Arnold Kling  

Recalculation, Normal Churn, and Deficient Demand

PRINT
Some Thoughts on Monetarism... A Glimmer of Hope on Freedom...

Karl Smith looks at gross job flows and ask whether they support or refute the Recalculation Story.

We can think of three reasons for people to lose jobs. First, normal churn, in which people shift out of declining firms and into expanding firms, with no net job loss. Second, deficient demand, where people are laid off from viable firms because of a drop in aggregate demand. Finally, Recalculation, in which nonviable firms have expanded by mistake, they shed workers, and the economy needs to figure out where those workers should go.

How do we distinguish Recalculation from the other two?

According to John Haltiwanger, much normal churn is intraindustry. Think of the large, integrated steel mills disappearing from the U.S., while mini-mills grow. Or think of the decline of many local retailers, and the expansion of Walmart and Costco.

A demand-driven decline and recovery ought to see mostly intra-industry (or even intra-firm) fluctuations in employment. The automobile industry and its suppliers lay off workers in a recession, and they recall them in a recovery.

With a Recalculation, the main employment change is across industries. Workers in overbuilt industries lose jobs permanently, and employment gains occur in new industries, with a lag.

Normal churn is not preceded by any imbalance or miscalculation. As a result, flows into jobs and flows out of jobs are such that we maintain full employment.

Demand-driven recessions are driven by inventory miscalculations (failure to forecast sales correctly). Workers are laid off when inventories get too high, and they are recalled when the excess inventory is worked off.

Recalculation is driven by excess capacity that is built up based on unsustainable expectations. Nowadays, excess capacity consists of human capital, not just physical capital.

Remember the Garett Jones point that many workers nowadays build organizational capital, not widgets. In the information age, hiring workers is an act of investing in capacity, analogous to building a new factory in the industrial age. Call the information worker a worker-factory. Old-fashioned workers are assembler-workers. They are part of variable cost. Modern worker-factories are part of short-run fixed cost.

With (temporarily) deficient demand, worker-factories are not affected. Instead, assembler-workers are laid off until balance is restored between supply and demand.

During normal churn, worker-factories at some firms get shut down, but not because they were hired by mistake in the first place. Technological change creates a need for worker-factories in some firms and obsolescence in others.

Recalculation results from big mistakes. In addition to shutting down old, obsolete worker-factories, you have to shut down some of the newest worker-factories. These new worker-factories were brought in as part of an unsustainable expansion (think of the Doctoms of the late 1990's or the real estate trading and finance industry of 2003-2007). When reality hits everyone over the head, these uneconomical worker-factories get torn down. It takes a long time to rebuild them somewhere else.

Another source of Recalculation may be an acceleration in churning, beyond what "normal churn" can handle. I think this may be part of the story of the Great Depression. The amount of economic realignment caused by the internal combustion engine ultimately was huge. You used to have factories and people in central cities, with farms on the fringe. You wound up with offices in central cities, people in suburbs on the fringes of cities, and farming concentrated in areas far from where the food was processed and eaten.

A source of the current Recalculation is the Internet. It is changing the nature of retailing and advertising, with impacts on newspapers and other media. We may be dealing with a lot more churn than we would have had to deal with prior to the advent of the Internet.

I am sure this description still leaves many questions unanswered. But I'll stop there.


Comments and Sharing


CATEGORIES: Macroeconomics




COMMENTS (5 to date)
Steve writes:

Sometimes I think of economic competition being similar to natural selection. It sounds like the normal churn you discuss is akin to the gradual evolution that Darwin witnessed with the finches on the Galapagos, whereas your Recalculation is more akin to a Stephen Jay Gould point of punctuated equilibrium.

Boonton writes:

You're getting better developing this recalculation idea. One thing I'm seeing from this post is that recalculation makes sense as part of the story, not the whole thing.

I think we are experiencing a depression caused by a financial panic. Recalculation is part of the story but only indirectly. Recalculation is coming in the form of a paradign shift as people lower their consumption, increase their savings and lower their use of credit. I suspect that shift is not short term but long term.

The panic from recalculation is the fear that there is 'no answer'. That thousands of workers who become unemployed will have no 'new idea' to score jobs in. This causes an accross the board demand driven job loss accross the economy.

I think the dot-com bust is interesting because it illustrate a recalculation scenaro without the demand panic. Yes there was a small recession and some unemployment but the economy recovered quickly. Recalculation may very well be a feature of the economy but its not in itself the cause of Depressions.

This is why I think you're attempt to depict the Great Depression as a 'recalculation' away from agriculture and towards manufacturing fell short. There was already a shift in the previous two decades towards manufacturing and away from agriculture (the roaring 20's were not a great period for farming).

Here's another consideration. If the economy can suddenly decide it made a big mistake, why couldn't it suddenly get 'cold feet'? Why couldn't it, in say 1929, suddenly get nervous about moving so far away from farming? Even though that was the 'right decision' it seems to me 'cold feet' could likewise cause a recalculation crises as the economy puts itself on hold to decide if it really is heading in the right direction.

At the end of the day, recalculation continues to seem more like a dressed up version of Keynes's animal spirits to me. The economy is rational but it is impossible to predict the future rationally. As a result future investment depends to a certain degree on blind hope. When that is absent, the economy gets hiccups. You can call that recalculation if you feel uncomfortable with terminology sounds unmathematical but are you really giving us a new idea or just a new name?

jsalvatier writes:

Except you didn't answer his question at all. Karl Smith noted that the increase in unemployment seemed to be mostly caused by a reduction in the hiring rate rather than an increase in the firing rate. However, you say the opposite in your story "Workers in overbuilt industries lose jobs permanently, and employment gains occur in new industries, with a lag. " He challenged you to explain this.

MikeM writes:

"At the end of the day, recalculation continues to seem more like a dressed up version of Keynes's animal spirits to me. The economy is rational but it is impossible to predict the future rationally. As a result future investment depends to a certain degree on blind hope. When that is absent, the economy gets hiccups. You can call that recalculation if you feel uncomfortable with terminology sounds "

Actually, although he continually denies it, Kling's recalculation theory is a restatement of the Austrian Business Cycle Theory. The restatement isn't in explicitly Austrian terms so it's easier for him to deny the relationship, but it's certainly there. I'm trying to do something similar(restate the ABCT in terms that mainstream economists can understand)), myself, but with significantly less parsimony than Kling.

Philo writes:

"[M]uch normal churn is intraindustry." But much is not. It is normal for some industries to be declining and others expanding.

"Recalculation is driven by excess capacity that is built up based on unsustainable expectations." Or by deficient capacity, resulting from too-negative expectations? There seems no theoretical reason to focus exclusively on "irrational exuberance," to the exclusion of "irrational pessimism."

"Recalculation results from big mistakes." Or from little mistakes (perhaps *a lot* of little mistakes)? It seems that the distinction between "normal churn" and "recalculation" is simply a matter of degree.

Does Smith have a point, that jobs data fail to support the Recalculation Story about the present recession? (I don't know how he is measuring "gross" job gains/losses.)

Comments for this entry have been closed
Return to top