Archive for June, 2016

Walter Oi and the Productivity Puzzle

Just over a year ago I wrote a post suggesting that slow productivity growth in the current recovery might have something to do with the changing demographic composition of the US labor force and the significant structural changes in the US economy following the 2008 financial crisis and downturn. Here’s how I put it last year.

I don’t deny that secular stagnation is a reasonable inference to be drawn from the persistently low increases in labor productivity during this recovery, but it does seem to me that a less depressing, though perhaps partial, explanation for low productivity growth may be available. My suggestion is that the 2008-09 downturn was associated with major sectoral shifts that caused an unusually large reallocation of labor from industries like construction and finance to other industries so that an unusually large number of workers have had to find new jobs doing work different from what they were doing previously. In many recessions, laid-off workers are either re-employed at their old jobs or find new jobs doing basically the same work that they had been doing at their old jobs. When workers transfer from one job to another similar job, there is little reason to expect a decline in their productivity after they are re-employed, but when workers are re-employed doing something very different from what they did before, a significant drop in their productivity in their new jobs is likely, though there may instances when, as workers gain new skills and experience in their new jobs, their productivity will rise rapidly.

In addition, the number of long-term unemployed (27 weeks or more) since the 2008-09 downturn has been unusually high. Workers who remain unemployed for an extended period of time tend to suffer an erosion of skills, causing their productivity to drop when they are re-employed even if they are able to find a new job in their old occupation. It seems likely that the percentage of long-term unemployed workers that switch occupations is larger than the percentage of short-term unemployed workers that switch occupations, so the unusually high rate of long-term unemployment has probably had a doubly negative effect on labor productivity.

I wrote that post trying to find some reason for optimism in the consistently dismal productivity data that have been reported since a recovery of sorts began in 2009. Unfortunately, the productivity data reported since I wrote that post last year have not improved. Job growth, until last month at any rate, has continued to be strong, while productivity growth has remained nearly anemic. Although it’s disappointing that productivity growth hasn’t picked up in the last ‘year, I haven’t totally given up hope that productivity growth could still revive.

Aside from the demographic and structural changes that I mentioned last year, there is another factor operating and also tend to hold down productivity growth when the growth in employment involves a lot of new entrants into the labor force and a lot of switching between jobs and, even more so, switching between occupations. The basic idea, developed by the great Walter Oi is that labor is a quasi-fixed factor.

From a firm’s viewpoint labor is surely a quasi-fixed factor. The largest part of total labor cost is the variable-wages bill representing payments for a flow of productive services. In addition the firms ordinarily incurs certain fixed employment costs in hiring a specific stock of workers. These fixed employment costs constitute an investment by the firms in its labor force. As such they introduce an element of capital in the use of labor. Decisions regarding the labor input can no longer be based solely on the current relation between wages and marginal value products but must also take cognizance of the future course of these quantities. The theoretical implications of labor’s fixity will be analyzed before turning to the empirical magnitude of these fixed costs.

For analytic purposes fixed employment costs can be separated into two categories called, for convenience, hiring and training costs. Hiring costs are defined as those costs that have no effect on a worker’s productivity and include outlays for recruiting, for processing payroll records, and for supplements such as unemployment compensation. These costs are closely related to the number of new workers and only indirectly related to the flow of labor’s services Training expenses, on the other hand, are investments in the human agent, specifically designed to improve a worker’s productivity.

The training activity typically entails direct money outlays as well as numerous implicit costs such as the allocation of old workers to teaching skills and rejection of unqualified workers during the training period.

So if the increase in employment during this recovery has been associated with more job and occupation switching and more new entrants into the labor force than in previous recoveries, then at least part of the deficit in productivity in this recovery relative to earlier recoveries might be accounted for. And if so, we might still expect that the rate of productivity growth will start increasing before long as the on-the-job training they have received enables the recently hired workers to improve their skills in their new jobs and occupations.

What’s Wrong with Econ 101?

Hendrickson responded recently to criticisms of Econ 101 made by Noah Smith and Mark Thoma. Mark Thoma thinks that Econ 101 has a conservative bias, presumably because Econ 101 teaches students that markets equilibrate supply and demand and allocate resources to their highest valued use and that sort of thing. If markets are so wonderful, then shouldn’t we keep hands off the market and let things take care of themselves? Noah Smith is especially upset that Econ 101, slighting the ambiguous evidence that minimum-wage laws actually do increase unemployment, is too focused on theory and pays too little attention to empirical techniques.

I sympathize with Josh defense of Econ 101, and I think he makes a good point that there is nothing in Econ 101 that quantifies the effect on unemployment of minimum-wage legislation, so that the disconnect between theory and evidence isn’t as stark as Noah suggests. Josh also emphasizes, properly, that whatever the effect of an increase in the minimum wage implied by economic theory, that implication by itself can’t tell us whether the minimum wage should be raised. An ought statement can’t be derived from an is statement. Philosophers are not as uniformly in agreement about the positive-normative distinction as they used to be, but I am old-fashioned enough to think that it’s still valid. If there is a conservative bias in Econ 101, the problem is not Econ 101; the problem is bad teaching.

Having said all that, however, I don’t think that Josh’s defense addresses the real problems with Econ 101. Noah Smith’s complaints about the implied opposition of Econ 101 to minimum-wage legislation and Mark Thoma’s about the conservative bias of Econ 101 are symptoms of a deeper problem with Econ 101, a problem inherent in the current state of economic theory, and unlikely to go away any time soon.

The deeper problem that I think underlies much of the criticism of Econ 101 is the fragility of its essential propositions. These propositions, what Paul Samuelson misguidedly called “meaningful theorems” are deducible from the basic postulates of utility maximization and wealth maximization by applying the method of comparative statics. Not only are the propositions based on questionable psychological assumptions, the comparative-statics method imposes further restrictive assumptions designed to isolate a single purely theoretical relationship. The assumptions aren’t just the kind of simplifications necessary for the theoretical models of any empirical science to be applicable to the real world, they subvert the powerful logic used to derive those implications. It’s not just that the assumptions may not be fully consistent with the conditions actually observed, but the implications of the model are themselves highly sensitive to those assumptions. The meaningful theorems themselves are very sensitive to the assumptions of the model.

The bread and butter of Econ 101 is the microeconomic theory of market adjustment in which price and quantity adjust to equilibrate what consumers demand with what suppliers produce. This is the partial-equilibrium analysis derived from Alfred Marshall, and gradually perfected in the 1920s and 1930s after Marshall’s death with the development of the theories of the firm, and perfect and imperfect competition. As I have pointed out before in a number of posts just as macroeconomics depends on microfoundations, microeconomics depends on macrofoundations (e.g. here and here). All partial-equilibrium analysis relies on the – usually implicit — assumption that all markets but the single market under analysis are in equilibrium. Without that assumption, it is logically impossible to derive any of Samuelson’s meaningful theorems, and the logical necessity of microeconomics is severely compromised.

The underlying idea is very simple. Samuelson’s meaningful theorems are meant to isolate the effect of a change in a single parameter on a particular endogenous variable in an economic system. The only way to isolate the effect of the parameter on the variable is to start from an equilibrium state in which the system is, as it were, at rest. A small (aka infinitesimal) change in the parameter induces an adjustment in the equilibrium, and a comparison of the small change in the variable of interest between the new equilibrium and the old equilibrium relative to the parameter change identifies the underlying relationship between the variable and the parameter, all else being held constant. If the analysis did not start from equilibrium, then the effect of the parameter change on the variable could not be isolated, because the variable would be changing for reasons having nothing to do with the parameter change, making it impossible to isolate the pure effect of the parameter change on the variable of interest.

Not only must the exercise start from an equilibrium state, the equilibrium must be at least locally stable, so that the posited small parameter change doesn’t cause the system to gravitate towards another equilibrium — the usual assumption of a unique equilibrium being an assumption to ensure tractability rather than a deduction from any plausible assumptions – or simply veer off on some explosive or indeterminate path.

Even aside from all these restrictive assumptions, the standard partial-equilibrium analysis is restricted to markets that can be assumed to be very small relative to the entire system. For small markets, it is safe to assume that the small changes in the single market under analysis will have sufficiently small effects on all the other markets in the economy that the induced effects on all the other markets from the change in the market of interest have a negligible feedback effect on the market of interest.

But the partial-equilibrium method surely breaks down when the market under analysis is a market that is large relative to the entire economy, like, shall we say, the market for labor. The feedback effects are simply too strong for the small-market assumptions underlying the partial-equilibrium analysis to be satisfied by the labor market. But even aside from the size issue, the essence of the partial-equilibrium method is the assumption that all markets other than the market under analysis are in equilibrium. But the very assumption that the labor market is not in equilibrium renders the partial-equilibrium assumption that all other markets are in equilibrium untenable. I would suggest that the proper way to think about what Keynes was trying, not necessarily successfully, to do in the General Theory when discussing nominal wage cuts as a way to reduce unemployment is to view that discussion as a critique of using the partial-equilibrium method to analyze a state of general unemployment, as opposed to a situation in which unemployment is confined to a particular occupation or a particular geographic area.

So the question naturally arises: If the logical basis of Econ 101 is as flimsy as I have been suggesting, should we stop teaching Econ 101? My answer is an emphatic, but qualified, no. Econ 101 is the distillation of almost a century and a half of rigorous thought about how to analyze human behavior. What we have come up with so far is very imperfect, but it is still the most effective tool we have for systematically thinking about human conduct and its consequences, especially its unintended consequences. But we should be more forthright about its limitations and the nature of the assumptions that underlie the analysis. We should also be more aware of the logical gaps between the theory – Samuelson’s meaningful theorems — and the applications of the theory.

In fact, many meaningful theorems are consistently corroborated by statistical tests, presumably because observations by and large occur when the economy operates in the neighborhood of a general equililbrium and feedback effect are small, so that the extraneous forces – other than those derived from theory – impinge on actual observations more or less randomly, and thus don’t significantly distort the predicted relationship. And undoubtedly there are also cases in which the random effects overwhelm the theoretically identified relationships, preventing the relationships from being identified statistically, at least when the number of observations is relatively small as is usually the case with economic data. But we should also acknowledge that the theoretically predicted relationships may simply not hold in the real world, because the extreme conditions required for the predicted partial-equilibrium relationships to hold – near-equilibrium conditions and the absence of feedback effects – may often not be satisfied.

What’s So Bad about the Trade Deficit?

The ravings of a certain candidate for President — in case you have been living under a rock, I mean the one that has been having a bad hair decade — about the evils of the US trade deficits with China, Mexico, Japan, and assorted other countries reminded me of a column I wrote for the New York Times in another election year, 1984 to be exact. So I went back and looked for it, and it seemed sadly still to be relevant, so I will reproduce it here. Not that I expect it to contribute much to general enlightenment, but, at times like these, one feels that one just has to do something to resist the madness.

The Much Maligned Trade Gap

No economic statistic is reported more dolefully these days than the country’s trade balance.

Ever on the alert for signs of impending economic disaster, the press routinely couples reports of record monthly trade deficits with warnings of experts and Government officials of the dangers of the deficit.

Just what is so dangerous about receiving more goods from foreigners than we give them back is never actually explained, but it is often suggested that that it causes a loss of American jobs.

News reports sometimes even provide estimates of the number of jobs lost owing to every billion dollar increase in the trade deficit. Heaven only knows how these estimates are made, but presumably they are based on the assumption that imports deprive Americans of jobs they could have had producing domestic substitutes for the imports.

It almost seems tedious to do so, but it apparently still needs to be pointed out that buying less from foreigners means that they will buy less from us for the simple reason that they will have fewer dollars with which to purchase our products.

Thus, even if reducing imports increases employment in industries that compete with imports, it must also reduce employment in export industries.

Moreover, the notion that the trade deficit destroys domestic jobs is contradicted by the tendency of the deficit to increase during economic expansions and to decrease during contractions.

The demand for imports rises with income, so imports normally tend to rise faster than exports when a country expands more rapidly than its trading partners. The trade deficit is a symptom or rising employment — not the cause of rising unemployment.

That balance-of-trade figures are misunderstood and misused is not surprising, since their function has never been to inform or to enlighten. Their real purpose is to provide spurious statistical and pseudo-scientific support to groups seeking protectionist legislation. These groups try to cloak their appeals to protection with an invocation of the general interest in a favorable balance of trade.

Anyone who has ever thought about it has probably wondered why a country that gives up more goods in trade than it gets back is said to have a favorable balance of trade.

If you have ever wondered about it and couldn’t think of an answer, don’t worry, because you are in good company. Adam Smith couldn’t either. “Nothing,” Smith once observed, “can be more absurd than this whole doctrine of the balance of trade, upon which . . . almost all the . . . regulations of commerce are founded.”

The absurdity of the doctrine ought now to be manifest owing to the current international debt crisis. The crisis, as we all know, arose because large numbers of developing countries are apparently unable to make the scheduled payment on loans to American banks from which they borrowed.

It is, I believe, just about universally acknowledged that it would be a bad thing if the debtor countries failed to repay their loans.

The debtor countries would suffer because they would be less able to borrow in the future, and thus less able to import the products they need to take care of their populations and to promote development.

Creditor countries would  also suffer because default would impose huge losses on the banks and their shareholders. And since such losses might undermine the domestic and international banking systems, they would undoubtedly be made up, at least in part, by the Government and the taxpayers.

Yet it is remarkable how little, even now, the relationship between the ability of the debtor countries to repay their debts and the size of the American trade deficit is understood. For everyone continues to rail against the trade deficit even though reducing it would make the default of the debtor countries all the more likely.

A simple example will help to explain why that is so.

Suppose I borrow money from you and promise to repay you next year. And, for simplicity, suppose that neither of us engages in transactions with third parties. Thus, I produce goods, some of which I consume myself and the rest of which I sell to you, and you produce goods, some of which you consumer and the rest of which you sell to me.

Now the reason that I am borrowing from you is that  the value of the goods I want from you this year exceeds the value of what I am willing to sell you this year. But next year I shall have to sell you enough not only to cover what I buy from you, I shall have to sell you enough to earn the money with which to repay you.

Thus, to avoid default, I must run a trade surplus with you next year. And if you want to be repaid, you have to reconcile yourself to the idea of running a trade deficit, because repayment consists in, and is equivalent to, my trade surplus and your trade deficit.

The debtor nations are faced with default because they haven’t enough dollars to repay the banks from whom they have borrowed. Why not? Because their trade surplus with the United States — our trade deficit with them — is too small for them to earn the dollars they need for repayment.

How could they earn more dollars? 1. They could reduce their imports from us. 2. They could increase their exports to us. 3. They could borrow more dollars from us. 4. We could give them the dollars.

The first two options both imply an increase in our trade deficit. That sounds bad only if you ignore the alternatives. The third option might have some attraction if the debtor countries could repay their existing debts. But since they can’t even do that, further lending seems inadvisable.

The fourth option, it goes without saying, is the economic equivalent of default.

Those who insist that the United States trade deficit must be reduced had better think through the implications. They should ask themselves whether they really want to drive the debtor countries to the wall and whether they are prepared to absorb the losses associated with a default by the debtor countries just to stop American consumers from buying as much of the products of debtor countries as they want.

Allowing unrestricted access of those products into our markets would not necessarily prevent default, but maintaining or tightening restrictions can only increase the likelihood and the severity of an eventual default.

And at a more fundamental level, isn’t there something perverse in first lending to someone, and then, after having refused to accept payment, hauling him into court because he won’t pay his debts?

Which brings to mind the following thought: the very same candidate that is promising to convert the US trade deficit into a trade surplus is also the candidate that wants America’s European and Asian allies to increase their payments to the US to cover the costs incurred by the US in defending them? How does this candidate suppose that these allies can simultaneously increase their dollar payments to the US without either exporting more to, or importing less from, the US. Or perhaps the candidate believes that these allies can just print the money with which to purchase the dollars from the US, and then pay us back with the dollars they acquired with the money they printed. But that would mean that their currencies would depreciate against the dollar. But this candidate doesn’t like it when other countries devalue their currencies against the dollar; the candidate calls that currency manipulation. My oh my, what a tangled web we weave . . .

About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. 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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