Saturday, December 17, 2011

What We Talk About When We Don't Talk About Demand

There sure are a lot of ways to not say aggregate demand.

Here's the estimable Joseph Stiglitz, not saying aggregate demand in Vanity Fair:
The parallels between the story of the origin of the Great Depression and that of our Long Slump are strong. Back then we were moving from agriculture to manufacturing. Today we are moving from manufacturing to a service economy. The decline in manufacturing jobs has been dramatic—from about a third of the workforce 60 years ago to less than a tenth of it today. ... There are two reasons for the decline. One is greater productivity—the same dynamic that revolutionized agriculture and forced a majority of American farmers to look for work elsewhere. The other is globalization... (As Greenwald has pointed out, most of the job loss in the 1990s was related to productivity increases, not to globalization.) Whatever the specific cause, the inevitable result is precisely the same as it was 80 years ago: a decline in income and jobs. The millions of jobless former factory workers once employed in cities such as Youngstown and Birmingham and Gary and Detroit are the modern-day equivalent of the Depression’s doomed farmers.
This sounds reasonable, but is it? Nick Rowe doesn't think so. Let's leave aside globalization for another post -- as Stieglitz says, it's less important anyway. It's certainly true that manufacturing employment has fallen steeply, even while the US -- despite what you sometimes here -- continues to produce plenty of manufactured goods. But does it make sense to say that the rise in manufacturing productivity be responsible for mass unemployment in the country as a whole?

There's certainly an argument in principle for the existence of technological unemployment, caused by rapid productivity growth. Lance Taylor has a good discussion in chapter 5 of his superb new book Maynard's Revenge (and a more technical version in Reconstructing Macroeconomics.) The idea is that with the real wage fixed, an increase in labor productivity will have two effects. First, it reduces the amount of labor required to produce a given level of output, and second, it redistributes income from labor to capital. Insofar as the marginal propensity to consume out of profit income is lower than the marginal propensity to consume out of wage income, this redistribution tends to reduce consumption demand. But insofar as investment demand is driven by profitability, it tends to increase investment demand. There's no a priori reason to think that one of these effects is stronger than the other. If the former is stronger -- if demand is wage-led -- then yes, productivity increases will tend to lower demand. But if the latter is stronger -- if demand is profit-led -- then productivity increases will tend to raise demand, though perhaps not by enough to offset the reduced labor input required for a given level of output. For what it's worth, Taylor thinks the US economy has profit-led demand, but not necessarily enough so to avoid a Luddite outcome.

Taylor is a structuralist. (The label I think I'm going to start wearing myself.) You would be unlikely to find this story in the mainstream because technological unemployment is impossible if wages equal the marginal product of labor, and because it requires that output to be normally, and not just exceptionally, demand-constrained.

It's a good story but I have trouble seeing it having much to do with the current situation. Because, where's the productivity acceleration? Underlying hourly labor productivity growth just keeps bumping along at 2 percent and change a year. Over the whole postwar period, it averages 2.3 percent. Over the past twenty years, 2.2 percent. Over the past decade, 2.3 percent. Where's the technological revolution?

Just do the math. If underlying productivity rises at 2 percent a year, and demand constraints cause output to stay flat for four years [1], then we would expect employment to fall by 8 percent. In other words, lack of demand explains the whole fall in employment. [2] There's no need to bring in structural shifts or anything else happening on the supply side. A fall in demand, plus a stable rate of productivity increase, gets you exactly what we've seen.

It's important to understand why demand fell, but from a policy standpoint, no actually it isn't. As the saying goes, you don't refill a flat tire through the hole. The important point is that we don't need to know anything about the composition of output to understand why unemployment is so high, because the relationship between the level of output and employment is no different than it's always been.

But isn't it true that since the end of the recession we've seen a recovery in output but no recovery in employment? Yes, it is. So doesn't that suggest there's something different happening in the labor market this time? No, it doesn't. Here's why.

There's a well-established empirical relationship in macroeconomics called Okun's law, which says that, roughly, a one percentage point change in output relative to potential changes employment by one a third to a half a percentage point. There are two straightforward reasons for this: first, a significant fraction of employment is overhead labor, which firms need an equal amount of whether their current production levels are high or low. And second, if hiring and training employees is costly, firms will be reluctant to lay off workers in the face of declines in output that are believe to be temporary. For both these reasons (and directly contrary to the predictions of a "sticky wages" theory of recessions) employment invariably falls by less than output in recessions. Let's look at some pictures.

These graphs show the quarter by quarter annualized change in output (vertical axis) and employment (horizontal axis) over recent US business cycles. The diagonal line is the regression line for the postwar period as a whole; as you would expect, it passes through zero employment growth around two percent output growth, corresponding to the long-run rate of labor productivity growth.

1960 recession

1969 recession

1980 and 1981 recessions
1990 recession

2001 recession
2007 recession

What you see is that in every case, there's the same clockwise motion. The initial phase of the recession (1960:2 to 1961:1, 1969:1 to 1970:4, etc.) is below the line, meaning growth has fallen more than employment. This is the period when firms are reducing output but not reducing employment proportionately. Then there's a vertical upward movement at the left, when growth is accelerating and employment is not; this is the period when, because of their excess staffing at the bottom of the recession, firms are able to increase output without much new hiring. Finally there's a movement toward the right as labor hoards are exhausted and overhead employment starts to increase, which brings the economy back to the long-term relationship between employment and output. [3] As the figures show, this cycle is found in every recession; it's the inevitable outcome when an economy experiences negative demand shocks and employment is costly to adjust. (It's a bit harder to see in the 1980-1981 graph because of the double-dip recession of 1980-1981; the first cycle is only halfway finished in 1981:2 when the second cycle begins.)

There's nothing exceptional, in these pictures, about the most recent recession. Indeed, the accumulated deviations to the right of the long-term trend (i.e., higher employment than one would expect based on output) are somewhat greater than the accumulated deviations to the left of it. Nothing exceptional, that is, except how big it is, and how far it lies to the lower-left. In terms of the labor market, in other words, the Great Recession was qualitatively no different from other postwar recessions; it was just much deeper.

I understand the intellectual temptation to look for a more interesting story. And of course there are obviously structural explanations for why demand fell so far in 2007, and why conventional remedies have been relatively ineffective in boosting it. (Tho I suspect those explanations have more to do with the absence of major technological change, than an excess of it.) But if you want to know the proximate reason why unemployment is so high today, there's a recession on still looks like a sufficiently good working hypothesis.

[1] Real GDP is currently less than 0.1 percent above its level at the end of 2007.

[2] Actually employment is down by only about 5 percent, suggesting that if anything we need a structural story for why it hasn't fallen more. But there's no real mystery here, productivity growth is not really independent of demand conditions and always decelerates in recessions.

[3] Changes in hours worked per employee are also part of the story, in both downturn and recovery.

Sunday, December 11, 2011

Is the Euro the Problem?

What's wrong in Europe?

Krugman is saying, again, that it's the inability to adjust exchange rates. He quotes Kevin O'Rourke:

The world nowadays looks very much like the theoretical world that economists have traditionally used to examine the costs and benefits of monetary unions. The eurozone members’ loss of ability to devalue their exchange rates is a major cost. Governments’ efforts to promote wage cuts, or to engineer them by driving their countries into recession, cannot substitute for exchange-rate devaluation. Placing the entire burden of adjustment on deficit countries is a recipe for disaster.
 In other words, it's a problem of relative prices. Wages are too high in Greece, Spain and Ireland, so those countries face unemployment; wages are too high in Germany, so it's experiencing an inflationary boom; and wages are just right in France, so it's chugging along at full capacity.

Wait, what?

Of course that's not what's going on at all.
There are a lot of ways not to talk about aggregate demand.

Sunday, December 4, 2011

The Mind of the Master Class

In comments, Arin says,
my view of the world is that there were (at least) two distinct phases ... First was the emergence of a market for corporate control through hostile takeovers in the 1980s, which may have changed managerial incentives to basically ward off such possibilities. However, it didn't lead to greater power of shareholders over management ... consolidation and mergers over time ended up actually increasing managerial prerogatives. However, it was of course a very different type of management ... one whose incentives were quite aligned with short term capital gains which were also potentially helpful to ward off challenge for control... So yes, the market for corporate control changed the world - but ironically it changed it by passing more rents to managers, not less.
I don't know that I agree -- or at least, it depends what you mean by managerial prerogatives. Relative to workers, to consumers, to society at large? Sure. Relative to shareholders? I'm not so sure. But let's say Arin is right. I don't think it fundamentally changes the story. What I'm talking about isn't fundamentally a conflict between two different groups of people, but between two functions. Capital, as we know, is a process, value in a movement of self-expansion: M-C-C'-M'. The question is whether capital as a sociological entity, as something that act on its own interests, is conscious of itself more in the C moments or in the M moments. Do the people who exercise political power on behalf of capital think of themselves more as managers of a production process, or as stewards of a pool of money? The point is that sometime around 1980, we saw a transition from the former to the latter. Whether that took the form of an empowering of the money-stewards at the expense of the production-managers, or of everyone in power thinking more like a money-steward, is less important.

I heard a story the other day that nicely illustrates this. Back in the Clinton era, a friend of a friend was on a commission to discuss health care reform, the token labor guy with a bunch of business executives. So, he asked, why don't the Big Three automakers and other old industrial firms support some kind of national health insurance? Just look at the costs, look at how much you could save if you focus on making cars instead of being a health insurer. Well yes, the auto executives at the meeting replied, you make a good point. But you know, our big focus right now is on reducing the capital gains tax. Let's deal with that first, and then we can talk about health insurance.

If you're an executive in neoliberal America, you're an owner of financial assets first and foremost, and responsible for the long-term interests of the firm you manage second, third or not at all.