Arnold Kling  

Larry Summers vs. PSST

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He gives us a double whammy. He writes in the Financial Times,


That the problem in a period of high unemployment, as now, is a lack of business demand for employees not any lack of desire to work is all but self-evident, as shown by three points: the propensity of workers to quit jobs and the level of job openings are at near-record low; rises in non-employment have taken place among all demographic groups; rising rates of profit and falling rates of wage growth suggest employers, not workers, have the power in almost every market.

He writes in the Washington Post,

Pressure on private spending is enhanced by structural changes. The publishing industry provides a vivid example. As local bookstores have given way to megastores, megastores have given way to Internet retailers and Internet retailers have given way to ebooks, two things have happened. The economy's productive potential has increased and its ability to generate demand has been compromised as resources have been transferred from middle-class retail and wholesale workers with a high propensity to spend up the scale to those with a much lower propensity to spend.

Obviously, Summers is using the AS-AD paradigm and not the PSST paradigm. In the first quote, all it takes to convince Summers that we have a demand problem is the fact that the unemployed are willing to work. The PSST paradigm would say that the problem is that we have not established patterns of sustainable specialization and trade in which those workers have high marginal revenue product. The industries in which they are to work have yet to be discovered.

In the second quote, Summers recognizes that structural change is taking place. However, he sees it as a problem with aggregate demand. Incomes are being shifted to people who spend less.

In the AS-AD framework, the solution is simple. Raise aggregate demand. In the PSST framework, it is not so simple. The challenge is for entrepreneurs to discover new industries, and for workers to adapt.


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CATEGORIES: Macroeconomics



COMMENTS (14 to date)
Lewis writes:
In the AS-AD framework, the solution is simple. Raise aggregate demand. In the PSST framework, it is not so simple.

According to PSST, what would happen if the government were to raise aggregate demand?

Thomas DeMeo writes:

I think you should spend more time thinking about solutions. Consider the publishing industry. The sustainable model, where content is fully digital, is not something to be "discovered". The new model is obvious and in plain sight. The transition requires a very large number of accommodations between stake holders. A concoction of changes in technology, logistics, standards, laws and contractual modifications must take place.

ThomasL writes:

@Lewis

If the government is successful, it will be compelled to continue pouring in the stimulus without end, because it is propping up products people don't really want at the price they cost to produce, or in the quantity they are being made available.

So, you can perhaps subsidize it to the point that the price goes down and demand goes up, but the second you remove that subsidy, the demand collapses, and the workers in those industries would still have to find new jobs in other sectors.

Lewis writes:

@ThomasL I mean broadly raising aggregate demand without regard to particular products. There are ways government can raise nominal spending, such as tax cuts and monetary policy, that leave the actual targets of higher spending up to consumers and businesses. If government raises nominal spending back to trend or to a previous level but people are free to choose which products to purchase, I'm not sure why the industries that produce those products are "unsustainable."

I am wondering if PSST claims higher nominal spending, amid a huge structural adjustment like ours, is either (a) impossible or (b) leads to inflation in a one-to-one fashion such that RGDP is unchanged. I question this because I can just as easily see higher aggregate demand facilitating a structural adjustment as forestalling it.

Philo writes:

Why not combine these frameworks? The government (preferably through monetary policy) can raise aggregate demand, and at the same time entrepreneurs can enterprise and workers can adapt. VoilĂ --prosperity returns!

Jon writes:

Where is the evidence that says income is shifting to people with a higher propensity to accumulate cash balances?

Summers appears to be playing a word game as he surely knows that savings in Keynesian models is cash not merely the lack of consumption spending.

kebko writes:

That second quote is bothersome. If more books are being read than ever, but they require fewer resources and employment, AD isn't the problem. The way Mr. Summers is measuring output is the problem.

Seth writes:

"The way Mr. Summers is measuring output is the problem." -kebko

I agree. I believe the problem lies in the assumption that GDP growth is a valid measure of economic health.

I think it might be more valid if the coefficient on G was -2.

ThomasL writes:

@Lewis

I don't know if PSST does, but I certainly think it is a reasonable concern.

Fiscal spending has the complication of partiality, by legislatively picking the recipients of the funds. If that were not directed toward unsustainable sectors, where there exists a purported "slack", then it implies the ability to centrally plan the economy.

Printing money is also partial, as the early recipients are preferred to the later. And since it raises nominal GDP, not real GDP, that Cantillon aspect effects a transfer not an increase.

Tax expenditures have something of the same partiality problems, (eg, in practice always targeting lower income brackets as those "most likely to spend" rather than everyone equally, which, since so many people pay no taxes at all, is just another transfer) but certainly have more leeway than the others.

So, focusing on tax expenditures, if it were so easy to expand demand, so that all of the sustainable sectors can be boosted by a degree that is equal or better to the fall off in the unsustainable sectors, why not do it all the time?

And what problem does it solve? The workers in all those unsustainable sectors are still unemployed. The boosted, sustainable sectors are certainly a plus--but not to them. If you redistribute the gains from the sustainable to help those displaced from the unsustainable, you erode the gains you made, damage the incentives to produce more, and may delay the relocation of the unemployed workers further.

If you don't, then the happy end is that they may well be drawn into employment in the growing, sustainable sectors, but I see no way to hurry up the process of deciding which ones will grow most, and so need the most workers.

If you owned a restaurant across the street from an office complex that housed some financial services storefronts, and those branches closed, so your foot traffic went down, and eventually you closed too. Now that the economy is really humming, and tax breaks have iPod2's flying off the shelves so quickly as to more than make up for the little blip to GDP that was your restaurant, what do you do now? Reopen? Start over somewhere else? Do something else? Did the increase in iPod2 sales make this decision any easier?

Matt writes:

Arnold, is it true that job-openings are at a record low? I remember reading not too long that there are more job openings than there are people looking for jobs? These things aren't necessarily inconsistent, but I would like some clarification.

Also, I don't quite buy that workers are as willing to work as ever. This is only anecdotal, but I have talked to quite a few people on unemployment who are pretty laissez-faire about finding a new job. I've also heard quite a few stories of employers looking for workers only to have people on unemployment turn down the job. Again, this is anecdotal, but maybe there is a connection. There has to be a point in which the effort put into looking for workers becomes more inefficient than operating without the workers.

Costard writes:

Logically, Summers' position is absurd. Why not call it a supply problem? Too many workers asking for too much in wages, in fields that no longer need them. An equally valid approach, but one requiring a different solution -- and most likely, different economists.

If it were a demand problem, they should cut taxes; if structural, they should ease the mandates, regulations and subsidies that favor existing industries and choke out new entrants. Instead we've seen concrete and windmills, moral hazard and too-big-to-fail.... so we should not wonder too greatly, if the problem enunciated is as chimerical as the solution implemented.

Lord writes:

"The industries in which they are to work have yet to be discovered."

So you are explicitly excluding the possibility that the solution is simply doing more of what we already are doing? That seems the crucial different between AD and PSST. AD presumes what we are doing is sustainable and can grow to use available resources where PSST presumes it is only sustainable using current technology at current levels, and volume, and growth requires new innovation. AD would suggest that new innovation requires increased AD and falling AD would lead to falling innovation. PSST would suggest innovation should be picking up but not sufficiently or quickly enough to show up in AD, but seems silent on whether increasing AD can increase innovation. It doesn't seem unreasonable that it could.

Scott Sumner writes:

I wouldn't say Summers is using AS/AD, I'd say he's misusing AS/AD. Changes in income distribution don't affect AD when the central bank is targeting inflation. And the Fed's decision to end QE out of fear of higher inflation is certainly a form of inflation targeting.

Mike Rulle writes:

I enjoy your clarity. But I am not so sure your PSST argument captures the essence of our current woes in their entirety (not that you claim so). It reminds me of Hayek's spontaneous order characterization, except for some reason the spontaneous order has gotten stuck in the mud. It has gotten stuck in the mud, but I do not believe that PSST is the reason, or not the major reason. Cliff Asness wrote an excellent polemic in the WSJ the other day. What is preventing PSST from speeding up the spontaneous order is the acceleration of government interference at all levels. I agree with Asness that we would see the mother of all economic booms if we can free ourselves from our current policies. In other words, I really do not think we have a PSST problem---rather we have a significant policy problem---which would accelerate the spontaneous order out of the mud and your PSST problem would be solved. In other words, the PSST paradigm you outline may be reversed as to cause and effect.

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