Arnold Kling

Evidence for PSST: A Rejoinder

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Reply to Arnold on PSST... Youth Unemployment: A Puzzle f...

Bryan writes,


What's the best available "Guide to Discontinuity/ZMP for Skeptics"? Non-economists have always been quick to believe stories about technological unemployment. Economists have been ridiculing this popular fear for centuries. What happened in the last three years that ought to make economists reconsider?

Economists have been ridiculing technological unemployment based on the theory that the economy adjusts to equilibrium. When (homogeneous) labor needs to be reallocated due to technological change in one industry, changes in relative wages send signals and workers respond. Unfortunately, if you ridicule this form of unemployment, you also have to ridicule aggregate demand and aggregate supply, because adjustments in wages should take care of that as well.

Obviously, there must be some impediments to adjustment in order for unemployment to persist. If you think that the only impediment is nominal wage rigidity, then of course monetary expansion and inflation are the cure for any adjustment problem.

The PSST story is that a major impediment to adjustment is that entrepreneurs must come up with new uses of labor to employ workers released from sectors where they are no longer needed. This requires imagination, experimentation and evolution. It takes time.

The main evidence that I cite against the AD/AS story is the length of unemployment spells and the large number of workers who are not going to return to jobs in their previous industry, much less their previous employer. At some point, even the 99 weeks of unemployment benefits is not sufficient to explain long-term (approaching permanent) unemployment. I view the large number of workers who have permanently lost their former jobs, and for whom no similar job is available, as evidence that:

--labor is heterogeneous
--adjustment to sectoral shifts due to demand factors (housing) and technological factors (retail clerks displaced by Internet shopping) is difficult
--a reduction in real wages of 10 or 20 percent due to inflation would not be sufficient to make the old jobs viable again


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COMMENTS (9 to date)
david writes:

But, as you have noted before, the difficult part is arguing that the technological substitution is responsible for the business cycle rather than just being an ongoing background process that happens all the time.

You acknowledged that this was the difficult part. Of course labor is heterogeneous. The question is whether the heterogeneity has the specified macroeconomic impact. To remind you of your own answer: "There are real costs of [price discovery]. That is, there are real adjustment costs." So, real and nominal rigidity? That sound you hear is of you conceding to Caplan ten months ago!

And, of course, qua Sumner: it's not structural and it wouldn't matter if it was.

Bill Woolsey writes:

Nominal expenditure fell and is now 14% below the previous trend. At that time, both output and employment fell below their trend.

For a century, technological improvement has caused people to lose jobs. But it was just 3 years ago, when spending on output fell, that this process began to result in growing unemployment.

Why not say that finally, three years ago, was when low priced foreign labor began to destroy our jobs, just like common sense tells us. Or, it was those high taxes and regulation that caused it. Or, it was the fact that the rich take up all the income and don't spend. Or... Or... any of the other explanations that noneconomists come up with.

More fundamentally, why is it necessary to come up with new products? Why not produce a bit more of all of the old products. Perhaps fewer new homes, but more of everything else. If the demand for all goods is _perfectly inelastic_ then lower prices wouldn't result in more demand for any of them. Of course, that is what one would expect if there is no scarcity. Everyone is satiated with everything. Suddenly, we need less of one thing, and so, we need less of everything. No matter how low the price, no one buys any more of anything.

If that is not the case, if people would buy more of many goods if they were cheaper, then if nominal expenditure rises, then the demand for all existing goods should rise a bit.

Now, if the problem isn't too little demand, but rather an inability to produce a bit more of everything else, then rising nominal expenditure just creates inflation. We end up with bottlenecks because there are some resources needed to produce everything else whose supply cannot be increased immediately. And so, output cannot expand. And so, there is no need for entry level workers to produce more output.

And that is why, in this scenario, there is no deflation of prices. If prices fell, people would want to buy more, but no more can be produced. There are key resources that would be needed to expand the production of everything, and they cannot be increased. And so, prices don't fall. It is a bit puzzling why wages don't fall don't fall on this theory. The owners of these special resources should be making lots of money, and everyone else less.

We have to come up with new products is just wrong. It is a red herring.

If some goods are scarce, and there are are adequate resources to produce at scarce goods, then higher nominal expenditure will raise output. (Or alternatively, lower prices and wages will raise output.)

PSST is mistaken.

fundamentalist writes:
“All I've seen this recession, however, is that nominal GDP sharply fell, and real GDP fell almost proportionally.”

And that’s the problem. GDP figures hide a lot of good information. What’s most important in a depression is the loss of capital. Almost all jobs requires some kind of capital, either fixed, such as buildings and equipment, or complementary, in the form of materials such as steel or copper.

In the boom, capital gets invested in industries for which the demand is not sufficiently large, such as housing and autos. When it becomes clear that over investment has occurred in those industries, that capital becomes worthless. At the same time, many of the skills used in those industries become worth very little.

Reducing wages will get you manual labor, but that often requires some capital if nothing more than a shovel. For all industries to hire unemployed house builders and auto workers, they need to save and acquire the needed capital goods for the new workers to use. That takes time. Or they need to borrow the funds, but to do that you have to have almost perfect credit, good collateral and a low debt ratio.

PS, the wing-walker analogy is cute, but what if your hold turns out not to be a hold at all but just air?

D. F. Linton writes:

Isn't the whole idea that wage rigidity is only nominal kind of strange? Workers (indeed everyone) doesn't want to reduce the price at which they sell things, so prices stay high until sellers are forced by circumstances to give up and lower their prices or until buyers will pay the current prices or a mixture of both.

The two ways for a government to increase AD are increased spending and monetary inflation.

When people believed that the dollar was "as good as gold", the money illusion could work: debase the currency, real prices fall, and the markets clear. But doesn't that depend on the buyers recognizing that real prices have fallen while the seller remain ignorant? Clearly it wouldn't work if both buyers and sellers have the same real/nominal price ratio expectations. Assuming the ignorance of the sellers is necessary unless you're willing to base the whole concept of nominal wage rigidity on the idea of "face saving", i.e. you know I'm cutting my wages and I know I'm cutting my wages, but we'll agree to count in different units to make me feel better.

Of course, if like the Spanish Inquisition, nobody expects the monetary inflation it could work for a time, but then would it be smart for economists advocating this policy to write about it in newspapers and blogs?

Maybe the whole currency-manipulation-for-AD game has exhausted its required store of ignorance.

david writes:

New Keynesians tend to have a degree of real rigidity now, too. Both price and wage rigidity, mind.

Rick Hull writes:

> If you think that the only impediment is nominal wage rigidity, then of course monetary expansion and inflation are the cure for any adjustment problem.

Admittedly tangential -- but this is a bit too glib for my tastes. I wonder what Bastiat would say, regarding the seen and unseen effects of monetary expansion.

Daublin writes:

Bill writes, "More fundamentally, why is it necessary to come up with new products? Why not produce a bit more of all of the old products. Perhaps fewer new homes, but more of everything else. "

Arnold anticipated this objection in his post. I do wish more people would read the blog before posting to it.

Arnold argues that "labor is heterogeneous" and that, for any given field, many people have zero marginal productivity.

To make it concrete, your argument suggests that a cosmetic surgery firm could make use of an ex-construction worker if the construction worker's price was low enough. The construction worker isn't a very good cosmetic surgeon, but they surely are better than nothing, so there must be some low enough wage where they'd produce more cosmetic surgery.

In practice, in this example, they are worse than nothing. Arnold's argument is that, with the existing pattern of firms, lots of people are worth less than nothing on the job market.

Costard writes:

Growth industries are almost always draw their workforce from the unexperienced and the uncertified. A new thing requires ability rather than credentials. Witness the tech companies started in garages by college dropouts. Normally a crisis or a recession is the moment of opportunity... people retreat from skill sets that have become outmoded or corrupted and turn again to the foundational questions of "What am I good at?" and "What is possible?" Capital looks for new riverbeds and dry ground becomes green. Flutes sound and bird chirp and it's bright and sunny Springtime.

But when you have a government that's trying to backpedal you into Fall, gluing dead leaves to dead trees, building dikes and dams and cannibalizing every green shoot in an effort to subsidize the great hulks of a decayed economy, you get precisely what we've got. A winter a la Groundhog's Day.

Evan writes:
The PSST story is that a major impediment to adjustment is that entrepreneurs must come up with new uses of labor to employ workers released from sectors where they are no longer needed. This requires imagination, experimentation and evolution. It takes time.
I have to be honest, I always thought that "It takes time" was understood. When I read the typical economist's arguments against technological unemployment I always thought that they were "Yeah, there might be technological unemployment in the short term, but eventually Say's Law will create new jobs for the unemployed workers." Are there actually economists out there who think the amount of time it takes for the economy to adjust to disruptive technology is zero? That seems utterly bizarre.

Of course, the first school of economics I became familiar with was the Austrian one, so it may be that I was projecting my already PSST-oriented paradigms onto arguments that didn't actually contain them.

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