Redirect


This site has moved to http://economistsview.typepad.com/
The posts below are backup copies from the new site.

September 1, 2009

Economist's View - 4 new articles

"Job Losses are Not the Problem"

Why has the rate of both job creation and job destruction been falling in recent years?

Job Losses Are Not the Problem, by Andy Harless: It is sometimes argued that recessions benefit the economy by allowing the destruction of old, inefficient economic structures so that newer, better ones can be created to replace them. On the surface, this story might seem to apply to the recent recession: ostensibly, a lot of useless jobs in finance, real estate, and construction were destroyed, as well as perhaps old manufacturing jobs that hadn't caught up with the latest technology, and jobs in retail trade that needed to be replaced by the Internet, and so on. But there's one problem with that point of view: overall (at least during the first four quarters of the recession, up through the end of 2008, for which we have the relevant data), there weren't an unusually large number of total jobs being destroyed.
But...but...but...haven't we been hearing about large numbers of job losses month after month since the recession began? Sort of. We've been hearing about large numbers of net job losses. That is, the number of jobs that have been lost has been a lot more than the number that have been created. And a lot of job losers have ended up collecting unemployment insurance for a long time, sending the figures for continuing claims up to records, instead of getting new jobs. But the gross number of jobs being destroyed has not been unusually large. In fact, relative to the overall level of employment, job destruction was happening at a faster rate during the boom of the late 1990s than it was during the last quarter of 2008.
How can that be? For one thing, when you take out the business cycle, there seems to have been a general downward trend in the rate of job destruction over the past 10 years. More important, the rate of job creation also had a downward trend, and it dropped to new lows during the recession of 2008. If you lost a job in 1999, you weren't actually all that atypical, but it wasn't a big problem, because typically, you could find a new job fairly easily. If you lost a job in 2008, you were (typically) out of luck.
Source: Business Employment Dynamics data from the Bureau of Labor Statistics
The fact is, job creation and job destruction take place during booms at rates that are not dramatically different from the rates during recessions. It's just the difference between the two that changes. In a typical boom quarter, about 7 million jobs are destroyed, and about 8 million are created. In a typical recession quarter, about 8 million are destroyed and about 7 million are created. There just isn't much support for the idea that recessions give us a special ability to reallocate resources more intensely than we do during a boom or a period of normal growth. "Creative destruction" is a dynamic process that continues all the time, not one that occurs in separate phases of creation and destruction.
And the most salient feature of the current episode is that there has been unusually little creation. From the 1990's to the 2000's, the quarterly job creation rate fell from about 8% to about 7%. Since 2006, it has fallen to about 6%.
Some might argue that this type of slowdown in job creation is inevitable during times of structural change and that it is useless to try to oppose it with monetary and fiscal policy. It takes a long time (Arnold Kling, for example, would argue) for the economy to come up with ideas for new, productive uses of resources when the old uses are no longer productive. Monetary and fiscal policies can't do much to speed up this process. They can't make entrepreneurs more creative.
I'm skeptical of that view: entrepreneurs were plenty creative during the 90's, once the booming stock market gave them a reason to apply their creativity. Monetary policy really did help speed up the process of finding new uses for resources: low interest rates led to high equity prices, which made it easy to raise capital and thereby made it advantageous to find new ways of using capital. Some would say the process went too fast in the end, with a large fraction of the uses proving ultimately unproductive, but statistics show aggregate productivity rising rapidly and continuing to rise during the subsequent years, even (atypically) during the recession that immediately followed the boom. There may have been a lot of froth, but there was plenty of good beer underneath, and monetary policy is what opened the tap.
In any case, even if I were to concede that monetary and fiscal policies don't help speed up the adjustment process, they do help us get the most out of the economy in the mean time. With nearly 10 percent of the labor force unemployed, there are a lot of resources being wasted – people spending their time looking for jobs that many of them just aren't going to find until we get a lot more economic activity. There are plenty of useful things that those people could be doing in the mean time.
Perhaps more important, monetary and fiscal policies help us reduce the risk that a weak economy – too weak for too long – will fall into a deflationary spiral. As long as job creation remains weak, employers have little incentive to raise wages, and competition will tend to push down prices. Even an "artificial" stimulus, one that doesn't accelerate the structural adjustment process, will create a demand for labor and force employers to compete somewhat for workers. That competition, in turn, will prevent them from competing too aggressively in product markets and keep prices reasonably stable.
There is, of course (in theory, at least), the risk that policies will go too far and not just prevent deflation but produce excessive inflation. As I have argued before, we are nowhere near that point right now. I made the case against inflation using mostly the unemployment rate, but the case becomes even stronger when you consider the job creation statistics. This unemployment is specifically being induced by a slowdown in job creation. Job creation is specifically what leads to inflation: it's when companies want to hire aggressively that they start raising wages excessively and competition becomes unable to keep prices in check. If unemployment – which arguably has a more tenuous relationship to inflation – is far, far away from the danger point, job creation – which has a direct relationship to inflation – is even further away.

Quick reaction (I had hoped to say more about the decline in the rates of job creation and destruction, but that will have to wait, so your thoughts on this are welcome):

I think both monetary and fiscal policy can help with restructuring, as noted above monetary policy can increase the return on projects and thus creates an incentive to find "new, productive uses of resources." Fiscal policy can, both literally and figuratively, pave the way for those projects to come to fruition.

But, though fiscal policy in particular could have been devoted more toward helping labor and other resources make the transitions to new industries, and perhaps more could have been done to help with the creation of new opportunities, the main point I want to make is that we should distinguish between cyclical and structural unemployment. Much of the unemployment we are seeing is due to the business cycle, it has little to do with the need to restructure the economy, and both monetary and fiscal policy can be of great help with this problem. I don't know for sure how much of the change we are seeing is structural and how much is cyclical, but I am willing to assert that most of the change in unemployment is a cyclical rather than a structural phenomena. Thus, "even if I were to concede that monetary and fiscal policies don't help speed up the adjustment process," though I see no reason to concede this, it only speaks to the ability of these policies to help with structural adjustment, monetary and fiscal policy are still very much needed to deal with the unemployment related to the business cycle.


Ideas versus Discipline

"This is just the latest chapter of a long saga":

The Guns of August, and Why the Republican Right Was So Adept at Using Them on Health Care, by Robert Reich: What we learned in August is something we've long known but keep forgetting: The most important difference between America's Democratic left and Republican right is that the left has ideas and the right has discipline. Obama and progressive supporters of health care were outmaneuvered in August -- not because the right had any better idea for solving the health care mess but because the rights' attack on the Democrats' idea was far more disciplined than was the Democrats' ability to sell it.
I say the Democrats' "idea" but in fact there was no single idea. Obama never sent any detailed plan to Congress. Meanwhile, congressional Dems were so creative and undisciplined before the August recess they came up with a kaleidoscope of health-care plans. The resulting incoherence served as an open invitation to the Republican right to focus with great precision on convincing the public of their own demonic version of what the Democrats were up to -- that it would take away their Medicare, require "death panels," raise their taxes, and lead to a government takeover of medicine, and so on. ...
This is just the latest chapter of a long saga. Over the last twenty years, as progressives have gushed new ideas, the right has became ever more organized and mobilized in resistance -- capable of executing increasingly consistent and focused attacks, moving in ever more perfect lockstep, imposing an exact discipline often extending even to the phrases and words used repeatedly by Hate Radio, Fox News, and the oped pages of The Wall Street Journal ("death tax," "weapons of mass destruction," "government takeover of health care.") I saw it in 1993 and 1994 as the Clinton healthcare plan -- as creatively and wildly convoluted as any policy proposal before or since -- was defeated both by a Democratic majority in congress incapable of coming together around any single bill and a Republican right dedicated to Clinton's destruction. ...
You want to know why the left has ideas and the right has discipline? Because people who like ideas and dislike authority tend to identify with the Democratic left, while people who feel threatened by new ideas and more comfortable in a disciplined and ordered world tend to identify with the Republican right. Democrats and progressives let a thousand flowers bloom. Republicans and the right issue directives. This has been the yin and yang of American politics and culture. But it means that the Democratic left's new ideas often fall victim to its own notorious lack of organization and to the right's highly-organized fear mongering. ...
August is coming to a close, and congressional recess is about over. History is not destiny, and Democrats and progressives can yet enact meaningful health care reform... But to do so, we'll need to be far more disciplined about it. All of us, from Obama on down.

[On another issue - people "who like ideas and dislike authority" are the types who tend to end up in universities, so this would also explain how self-selection could lead to a disproportionate number of Democrats in academia.]

Update: Andrew Samwick says this all sounds familiar:

Robert Reich Is Having Deja Vu, Too, by Andrew Samwick: But he doesn't quite realize it. In his latest post..., he laments the way Democrat "ideas" couldn't persevere against the onslaught of Republican "discipline." Change a few details, and he's talking about failed Social Security reform in 2005:

I say the Democrats' "idea" but in fact there was no single idea. Obama never sent any detailed plan to Congress. Meanwhile, congressional Dems were so creative and undisciplined ... they came up with a kaleidoscope of health-care plans. The resulting incoherence served as an open invitation to the Republican right to focus with great precision on convincing the public of their own demonic version of what the Democrats were up to... The Obama White House -- a veritable idea factory brimming with ingenuity -- thereafter proved unable to come up with a single, convincing narrative to counteract this right-wing hokum. Whatever discipline Obama had mustered during the campaign somehow disappeared.

Being "coherent" enough to overcome "hokum" ought to be the minimum standard for legislation on this scale. Like it or not, if you want to use the tools of a democratic government to reorganize markets for health care, you need more than an idea factory and staged townhall meetings. You need some discipline yourself. And we're not talking about Ironman triathlon level discipline. We're only talking about government level discipline: white papers, Congressional hearings, and, critically, a forum in which the ideas in the bills that are moving through Congress are shown to be better ideas than the alternatives. We haven't seen that at all. In particular, show me why the bills moving through Congress, with all of their attendant costs, are better than a simple reform consisting only of:

  1. Community rating
  2. Guaranteed issue
  3. Ex post risk adjustment
  4. An individual mandate, with Medicaid for a fee as the backup option

And spare me the whining about how the Republicans don't have a better plan. They don't have the White House. They don't have the Senate. They don't have the House. They don't have to have a better argument than the claim that the Democrats' plan isn't better than the status quo. It's not as if the Democrats shot down Social Security in 2005 and have now done something better.


Triple Time-Inconsistent Policy

The middle of a financial crisis is the wrong time to try to reestablish credibility:

Dumping Russia in 1998 and Lehman ten years later: Triple time-inconsistency episodes, by Guillermo Calvo, Vox EU: In the last decade we have witnessed two major systemic financial crises, namely, the 1998 Russian crisis and the current crisis, the latter initially associated with the subprime mortgage market (henceforth, subprime crisis). A critical event in the subprime crisis was the Lehman Brothers' episode in September 2008. Lehman's collapse, coming on the heels of the sell-off of Bear Stearns, took the market by surprise. The ensuing about-face regarding AIG was perhaps less surprising but still added a heavy dose of policy uncertainty.

Many observers have been critical of that erratic policymaking and see it as directly responsible for the worldwide collapse of stock markets and near panic that took place soon afterwards. Repeated bouts of time inconsistency – as I will characterize this type of episode – have also been argued to have triggered the spreading of the Russian crisis across most emerging market economies in August 1998. As the argument goes, the market was aware that Russia was facing an unsustainable fiscal deficit before August but it was expecting that if a run against Russian public debt obligations materialized, the IMF and other multilateral institutions would rise to the occasion and bail them out. One often-heard reason for this was that Russia was "too nuke to fail." However, the bailout did not happen, Russia was forced to default and, as if coordinated by a magic wand, the JP Morgan EMBI for all emerging markets went through the roof, with the average interest spread exceeding 1500 basis points. This episode raised fears that Brazil – Latin America's kingpin – would follow suit and collapse, and apparently led the IMF to soften its stance and extend a very generous standby loan to Brazil on the basis, according to rumour, of skimpy fiscal account information – likely lowering IMF's credibility as enforcer of market discipline.[1]

These episodes are cases of what one might call "triple time inconsistency". First, a public institution is expected to depart from earlier statements and offer a bailout to prevent a major crisis (this is the first round of time inconsistency); then, in an attempt to regain credibility, the bailout is pulled back (the second round) and, finally, having witnessed the wreckage caused by the policy surprise, it resume bailouts of the still-standing dominoes (third round). This seesaw policymaking cannot be right. The initial refusal to continue offering bailouts can only be justified as a warning signal to market players against getting involved in situations in which they will need a bailout. But this "investment in credibility" goes to waste as the policymaker chickens out and bailouts resume.

The example below aims at making these intuitions more precise. I think the effort is worth it, given that the similarity between the episodes highlighted above suggests that the phenomenon is likely to repeat itself unless we better understand it and develop ways to prevent it. I would like to point out, however, that the example focuses on the costs of different rounds of time inconsistency but stops short of addressing the policy uncertainty generated by policies that are not in line with private-sector expectations. The latter is a major task that requires more substantive research.

A simple model of "triple time-inconsistent" actions

Consider an economy with a two-period time span: today and tomorrow. Individuals have an output endowment today that they could consume or allocate to capital accumulation. This is the only decision that they have to make today. Tomorrow's output can be produced by two independent technologies: (1) output proportional to the capital stock (which is predetermined as of tomorrow) and (2) output proportional to labor supply (which individuals will choose tomorrow as a function of the wage rate net of taxes). Net (consumable) income is output minus taxes. Taxes are of two types: (1) a tax proportional to capital holdings and (2) a tax proportional to wages. The government collects taxes in order to pay back outstanding debt. In a fully conventional way, I will assume that social welfare depends on today's consumption, tomorrow's consumption, and tomorrow's leisure.

From today's perspective, the two taxes are distorting. The capital tax distorts allocation between consumption today and tomorrow, and the wage tax distorts the allocation between consumption and leisure tomorrow. Therefore, it is intuitive that there should be a robust set of cases in which optimal taxation from the perspective of today calls for setting positive taxes on capital and wages. However, if a benevolent government is free to reset taxes tomorrow, it will set the wage tax equal to zero and finance government expenditure entirely out of capital taxes (assuming that government expenditure does not exceed the value of the capital stock). This is because tomorrow the capital accumulation decision has already been taken and there is no output or welfare cost (i.e., no distortion) involved in changing the tax on capital. Thus, there are solid grounds for individuals to expect that a benevolent government will be time inconsistent and that government expenditure will be fully financed from capital taxes. This outcome, of course, is suboptimal from today's perspective but, unless institutional constraints bar a benevolent government from engaging in time inconsistency, once tomorrow arrives, the best available policy will take that form (This suboptimality of time-inconsistent policy is well known; see Kydland and Prescott 1977 and Calvo 1978).

Let us consider the case in which the private sector has reached the conclusion that the government will follow the time-inconsistent optimal policy (in the above-mentioned episodes this would correspond to the cases in which, counterfactually, the IMF bailed out Russia in 1998, and the Fed/Treasury bailed out Lehman Brothers in 2008) and suppose that, contrary to those expectations, the government decides to stick to today's announcement and avoid the first round of time inconsistency. Notice that tomorrow's economy is already exhibiting the effects of expected time inconsistency. Therefore, in that context, from the private sector's point of view, the government not behaving in a (first round) time-inconsistent way boils down to a second round of time inconsistency. Could this be optimal? The second round of time inconsistency takes place tomorrow when the cost of lower capital accumulation (as a result of expected first round of time inconsistency) has already been incurred. Thus, the best policy from tomorrow's perspective is to eliminate wage taxation; in other words, to behave as expected by the private sector. In this simple model, the second round of time inconsistency pointlessly reduces welfare. In a richer and more realistic model, though, the second round of time inconsistency may have some redeeming value because it could send a strong signal that the government is prepared to incur severe costs to ensure the credibility of time-consistent policy. But the third round of time inconsistency (corresponding to the about-face after failing to bailout Russia and Lehman Brothers) destroys the credibility investment in one fell swoop.

Improving public policy responses

It is far from me to chastise or ridicule those involved in triple time inconsistency. There are always good reasons why bright and well-intentioned public officials make serious mistakes during major crises. The two cases singled out in this note took place in arguably "unprecedented" circumstances. In situations like these, "shooting from the hip" becomes the rule, and errors are to be expected. However, I believe that there are at least two lessons that we could draw from these episodes, which could help to lower the incidence of triple time inconsistency and other inefficiencies:

  • A financial crisis is not the best time for reform or building credibility, especially if those actions go against the private sector's expectations. Policymakers should focus their attention on putting out the fires and minimize the short-run social costs.
  • Policymakers should spend more time discussing worst-case scenarios before crises occur. These discussions should be carried out with some regularity (much like fire drills) and involve a wide spectrum of public officials that might eventually have to be involved in rescue operations during crisis. This will ensure a better understanding of the involved risks and tradeoffs, and improve the effectiveness of policies that need to be implemented in the spur of a moment.

References

Calvo, G. (1978), "On the Time Consistency of Optimal Policy in a Monetary Economy," Econometrica 46, pp. 1411-1428.

Calvo, G. (2005), Emerging Capital Markets in Turmoil, Cambridge, MA: MIT Press, Chapters 5 and 12.

Kydland, Finn E. and Edward C. Prescott (1977), "Rules Rather than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, 85, 3, June, pp. 473-492.


links for 2009-09-01

No comments: