Arnold Kling  

Joseph Stiglitz Crosses Nick Rowe

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Stiglitz writes,


At the beginning of the Depression, more than a fifth of all Americans worked on farms. Between 1929 and 1932, these people saw their incomes cut by somewhere between one-third and two-thirds, compounding problems that farmers had faced for years. Agriculture had been a victim of its own success. In 1900, it took a large portion of the U.S. population to produce enough food for the country as a whole. Then came a revolution in agriculture that would gain pace throughout the century--better seeds, better fertilizer, better farming practices, along with widespread mechanization. Today, 2 percent of Americans produce more food than we can consume.

What this transition meant, however, is that jobs and livelihoods on the farm were being destroyed. Because of accelerating productivity, output was increasing faster than demand, and prices fell sharply. It was this, more than anything else, that led to rapidly declining incomes. Farmers then (like workers now) borrowed heavily to sustain living standards and production. Because neither the farmers nor their bankers anticipated the steepness of the price declines, a credit crunch quickly ensued. Farmers simply couldn't pay back what they owed. The financial sector was swept into the vortex of declining farm incomes.

Nick Rowe responds,

You just can't do macro like that. It all goes wrong from the very beginning. The fall in the price of gizmos, for a given quantity of gizmos sold, and for given prices of non-gizmos, reduces the real incomes of gizmo producers, but increases the real incomes of non-gizmo producers by an equal amount. If the price of gizmos falls by $1 each, and one million gizmos get sold each year, gizmo producers have $1 million less income, but non-gizmo producers now have an extra $1 million to spare which they can spend on something else.

Stiglitz is focused on telling an aggregate demand story, and Rowe calls him out on that one. When you change the terms of trade between two sectors, that in itself is not a shock to AD. It can be the basis of a shock, but you need to tell a more complicated story, about relative spending propensities or somesuch. I won't go into detail--it's Stiglitz's job, not mine.

(Scott Sumner calls out Stiglitz on the same issue, and more. But Nick got there first.)

Instead, let me try to tell a PSST story. That won't be easy, either, but here goes.

Let us stipulate that in the long run, resources shift out of sectors where productivity rises faster than demand and into sectors where demand rises faster than productivity. (Also, there may be a shift toward leisure, which is a superior good.)

In the short run, the marginal revenue product of labor in the gizmo industry falls to nearly zero (even as the average product of labor in that industry goes up). Think of a farmer who acquires a tractor. Now he can produce more by himself than he could previously with four farmhands. Higher average productivity for the farmer, but lower marginal productivity for the farmhands. (On the one farm, the fixed amount of land is what keeps marginal productivity low. In agriculture as a whole, inelastic demand is the factor that limits marginal revenue product.)

What about the consumers of gizmos who do not have to spend as much on gizmos? In the short run, their wants are not connected to the skills of the workers freed from gizmo production. (Note that the consumers might want more leisure, and again this may even be true in the long run.) Entrepreneurs have to figure out a way to satisfy consumer wants using the resources freed from the gizmo sector. This is the process that takes time. Nobody knows what the consumers want (or might want if it were invented). Nobody knows the potential uses of unemployed workers. Instead, new products, services, and production methods have to be discovered, by trial and error. I would call this the recalculation problem, while Peter Howitt would call it the coordination problem. Again, see our articles in Capitalism and Society.

In the long run, new patterns of specialization and trade have to be established. But we do not know what those will be. Government does not know, either, so its fiscal policy is a very clumsy instrument.

On the latter score, Stiglitz is quite disingenuous. He says that wartime spending magically cured unemployment by moving people from farms to the military and then to urban factories. I do not think that story will hold up. I think that a lot of what went on is that between 1930 and 1950 quite a few manual workers aged out of the labor force and were replaced by a new vintage more suited to clerical work that was a better fit for the technology available. You could not have slotted the work force of 1930 into the jobs of 1950. Conversely, if you had kept the jobs of 1930, you would have been way inside the production possibility frontier and badly under-utilized the skills of the work force of 1950.

Stiglitz also complains that in the most recent recession 700,000 government workers lost jobs. Well, first of all, 7 million private sector jobs were lost. Second, not a single government job had to be lost due to budgetary restraint--a small cut in pay could have saved all of those jobs.

Anyway, Stiglitz refers to research that he has been doing on the Great Depression, and the role of higher productivity in the farm sector as a causal factor. I look forward to reading more about this, because I think it fits at least as well with a PSST story as with an AD story.


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CATEGORIES: Macroeconomics



COMMENTS (19 to date)
RPLong writes:

See, when I read stuff like this, I have a really hard time understanding objections to PSST.

Good one.

Scott Sumner writes:

Farm productivity rose throughout both the 1920s and 1930s. It plays zero role in the 50% collapse in NGDP and 30% decline in RGDP after mid-1929.

It has zero explanatory value. The unemployment was concentrated in mining, manufacturing, construction, etc. That's where output collapsed.

Ryan Avent also bashed Stiglitz.

Glen S. McGhee writes:

I go with Stiglitz regarding the changes in the occupational structure, changes that track the emergence of the high school as a widespread institution. What does PSST have to say about that?

Arnold Kling writes:

Scott,
My story would be that manual labor was displaced by machines in these other industries as well.

Scott and Glen,
Suppose someone had written "The race between education and technology" in 1930. They might have said that education had fallen behind in the sense that we were stuck with too many workers over 40 who did not have a high school education. By 1950, those workers has aged out of the labor force and a new generation of better-educated workers had taken their place.

Nick Rowe writes:

Thanks Arnold!

I was hoping you might do a PSST version of Stiglitz. Right or wrong, a PSST version at least makes logical sense.

Alex Godofsky writes:

Why didn't entrepreneurs have such a hard time "recalculating" after the war ended and literally tens of millions of individual patterns of specialization and trade were invalidated in the span of a year?

Yancey Ward writes:

Alex Godofsky wrote:

Why didn't entrepreneurs have such a hard time "recalculating" after the war ended and literally tens of millions of individual patterns of specialization and trade were invalidated in the span of a year?

It took more than a year, but that is beside the point. What was the trajectory of government actions/interventions after 1945?

Alex Godofsky writes:

Is that a trick question? Total government expenditures fell by somewhere north of 50% after WW2.

Arnold Kling writes:

Alex,
Government purchases, including during a war, are not sustainable patterns of specialization and trade. So, yes, there is a recalculation problem, but you are not starting from a pattern of *sustainable* specialization and trade.

What is remarkable about the post-war period is how quickly entrepreneurs developed sustainable patterns of specialization and trade utilizing the labor resources that were freed up at the end of the war. One hypothesis is that the war created new social networks among the soldiers who fought together, and these new ties helped to produce a lot of new businesses.

Of course, if a PSST story is hard to tell to explain the postwar recovery, try telling an AD story!

Alex Godofsky writes:

Arnold:

Government purchases, including during a war, are not sustainable patterns of specialization and trade. So, yes, there is a recalculation problem, but you are not starting from a pattern of *sustainable* specialization and trade.

The difference shouldn't matter here. Workers and entrepreneurs were presented with a really simple formula for earning money - join the army or make guns. Then that formula was invalidated and they had to figure out new ways. It turned out that they did so very easily (much more readily than after 1929). It looks like recalculation just isn't that hard.

What is remarkable about the post-war period is how quickly entrepreneurs developed sustainable patterns of specialization and trade utilizing the labor resources that were freed up at the end of the war. One hypothesis is that the war created new social networks among the soldiers who fought together, and these new ties helped to produce a lot of new businesses.

I understand you're just setting that out there as a possibility, but it isn't a very convincing hypothesis. It suggests we could fix the current recession by sending millions of people to summer camp, etc.

Of course, if a PSST story is hard to tell to explain the postwar recovery, try telling an AD story!

Sure, here's a hypothesis: soldiers returning home from war have more wage flexibility than other workers, because they expect to go into a totally different profession than before.

Yancey Ward writes:

Alex,

Rhetorical question, yes. However, what were the trajectories after 1929 vs 1945?

Arthur_500 writes:

The AD story of after the war states that there was pent up demand for goods in the United States and we were supplying goods for the rebuilding of Europe. There is much to be said about this.

American factories survived the war. We were in full production of everything from cars to telephones. (Many 'excess' workers went to college) However we were still using the same old factories and methods of production that remained labor intensive. Between exports, pent-up demand and government programs (GI Bill, Marshall Plan, etc)business was humming along on the old equipment and methods.

Europe built new factories and methods of production (with many fewer people in their workforce) and by the late 1950's were becoming more efficient than Americans.

WWII allowed 'excess' employees to be put to work and death. Post WWII we bought additional time through demand and lack of viable competition.

Once might argue that we plodded along until the Internet age. At this time the technological advances have happened so quickly that our economy cannot absorb the efficiency.

I think this is where the AD and PSST coverge.

Steve Sailer writes:

It's not uncommon for wars in American history to galvanize leaps forward in productivity. For example, before the Civil War, the U.S. was highly rural rather than industrial, although our farmers were famously inventive at coming up with new farming tools. During the Civil War, Americans organized on a vastly larger scale to produce industrial goods, and kept right on getting better at industry after the Civil War. For example, the organizational and technological advances made necessary by the Civil War were then applied to the new oil industry, which remains central to American prosperity today.

Something similar was seen following WWI during the great prosperity of the 1920s.

The Post-WWII era looks similar -- we had a much better educated workforce following the Depression, when kids stayed in school longer to avoid competing for scarce jobs with grown men. And Americans had gotten extremely competent at undertaking vast high tech projects during WWII (e.g., Los Alamos).

Robert writes:

Interesting! What is meant by PSST?

Steve Sailer writes:

Farmers were already hurting throughout the 1920s. My vague impression of the Great Depression was overshoot: the U.S. had done a reasonably good job of adapting in the 1920s to the farm to industry transition. But we got over-optimistic about how we were doing, and over-invested in industry and real estate (e.g., a 102-story building), which, along with some of the usual chicanery possible when animals spirits are high, led to a sharp correction. But, then, for various reasons, the correction didn't lead to new prosperity as in 1921.

Chris Koresko writes:

Alex Godofsky: "Why didn't entrepreneurs have such a hard time "recalculating" after the war ended...?"

Bob Higgs suggested that was because the New Deal essentially ended during the war. That reduced a lot of the barriers to reorganization, like government-sponsored cartels, and perhaps more importantly reduced the "regime uncertainty" caused by an active and unpredictable economic policy.

As a result, there was a big increase in net investment, which had been mostly negative during the Depression. That investment brought the technological innovations developed over the previous 15 years (the 1930s was a period of rapid tech progress) into widespread use, raising both the potential and actual output of the economy. Factor in the rapid growth of the young workforce over the next couple of decades, and you have a recipe for sustained, rapid growth.

Alex Godofsky writes:

Yancey Ward: could you please state your argument plainly?

Chris Koresko: the problem with your narrative is that the Great Depression started long before the New Deal.

Chris Koresko writes:

Alex Godofsky: the problem with your narrative is that the Great Depression started long before the New Deal.

Not really a problem, for two reasons, the most important being that I don't claim that the New Deal caused the Depression. Actually, I'm basically with Stiglitz on the cause: technological changes made the work done by a significant fraction of the U.S. population unsustainable.

I see the New Deal as an attempt by Progressives to reclaim the gains they'd made in the previous catastrophe -- WW1 -- and lost again in the 1920s. Those big Progressive pushes tend to happen in the aftermath of a crisis, when people are scared and confused and willing to accept big expansions in the size and scope of government. That's what makes a crisis a "terrible thing to waste" in Progressive eyes.

What the New Deal did do was lock the economy into its pre-Depression patterns of trade when it needed to be deeply restructured, and generally prevented capitalists from identifying solid investment opportunities. So instead of the two-year problem we had in the previous, equally severe depression, we had a decade-plus nightmare.

The second reason is that the ND was mostly an expansion on policies implemented by Hoover, so it could be claimed to have started before its official announcement under FDR (though still not before the Depression, which I believe was well underway in agriculture years before the big 1929 stock-market crash).

Fake Herzog writes:

Here is Jim Manzi on the same subject:

http://theamericanscene.com/2011/12/16/storytime-with-joseph-stiglitz

(Steve Sailer makes another appearancce in the comments...does everyone who is anyone all read the same blogs?)

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