Arnold Kling  

Lectures in Macro, No. 2

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Unpresidential Remarks... Lectures on Macroeconomics, No...

I continue to focus on the issue of unemployment. In this lecture, I want to emphasize two things. One is the problems with popular intuition that jobs are scarce. The other is the wide variety of jobs, and hence labor markets, in a modern economy.

If you're paying $12, $13, $14 an hour for factory workers and you can move your factory South of the border, pay a dollar an hour for labor, hire young -- let's assume you've been in business for a long time and you've got a mature work force -- pay a dollar an hour for your labor, have no health care -- that's the most expensive single element in making a car -- have no environmental controls, no pollution controls and no retirement, and you don't care about anything but making money, there will be a giant sucking sound going south.
--Ross Perot, October 15, 1992

Ross Perot's famous warning that the North American Free Trade Agreement (NAFTA) would produce a "giant sucking sound" still rings in our ears. The implication was that free trade with Mexico would cause significant job losses in the United States. Despite Perot's warnings, President Clinton signed the agreement in January of 1994. Subsequently, employment in the United States increased steadily and dramatically, with the share of the working-age population employed reaching an all-time historical high in 2000.

The issue of whether trade costs jobs--or whether jobs are intrinsically scarce at all--is one that divides economists from non-economists. Bryan Caplan puts it,


The public often literally believes that labor is better to use than conserve. Saving labor, producing more goods with fewer man-hours, is widely perceived not as progress but as a danger. I call this the make-work bias, a tendency to underestimate the economic benefits of conserving labor. Where noneconomists see the destruction of jobs, economists see the essence of economic growth: the production of more with less.

Caplan has analyzed surveys of economists and non-economists in order to pinpoint differences. A persistent worry of non-economists is that better efficiency will cost jobs. This worry becomes particularly acute when the source of efficiency is trade, which registers with the public as "foreigners stealing our jobs."

Suppose that there were a central planner for an economy. People have unlimited wants. That is, consumers will always prefer having more goods and services available to having less. The central planner would never prescribe that some people not work. That is, the planner would never say, "We get enough from China. You can go home." Nor would the planner say, "Since we can now produce the same output with fewer workers, we will have some workers remain idle forever."

Instead, a central planner would find a use for all workers. The planner will move labor out of sectors where productivity growth exceeds demand growth and into sectors where demand growth exceeds productivity growth.

In the case of international trade, David D. Friedman in Hidden Order: The Logic of Everyday Life offers the illustration of growing cars in wheat fields. That is, instead of building cars in manufacturing plants, we can grow wheat, ship it overseas, and have the ships come back with cars. The car-growing process may require fewer auto workers, but those workers can be given other work to do.

In practice, central planners do not organize economies very well. There is often a lot of disguised unemployment in such economies, because people have little incentive to seek productive jobs.

In a market economy, prices and wages perform the function that in theory could be done by a central planner. When the economy needs to shift employment from manufacturing to health care (because productivity growth exceeds demand growth in the former but not the latter), wages will fall in manufacturing and rise in health care. When the U.S. economy needs to shift employment from customer call centers (which can be outsourced to India) to accounting, wages will rise in accounting and fall in domestic customer call centers.

As we saw in the previous lecture, millions of jobs are lost each month. But each month, millions of jobs also are gained. Some firms expand rapidly, and some firms cut back rapidly. The net differences between total monthly hires and total monthly separations are small.

In the 1990's, labor market policies in Europe were often geared toward stopping job losses. Ideas included a limited work week or penalizing firms for firing workers. The net result was higher unemployment and a lower share of the working-age population employed than in the United States. It turns out that the anti-job-loss policies make workers expensive to employ. As a result, they reduce new hires by more than they reduce job losses.

The fallacy is to confuse gross job losses with net job losses. A nation can have a large number of gross job losses without any net job loss, as long as additions to employment in expanding companies are at least as large as reductions in employment at contracting companies.

The overall key point is that the common intuition that jobs are scarce is dangerously wrong in many contexts. It leads to a fear of productivity gains. It leads to a particularly strong fear of the productivity gains that come from trade and comparative advantage. It leads to a faith in anti-job-loss policies that is counterproductive.

And yet, there is one context in which economists talk about job scarcity in the same terms as an ordinary layman guilty of make-work bias. That context is macroeconomics. When they talk macro, professional economists speak of the need to create jobs. Economists will grade Presidents on how many jobs are gained or lost during their administrations, rather than on, say, productivity growth during their tenure in office.

I worry that mainstream Keynesian macroeconomics is little more than fancy camouflage for make-work bias. That is, it allows economists to strike a sympathetic chord with non-economists, while maintaining an air of professional sophistication.

On the other hand, I worry that classical economics is vulnerable to appearing irrelevant in the face of episodes such as the Great Depression, the recession of 1980-1982, or the recession that looms at the end of 2008. We need a narrative of episodes of severe unemployment that does not embody crude make-work bias but does not deny the existence of large amounts of involuntary unemployment.

I suspect that a key to thinking usefully about macroeconomics is to shift from thinking in terms of a singular labor market to thinking about plural labor markets. One of the reasons I resist mathematical model-building is to avoid the temptation to specify the labor market, as if there were only one. My guess is that thinking in terms of one labor market puts you off track.

Think in terms of many labor markets, constantly in flux. Demand shifts across sectors, across firms, and across occupations. Even if the demand for accountants or computer programmers is rising on a secular trend, there will be failing firms that fire accountants and programmers.

Substitution mechanisms matter. It may be impossible for the same worker to walk off an assembly line one day and join a physical therapy practice the next. But the same change can be effected if an assembly-line worker reaches retirement age and is not replaced while a freshly-certified physical therapist reports to work for the first time the following day.

Some industries move quickly to add and subtract workers. In retail trade, firms hire for seasonal needs. There are always new stores opening and failing stores closing.

Other industries move more slowly. In manufacturing, the decision to add capacity or to take capacity off line is made cautiously. In law firms, investment banks, and other companies that employ highly-skilled workers, the decision to lay off an experienced professional is not taken lightly.

The economy is radically different today than it was in the 1930's, when the majority of the work force did manual labor. It is also different from the 1950's, when autos and steel were so significant that General Motors' Charles Wilson famously said that "What.s good for GM is good for the country, and vice-versa."

For further reading, I suggest browsing through the U.S. Department of Labor's Standard Occupational Classification web site. Particularly fascinating are Katherine Abraham's historical overview and the proposed structure for 2010, which highlights changes relative to 2000.

Previous entry in this macroeconomic lecture series: introduction


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COMMENTS (12 to date)
burger flipper writes:

Good stuff. Look forward to the rest.

Just started reading Hidden Order a couple days ago and am still wrestling with the heads I win, tails I win housing paradox.

Jaison writes:

Hey Arnold!

My question is that to you.. we are american
loosing our jobs and everything else is going down
hill. in recent months i have noticed that there are lots of people are from india and other countries they are coming here on H1B Visas (Working Visas). can you believe that? and do you have any solution for it? i think this got a stop
ASAP.

El Presidente writes:

This is where adopting Friedman's negative income tax frees us from the make-work bind. It's unpalatable for libertarians, but you can't have everything. The emphasis on employment that drives the make-work mentality is rooted in the concept that without work there is no income. So, for most people, being unemployed means being without the means to sustain one's self. If a person did not have to worry for their health and welfare, they would not demand employment. They might seek it, create it, expand it, but not because they were desperate for it. Our materialist preoccupation sets us up for this problem.

Microeconomists examine the relationship between labor and leisure using the wage as the pricing mechanism which binds them. They find that individuals have backward-bending utility curves. As the wage increases from zero, a person's desire to work increases and then decreases. This is instructive when we think about employment and unemployment. People are driven to work by material needs, but they are driven to not work by their needs for other things. If it were not so, the curve would not bend backward. Working less would be great if we still got paid as though we had worked. The imperative is to acquire income, not to have a job. It is the correspondence of the two in our economy that provide the constraint. As Brian recently pointed out, Gregory Mankiw acknowledges he is sated and thinks that he might stop taking additional work if marginal tax rates rise. So, we see the backward-bend in action. When individuals receive more capital-income instead of labor-income, their utility curve shifts, making work less attractive at any wage. As their incomes advance along a given utility curve, the wage (or income) is what determines the utility of any given amount of work.

fundamentalist writes:

Dr Kling should be very careful. He is dangerously close to describing the Austrian Business Cycle Theory.

Paul Gilmore writes:

Moving un-skilled labor off shore (or to Mexico) reduces mfg cost and benefits the consumer by reducing the costs of goods to the American consumer.

The down side is displacement of American factory workers who are removed from driving the US economy due to unemployment or reduced personal uncome.

If we continue to displace US workers in this manner, we need to create new jobs for these displace workers. One method is thru the use of fiscal policy.

Fiscal policy was in The Great Depression and happened in Raeagans era (although it was an unintended by product of Reagans Defense build up).

The Reagan Military build up began in 1981 and ended in 1989. The Reagan military build up created many high tech engineering and manufacturing jobs offering higher wages than other non-farm wages during the period. This industry sector contributed significantly to the US economy during the 1980’s.

I see a similarity between Barack’s proposed investment in Green Technology as to Reagan’s military build up.

Barack’s investment in Green Technology (if done right) would create high paying US jobs that could be the economic stimulus we need to turn the economy around.

This investment would return intellectual and physical capital to the US population by making us less dependent on foreign oil (as T. Boone Pickens says).

bob boyd writes:

it's wonderful how some comments serve to illustrate the non-economist's biases described in the orginal post.

Matt writes:

@fundamentalist

Disaggregating the models is certainly Austrian in spirit. However, Kling hasn't mentioned anything about manipulation of the interest rate 'fooling' entrepreneurs. In fact, he hasn't mentioned the interest rate at all, so I have a hard time seeing how this is "dangerously close" to ABC theory.

I suspect that Kling's intuition is that economic change + lots of different labor (and capital, and land) markets + various frictions preventing free movement of labor and capital (and, uh, land) = fluctuations and unemployment.

Bob Kozman writes:

You want us to think in terms of many labor markets, constantly in flux. But what if a whole sector goes down, say, General Motors? That many jobs involves a large chunk of a localized population.

Those people wouldn't integrate into other labor markets any more easily than the Katrina refugees integrated into their local environment. There would be lots of unemployed people, many of whom would not take the initiative to retrain. Some would be too old to start fresh, some don't have the flexibility to change.

A scarce job market in what used to be a large and thriving localized market would cause more than just unemployment problems. Then we would have a large area ripe for a crime and drug population.

MattYoung writes:

Egads on all the job categories!

Grant writes:

fundamentalist,

As Dr. Kling has posted earlier, he seems to think one of the major problems with the housing bubble was that too many houses were built. This is malinvestment in every sense of the word. However, I do not see why accepting that bubbles are clusters of bad business plans and investments must have anything to do with the Austrian description of how those errors come to be made in the first place.

Frédéric Schneider writes:

Dear Arnold,
it is true that perfect market conditions yield efficient allocations. However, the labor market is far from frictionless, it has idiosyncratic rigidities: not only is price adjustment imperfect (robust nominal wage rigidities in periods of low inflation impede real wage adjustments, e.g. Fehr/Goette 2005 in the JME); there are also inflexibilities due to the fact that individuals are neither infinitely mobile nor infinitely fast in re-training (i.e. in adjusting their human capital to the evolving demand for job qualifications). Hence, the labor market is intrinsically prone to inefficiencies which are at least worth to be mentioned in order not to sound too biased towards a particular standpoint.
Cheers,
Frédéric

fmb writes:

Is make-work a useful form of price discrimination necessary to make negative income taxes (or similar programs) more practical? I wish that it were not so, but fear it may be.

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