University of Rochester

Paper: “Resurrecting the Role of the Product Market Wedge in Recessions” (with Peter Klenow and Benjamin Malin)

The paper’s main takeaways, according to Bils:

  • Recessions look quite costly. Not just labor, but all down inputs drop sharply in recessions despite little fall in productivity.
  • We see this as a product market distortion that cuts demands for all inputs in recessions.

The Federal Reserve Bank of St. Louis hosted its 39th Annual Fall Conference on Oct. 9-10, 2014. David Andolfatto, a vice president and economist with the St. Louis Fed’s Research division, sat down with each of the conference presenters and discussed their work in plain English. The content below is from those interviews. All interviews have been edited for clarity and length, so the content below should not be considered a transcript. To read the papers presented at the conference, visit


I was wondering if you could tell us a little bit about what your paper is about and what the question is.


The paper is with Pete Klenow and Ben Malin, and anything I say shouldn’t be attributed or held against them.

The starting point is well-known, that we don’t really under­stand what happens in recessions. In recessions, there’s a big drop in employment and hours. At the same time, consump­tion drops a lot. So, given the drop in consumption and that hours and employment are low, we would expect, and I think it’s reasonable to expect, that people would be willing to work at a lower rate of pay. So the reservation wage for workers, what they’d require to work, should be low.

At the same time, for most recessions, productivity doesn’t fall that much. For the last three recessions, which is the period we look at, the last 25 years, on average, labor pro­ductivity doesn’t really drop. So then you have this puzzle. Why is it that people are getting laid off or that firms aren’t creating jobs or the work weeks are cut, even though it looks like the return on labor doesn’t look bad? The productivity looks pretty good, given what people would want to work at.

That’s referred to as the labor wedge. It shows up in other places in the literature. The whole unemployment puzzle, sometimes called the Shimer puzzle, is very closely related. So that’s our starting point. And then in the literature, a lot of that has been stressed as a problem from the labor market. It’s natural, because you’re trying to understand why labor drops so much in recessions. So it’s viewed as, “What’s the problem with the labor market?”

And so people have looked at average hourly earnings in the data and say, “Well, average hourly earnings also don’t fall that much during recessions, maybe a little bit compared to pro­ductivity, but not so much.” So maybe the problem is in the labor market. What’s keeping the wages sticky or not falling?

We make a couple of points. One is we don’t really know how to measure what the price of labor does in recessions, because we know that firms smooth people’s wages. New hires’ wages drop a lot more.


You mean the price of labor to the firm may not be fully reflected in the, say, the wage that they’re earning at that point?


Right. Suppose I don’t cut all the wages for my long-term employees, for convenience or to try to provide some insur­ance for them. That doesn’t mean that I can’t go out and find somebody new who would be cheaper, for instance.

We show that, for various different ways of measuring the price of labor, there is quite a drop in the price of labor compared to the productivity. It looks like the problem is not wage stickiness, but just that the demand for labor really is dropping a lot in recessions, just not in a way that we can link to productivity.

What we show then is, in a few different ways, that if we look at lots of inputs that don’t get purchased through the labor market, we see very much the same phenomena. I’ll just mention a couple. We look at self-employed workers, and we see very much a similar phenomenon, even though of course they don’t have any bargaining problems with their employers. They’re self-employed. They work for themselves.

And we look at intermediates. Intermediate purchases are huge in most industries. It’s like half of the value of their output. We see that the price of the intermediates drops a lot, yet the inputs drop a lot, and we see the same puzzle: that the firms seem to be pulling back a lot on intermediates, even though the productivity looks quite good.

We’re basically arguing it’s not a problem in terms of wage setting in the labor market. It’s a more general problem of firms drawing back and being more reticent to put output out on the market in recessions, and it’s just causing all factor demands to drop.


There are some people who have claimed that there’s some sort of composition bias. The workers you see laid off in a recession are the less skilled, lower productive workers. And as these workers are laid off, this raises the average labor productivity of the people who keep the jobs. Do you have any view on that?


You can calculate how big that is. And that helps to explain a little bit. You can just do sort of a back-of-the-envelope calculation. In a recession, for every percent fall in hours, maybe three-quarters of that is employment. The guys who are getting laid off are maybe 20 percent less productive. And then you can calculate that it makes a little bit of differ­ence in measuring productivity.

I can do other calculations, though, that would suggest that productivity actually drops even less in recessions. If I have any overhead labor, any overhead factors, the fact that I have to keep them on in the recession would tend to cause productivity to drop even more. So these things tend to, I think, kind of offset.

Also, that compositional bias shouldn’t show up for the factors we’re looking at, like intermediates.


So your findings then would call into question these approaches to try and understand recessions that focus on problems in the labor market, labor market frictions, things like this, and move the focus someplace else. Like what, where?


Well, I would say it a little differently. We would like to say that the focus shouldn’t be only on that. I wouldn’t argue that there aren’t some distortions coming from the labor market as well as the goods market. It’s just that I think the literature has moved to say it’s almost all in the labor market, and it’s largely based on looking at, like, average hourly earnings.

In fact, we say this literally: We think both what’s happening to other inputs and in the goods market deserves attention in the same way that the labor market does.


Do you have any, like, pet hypotheses here? What’s going on in the product market?


Let me just say again what we see and some possible expla­nations. We see that productivity does not drop so sharply in recessions, but the cost of a lot of inputs seems to be falling. So what could that be?

Well, one natural story would be that the firms are raising their markups during a recession, so they’re pulling back and they’re pricing higher. That shows up in Keynesian sticky price models just because the prices are slow to respond. I think these effects are bigger and longer than what one would get out of that story, in particular for the Great Recession. We see this for all three recessions, but this markup, this product market wedge, is particularly striking for the Great Recession.

So it could be price stickiness. It could be that firms feel like it’s a time where, if you try to keep producing at the same way you were, you’d have to slash prices so much that it doesn’t make sense.

A paper by Simon Gilchrist, Raphael Schoenle, Jae Sim and Egon Zakrajsek shows that, after Lehman Brothers, firms that had cash flow problems raised their price relative to the other guys. Their explanation was that these firms couldn’t afford to invest in their stock of customers. They had to get money now, so they had to charge a higher price, even if it cost them some of their customer base. They didn’t want to do it, but it’s just a form of cutting investment.

And I would say more generally, any decision at the margin to produce more is partly an investment. So when a firm hires a worker, it’s always partly an investment. You don’t know whether they’re going to be good or bad. If you really were just hiring based on that day, would you ever hire these guys? They might come in and screw things up for the day. There’s always an investment component to producing more. Because there’s less investment, firms will act like, “Well, I’m going to be more reticent to produce in the recession.” And that will show up as moving up a demand curve to a higher price, causing an increase in price markup.

I would also mention a paper by Cristina Arellano, Yan Bai and Patrick Kehoe. They show that, if uncertainty goes up in a recession and firms don’t want to overextend because they might go under and lose the whole firm, that causes firms to be more reticent and pull back more on producing in a recession.

All these forces lead to less dynamic, less competitive mar­kets in a recession. I think it could cause markups to go up. That’s what we’re arguing: People should be focused on these other forces as well as, say, wage setting.


In any case, it does seem to rule out some forces, like productivity shocks or stuff like this.


The acyclical data on productivity speak pretty well to that. It doesn’t mean there’s no role for them. But there has to be, I think, other shocks that are more important.

In recessions, firms don’t want to hire. I can’t rationalize that with a productivity shock, because productivity just doesn’t fall enough.


You don’t make any explicit policy recommendations on your findings, but do you see how your line of work, your line of inquiry, might one day inform policymakers in a particular manner? Or is it too removed from that right now?


Again, I’m not speaking for Pete or Ben, of course. I don’t think in terms of policy, but I would say the following: We don’t know what’s causing labor to fall in recessions. We don’t think it’s primarily wage stickiness. It’s likely factors we don’t understand well. If we recognize that we don’t under­stand recessions, that has important policy implications. You should tread lightly. That would be a lesson I would take. I wouldn’t take a view based on recessions that the labor mar­ket just doesn’t work well. That opens the door to all sorts of escapades in policy.

Our work reinforces that there are costs to recessions from inefficient drops in employment. But then what’s the right policy response? I could say, “Well, we should do things therefore to subsidize activity more in recessions.” But sometimes that’s counterproductive. If I look at policies that get made not according to rules, but ex-post, sometimes they make things worse. They create a situation where you don’t know what to do as an employer or firm because, even though you’re not necessarily in the rent-seeking business, in those times it pays to be.

I can give two examples. Assume we’re in a recession and you think maybe we’ll get a big investment tax credit. Maybe we won’t. Maybe it’ll come next year. So what should I do? I should invest less so that I would delay my investment until the tax credit kicks in.

Around 2009, there was a lot of discussion of creating a subsidy to hiring, so that if firms did net hiring, you would get a payment from the government. This is a terrible idea. Firms have to sit around and make calculations like, “I don’t want to hire now, because if I do, then I lose out on the subsidy. Better to let workers go, making room to hire when the subsidy kicks in.”

The lesson I would take is: Do nothing, or use a rule. If policymakers could credibly have a rule that, when employ­ment falls a lot, we’re going to have an investment tax credit or we’re going to have some payroll tax cut, I think our results could help rationalize that. But if a policymaker can’t explain and commit to what they will do under some future scenario, then I don’t think we should trust their choices after the fact on these policies. That's my view, but, again, not necessarily Pete’s and Ben’s.