Arnold Kling  

PSST and Aggregation

The Alternate Universe Problem... Monterey Sheriff Admits that D...

On PSST, my former thesis adviser writes via snail mail,

Obviously I don't have to be told that there are very many outputs and very many distinguishable inputs. A question arises whether aggregation of some degree is a last resort, a confession of failure, or a positively good thing, because useful approximation is a good thing.

Instinctively, I like aggregating total hours worked, and I do not like the idea of an aggregate production function. Let me see if I can justify that instinct.

I think that economic activity consists of taking advantage of specialization and trade. When you work in the market, you are doing a relatively narrow, specific job in order to be able to consume a remarkable variety of goods and services that would be much harder for you to provide for yourself. So, the more hours you spend doing market work, and the fewer hours you spend trying to produce your own consumption goods, the better, with a caveat.

The caveat is planned leisure. Hours worked could decline over time because people intentionally take more leisure. So it is good when people either have market work or take planned leisure. It is bad when they engage in home production and when they have unplanned leisure (aka involuntary unemployment). For aggregate hours worked to mean what I want it to mean, you have to adjust for trends in planned leisure.

A related caveat is housework as leisure. Some people like to cook, or garden, or build furniture, even though that is not their comparative advantage in the market. I would say just count the time that people spend on those activities as planned leisure.

Once you have a handle on how much people are working in the market, it is tempting to try to aggregate the value of what they produce. Hence nominal GDP. And real GDP, which requires more assumptions but is a more powerful measure of value.

I think where macro starts to go off the rails is when folks try to talk about potential real GDP. What they assume is that if more people were working, these additional workers would produce real output at the same rate as the people who are working now. That is the aggregate production function that I do not buy into. I think that if people are not working now, it is because at the moment the economy is not organized in a way that enables them to produce anything of value. Assigning a value to what they could be producing if they were producing something of value is like the old joke "If we had some ham, we could have ham and eggs for breakfast--if we had any eggs." As of now, they have Zero Marginal Product (to use Tyler Cowen's phrase), or more accurately, a marginal product that is below the minimum needed to justify hiring them.

It is the task of entrepreneurs to organize the economy so that people produce stuff that has value. Sometimes, entrepreneurs are not quite up to that task. Then you get unemployment. There is an incentive for entrepreneurs to try to figure out ways to create patterns of sustainable specialization and trade that utilize workers who are currently unemployed. However, it is not as easy as you would imagine if you only think in terms of an aggregate production function, where everybody works in the GDP factory.

In short, total employment is a useful aggregate. Total output is a useful aggregate. Potential GDP is not a useful aggregate, because it makes the unjustifiable assumption that people who are not working now could produce something of value if they were working. That assumes away the problem, which is to re-organize production and trade so that more people can produce something of value.

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CATEGORIES: Macroeconomics

COMMENTS (6 to date)
david writes:

- Implies the countercyclicity of entrepreneurship, when startup formation seems to be instead procyclical. This is probably the biggest problem. Do you prefer other choices of entrepreneurship measurements? Or is the theory that the current slump is sui generis, so past cyclicity studies do not apply?

- No apparent explanation for observed monetary phenomena

- also, recall the Sumnerian point that monetary policy greases structural adjustment; it is implausible to assert that monetary policy has no effect or that it is already at the optimal level

Lord writes:

Consider two countries, employedistan and unemployedistan. Is employedistan dependent on the demand of unemployistan? It doesn't seem it could be by much. Is the only reason unemployedistan can't mimic employistan that they would need training and why aren't jobs created to train them? Are they too overqualified to do the same work, or too underqualified to merit the training? Or is work so poorly paid, it does not merit training? There should always be areas of growth and areas of retrenchment. Are there any real areas of growth as demonstrated by wages? Where are the entrepreneurs trying new things?

mark writes:

Although generally sympathetic, I would suggest you rephrase some of your statements. When you assert that the unemployed are so because they won't produce anything of value at the moment, that is a giant oversimplification and also sounds, to a careless ear, like an evaluation of the persons. There is also the prospect of putting them to work on public works or goods, which can be argued to be "something of value". I don't mean to endorse any of those responses but I do suggest that you should consider rephrasing some of your very generally phrased points to head off these responses.

fmb writes:

If the police instituted a policy of randomly towing cars in parking lots, a lot of existing "patterns" would no longer be "sustainable" (e.g. driving to WalMart would become too risky). We'd take an immediate real hit, and then eventually devise some work-arounds that became new "patterns" and gradually recover some (but likely not all) of the real loss.

In other words, the legal, and monetary, environment are a key input into what makes a pattern sustainable. Of course monetary disequilibrium will disrupt existing patterns, but that doesn't mean we should wait around for new patterns, we should instead remove the disruption.

I don't at all mean to say that there's no need for recalculation, just that it might sometimes look like a recalculation problem when really it's a "correctable environment disruption problem". Only if it's actually *not* "correctable" (for whatever reason, e.g. Fed intransigence) does it truly become a recalculation issue.

Chris Koresko writes:

david: Implies the countercyclicity of entrepreneurship, when startup formation seems to be instead procyclical.

Is this true? I'm not sure what measure of entrepreneurship is being used. But it's easy to imagine that in the depth of a recession, when unemployment is high, there are a lot of laid-off workers kicking around ideas for businesses that might keep food on the table until they hear the result of their job interviews. That might cause the search for a new PSST to be ongoing without showing up in the aggregate statistics.

No apparent explanation for observed monetary phenomena

It seems likely (almost inevitable) that PSST is a significant part of the story. But it must also be true that there are other things going on that PSST is compatible with but doesn't account for. That doesn't strike me as a severe flaw.

Roger Sweeny writes:

I read the title of this post and began to sing the jingle for Psssssst, an "instant spray shampoo" that used to advertise a lot on programs I watched.

Wikipedia helpfully points out that the shampoo (6 s) should not be confused with Pssst (3 s), a video game dating from 1983. PSST (2s, capitalized) is nowhere mentioned, which I suppose indicates that wikipedia does a lot better job covering pop culture than economics.

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