Arnold Kling  

More on Recalculation and Asymmetry

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James Hamilton writes,


I'd like to add a paper I published in 1988. There I presented a model in which unemployment arises from a drop in the demand for the output of a particular sector. The unemployed workers could consider trying to retrain or relocate, or might instead decide to wait it out in hopes that the demand for their specialized skills will come back.

If instead of a drop in the demand for sector A there was a boom in the demand for sector B, it is true that some workers in sector A might choose to retrain or relocate, and be temporarily unemployed as a result. But the key kind of unemployment that I think this sort of model describes-- waiting for an opening in the particular area in which you've specialized-- is caused by drops in demand, not increases.

Read his whole post.

Charles Davi writes,


Asset bubbles create value out of thin air. Price trends develop that deviate sharply from historical norms, and eventually a new, albeit temporary, norm is established. As a result, asset bubbles make the bubble-asset look like a much better investment than it will eventually turn out to be in the long term.

That story helps answer the question of why booms create jobs, but it does so in what amounts to a one-sector model. That is, over-optimism leads to excess capital, which in turn is going to increase the demand for labor.

The Recalculation story is a multi-sector model, in which unemployment results from workers being stuck in between sectors when shifts are required. The asymmetry question is why a boom in one sector is any less of a problem than a bust in that sector. If you have one steady sector and one cyclical sector, why is shifting workers out of the cyclical sector when it is slumping any harder than shifting them in when it is booming?

I have suggested that one asymmetry is that booms are long and slow, while busts are short and sharp, so that busts create more difficult adjustment problems.

Another asymmetry that has been suggested is that a boom takes place in a single, known sector, whereas the bust releases workers into a diffuse economy. In 1849, everyone knows to rush to California. When the Gold Rush ends, to which other state should workers retreat? However, I'm not sure that, in principle, it should be harder to be absorbed back into a diffuse economy than it should to be pulled out of it to pursue a bubble.

As an aside, John Haltiwanger reminded us at lunch today that his findings are that the most dramatic restructuring takes place within an industry, rather than between industries. In the 1980-1982 recession, integrated steel mills in the United States disappeared, while smaller mills emerged instead. This sort of recalculation goes on all the time, but it seems to happen faster during deep recessions. This suggests that the challenge for the market is not to figure out which new industry will grow but to figure out which firms in existing industries need to die and which firms in existing industries are poised to expand.

One way to think of this is that there are always firms in all sectors of the economy that are somewhat inefficient and barely profitable. A recession starts when a bust in one sector knocks out all the marginal firms in that sector, but the impact reverberates onto other sectors, where marginal firms get knocked out as well. The recovery takes place in the firms that were most promising and most efficient to begin with.

I think that the most dangerous habit that macroeconomists have have been drawn into is the habit of thinking that we have a cure for unemployment. It is always easy to say, "If the government followed my policies, unemployment would be a lot lower." And it is easy to rationalize afterward why those policies fail to achieve their promised results. It is hard to come forward and say that we may not have an answer, and harder still to get anyone to listen if that is your message.


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CATEGORIES: Macroeconomics




COMMENTS (13 to date)
winterspeak writes:

Hi Arnold:

How does your multi-sector model explain the dramatic drop across all sectors? How does it explain the road life of cars going from 10 years to 20 years?

(Financial accounting has a clear explanation for unemployment across the broad economy. It has to do with balance sheets.)

The closest you come to explaining this broad fall in, let's use the phrase: aggregate demand, is "reverberation". Can you help me understand what transmission mechanism is employed in these "reverberations" -- I'm guessing it is not sonic waves. Mackerel maybe? ; )

Also, now that you support a payroll tax holiday for business alone, help me understand how that dampens the reverberations.

Felix writes:

Speaking of asymmetry, note that in the '49er boom, there was clear knowledge running around. Everybody *knew* to go to California.

During a bust, who knows were to steer the jalopy? Hence, ain't no recalculating going on during a '49er boom. The calculations have already been done. Now it's time to use the numbers. "bust" implies "recalculating," by definition? Or lack of certainty or faith about what to do in the future.

Or else, "bust" sounds like at least two places. One place would be where the plant shuts down in a company town or where the rain stops in a farming area. The other would be a general pandemic of nobody, anywhere willing to pay people for new stuff.

It's worth noting that as the whole world connects up more and more, pandemics should show up more often.

"most dramatic restructuring takes place within an industry"

Less likely to lead one astray: Most dramatic restructuring takes place within companies neighboring other companies already dramatically restructuring? There aren't a lot of pure-industry companies. I'm reminded of something read in a magazine years ago: "McDonalds is not a restaurant company, it's a real estate company."

It'd be interesting to see two things:

1) A metric of "restructuring".

2) An image/map of 1000's of companies displaying their "restructuring" numbers. In real time. Sorta like the maps of the world showing countries re-sized according to various metrics.

Greg Ransom writes:

Some of these questions can be answered to a great degree with field research.

The facts are out there -- has any economist every done the leg work to find out who is moving from what jobs to what jobs during the artificial boom -- and who is losing what jobs and what sort of jobs they are looking for while unemployed during the inevitable bust?

Can Krugman be bothered to leave his multi-million dollar penthouse and study the actual world? Can't he hire some research assistants to do some field research on this.

Why isn't there a field research culture in "economic science".

The taxpayers spend multi-millions on economists, and economists can do some leg work in the field?

Isn't a little leg work in the field just the thing that allowed Coase to understand the world enough to revolutionize economic science?


Greg Ransom writes:

The original recalculation "story" is exactly a multi-sector (heterogeneous capital) over-optimism story that distorts the heterogeneous structure of production across time. See F. A. Hayek (1929) _Monetary Theory and the Trade Cycle":

"Asset bubbles create value out of thin air. Price trends develop that deviate sharply from historical norms, and eventually a new, albeit temporary, norm is established. As a result, asset bubbles make the bubble-asset look like a much better investment than it will eventually turn out to be in the long term.

That story helps answer the question of why booms create jobs, but it does so in what amounts to a one-sector model. That is, over-optimism leads to excess capital, which in turn is going to increase the demand for labor."

The Recalculation story is a multi-sector model .."

Will writes:

Have you read Schumpeter's Theory of Economic Development? The final chapter of that book, on business cycles, is essentially the recalculation story, if you are interested in reading it some time. Basically, entrepreneurs pull resources out of their habitual use to produce new combinations, and this puts pressure on existing firms with inferior methods. This disrupts the "economic data" in the system, which inevitably leads to a depression, where all of the participants in the economic system need to figure out new rules of thumb.

Marcus writes:

Not being an economist perhaps this is obvious to everyone else but me yet, why isn't increasing leverage during the boom and decreasing leverage during the bust not part of the recalculation story?

As leverage increases purchasing power increases. I understand that if the money supply stayed constant then any increase in leverage in one part of the economy would have to come from an increase in savings in another. But does the money supply stay constant?

fundamentalist writes:

winterspeak: "How does your multi-sector model explain the dramatic drop across all sectors?"

I haven't checked this depression yet, but I'll bet you find that unemployment is concentrated in capital goods industries (autos and housing for example) and the industries that service them (engineering and banking). That's the Austrian business cycle forecast and it has proven reliable for decades.

Marcus: "why isn't increasing leverage during the boom and decreasing leverage during the bust not part of the recalculation story?"

Actually, I think it is. It's part of the Austrian theory.

I think Hayek describes the main asymmetry between booms and busts in "Profits, Interest and Investment" by the specificity of capital and labor. Non-specific capital like inventory or raw materials that can be used in many stages of production and is liquid so that it can be converted to cash quickly and easily. Specific capital is what we think of as fixed capital, like buildings and heavy equipment. During the boom, liquid capital gets turned into fixed capital easily. But in the bust, converting fixed capital to liquid capital is almost impossible; the fixed capital just loses value, which means savings and wealth are destroyed.

Specific labor is labor that requires specific capital in order to work, and has specialized skills that can't easily be transferred to another industry without significant retraining.

Greg Ransom writes:

"why isn't increasing leverage during the boom and decreasing leverage during the bust not part of the recalculation story?"

Read Hayek's _Monetary Theory and the Trade Cycle_ ....

Joshua Sharf writes:
If you have one steady sector and one cyclical sector, why is shifting workers out of the cyclical sector when it is slumping any harder than shifting them in when it is booming?

I think it is harder. Employers in the cyclical sector may well be willing to lower standards as it booms, while those in the steady sector have no incentive to do so when the cycle busts. Employers know that workers (well, some workers), can learn on the job, and be productive even as they learn. As a web developer, I've repeatedly benefitted from this tendency.

fundamentalist writes:

If you have one steady sector and one cyclical sector, why is shifting workers out of the cyclical sector when it is slumping any harder than shifting them in when it is booming?

If the only info you have is that one sector is steady and the other is cyclical, then you can't answer that question because you don't have enough information. As Greg suggests, economists need to do some leg work.

Some sectors aren't hard to shift between. For example, truckers often switch to construction work and back. But some sectors are harder, engineering, for example. I remember in the 1970's when thousands of aircraft engineers got laid off and some found work pumping gas. But most held out as long as they could for some type of engineering job. A few could be retrained at some other kind of engineering, but many had to go back to school for a couple of years and learn a new field.

Also, as Hayek pointed out, most modern day workers have to have capital to work with; for example truckers need a truck. If capital is wasted in the boom, then it takes a while for other industries to save, and for consumers to save, so that their are funds to invest in new capital so more workers can become employed.

Capital intensive production has enable more people to work and has fed more people than ever before in history, but the downside is that when capital gets destroyed in the boom, labor goes unemployed until capital gets rebuilt

Greg Ransom writes:

Fundamentalist -- I was just reading this stuff earlier in the weak. It's funny, but writers on Hayek and "Austrian" cycle theory seem not to know this exists:

"Hayek describes the main asymmetry between booms and busts in "Profits, Interest and Investment" by the specificity of capital and labor. Non-specific capital like inventory or raw materials that can be used in many stages of production and is liquid so that it can be converted to cash quickly and easily. Specific capital is what we think of as fixed capital, like buildings and heavy equipment. During the boom, liquid capital gets turned into fixed capital easily. But in the bust, converting fixed capital to liquid capital is almost impossible; the fixed capital just loses value, which means savings and wealth are destroyed."

Tyler Cowen and Paul Krugman -- stop trashing economics you don't know, and read a book !!

fundamentalist writes:

Greg, the more I read of Hayek the more astounded I am at how much economics he knew that modern economists don't. It will take another century for mainstream economics to catch up to Hayek.

tjames writes:

Just a couple of asymmetries from the viewpoint of the individual worker.

First, from that standpoint, there is a psychological asymmetry. During the boom, workers are presumably moving up the compensation ladder as they leave jobs and move into the booming industry. During a bust, many laid off workers are making their decisions always with an eye on their old jobs (and compensation), hoping that might come back, rather than figuring *any* job paying more than unemployment is better than what they have in hand.

Also, from a financial standpoint, many individuals who move 'up' in a boom also leverage up to match their new compensation (bigger house, better car, more credit card debt, etc). This is not easily reversed, leading to hardship and bankruptcies on the way down.

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