Arnold Kling  

Productivity, Inventory Recessions, and Recalculations

For Discussion... Missing Politics...

Nick Rowe notes that Spain and Ireland also have seen unusually high productivity, and hence high unemployment, relative to output during this recession.

Here's my guess. It's because all three countries had a big fall in construction. But what's so special about construction? My guess: construction workers have general human capital, not firm-specific human capital. Labour hoarding is what causes productivity to fall in a recession. And labour hoarding only makes sense when workers have firm-specific human capital.

The trouble is, declines in housing construction are characteristic of most U.S. post-war recessions, but many of those were associated with low productivity growth. My first thought is a different story, based on the difference between an inventory recession and a Recalculation.

An inventory recession means that you suddenly find yourself with too many cars on the lot (too many houses unsold, as well, which in turn means too many refrigerators, too many washing machines, etc.) This is typical of most U.S. recessions in through the 1970's. The workers you lay off are the workers who are making stuff, because you need to suspend making stuff in order to work off the excess inventories. You keep your overhead workers, and output per worker goes down.

The most recent two recessions--the Dotcom crash and the securitization crash--were not inventory recessions (we had a housing inventory recession in 2006-2007, but the really big overall economic hit came later). Think of them as financial shocks or recalculations. As a CEO, you worry about your firm surviving, so you focus on the balance sheet. You lay off your overhead workers in order to conserve cash. You try to restructure your organization. Output per worker goes up.

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COMMENTS (4 to date)
Nick Rowe writes:

Stephen Gordon has been doing some new graphs, showing construction employment over the recession in various countries. I think he will be posting them soon, on Worthwhile Canadian initiative.

They don't fit my story exactly. Ireland and Spain had very big declines in construction employment. Much bigger than the US.

Steve writes:

Does it make sense to talk about productivity if you're working in a Minksy-Jones model of the economy? If so, how would one measure gains to organizational capital?

The Unbeliever writes:

Surely a recalculation recession also causes producers to recalculate future demand, no matter which sector of the economy actually experienced the shock? ( Employment is then adjusted according to anticipated future inventory needs.)

I know the whole rational expectations idea has become a bit of a whipping horse when discussing inflation, or trying to justify QE2. But if we're going to posit economywide re calculations, then employers' calculations have to play a part.

david (not henderson) writes:

I think it's fair to expect as well that a Recalculation recession shortens time horizons - lots of "wait and see" and concern over firm survival, etc. The relevance of this is that management policies which raise productivity in the short run may not be the best policies to optimize productivity in the long run. Put another way, draconian measures work (or be acceptable to employees) in the short run but may not in the long run. In countries in which the crisis was less pronounced (e.g., Canada), more draconian measures may not have been perceived as necessary or economic.

I am also wondering what role relative price changes are playing. Obviously, excess demand and relative price incrceases are more likely in industries in which fewer people have been laid off. Quantity adjustments in excess supply industries have reduced the extent to which prices in those industries need to fall.

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