Bryan Caplan  

Discontinuity and the Real World

Discontinuity, Revisited... A Different Mr. Negative...
Arnold writes:
So, if the demand for mortgages collapses, all it takes to get back to 2006 levels is for mortgage underwriters to take a 20 percent pay cut?

In a world with no discontinuities, we would not get crazy subprime lending and sudden sharp drops in demand. The no-discontinuity world is what classical economists are trained to work with. Too bad it is not the real world.

The question isn't whether discontinuities ever exist in the real world.  The question is whether they're a big deal.  I see no reason to think they are.  Yes, a 20% wage cut probably wouldn't have saved many jobs in a handful of occupations like mortgage underwriting where demand suddenly dried up.  But what does this have to do with the vast majority of occupations?  What does this even have to do with the vast majority of firms? 

Take Borders.  It spent months hovering on the edge of bankruptcy.  Despite online competition, Borders still had plenty of customers and revenue.  It just couldn't quite manage to regain profitability.  Why wouldn't a 5 or 10% reduction in wages have sufficed to save the firm and its workers' jobs?

When an occupation or industry suddenly vanishes, Arnold can plausibly (though hardly decisively) point to discontinuities.  But when 10% of the workers in an occupation lose their jobs, or 5% of firms in an industry go out of business, continuity isn't merely a convenient assumption.  It's a hard fact.

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COMMENTS (7 to date)
Andrew writes:

Is anyone aware of any papers dealing with unemployment/wage dynamics and the variation in employment law across states? I suspect it would be really tough to actually write down a convincing regression, though.

Chris Stucchio writes:

According to Wikipedia, Borders had 20k employees. At $40k/year each (probably an overestimate, I doubt book shelvers get that much), Borders could have saved $80M/year with a 10% pay cut. In contrast, between 2008 and 2009 alone their holiday sales alone fell by $100M or so.

Borders went under because revenues fell drastically, and they were locked into many 10 and 20 year store leases. Employee comp was only a small part of the problem.

kio writes:

This discussion is funny. You are playing with small portions of a puzzle and do not observe the big picture. The economy is a closed system with some conservation laws like in physics (particles in a box). Whatever are individual incomes (particle velocities) the distribution over incomes (e.g. Gini ratio) or energies (Maxwell-Boltzmann distribution) is conserved. Accordingly, if one changes (isolates) some portion of the closed physical system the rest of the system by all means will recover the original distribution.
When one introduces some disturbances (natural or artificial, but with some constrains like not a war or pandemics when economic laws are not applicable any more) into an economic system it has to recover the original distribution over personal incomes. Actually, the evolution of personal income distribution in the USA is driven by a simple physical law - . The evolution of the overall personal income distribution and those in various age groups with their relevant Gini ratios since the start of the CPS in 1947 shows almost no change despite all perturbations. This is an empirical answer to the problem you are tackling.

Steve Sailer writes:

Right, Borders was largely killed by its long term leases. For example, its San Fernando Valley store was in of the most expensive blocks in the entire SFV, on the nicest stretch of Ventura Blvd. in Sherman Oaks.

Steve Sailer writes:

Right, Borders was largely killed by its long term leases. For example, its San Fernando Valley store was in of the most expensive blocks in the entire SFV, on the nicest stretch of Ventura Blvd. in Sherman Oaks.

Sonic Charmer writes:

Is it just me or is Bryan still speaking as if the entire cost of running a business is employee comp and profits are (revenues) minus (employee comp)?

Bryan's argument just seems to fall apart if instead profits are (revenues) - (employee comp) - a bunch of other stuff).

Saturos writes:

Sonic Charmer,

As Marx reminds us, the "other stuff" is (pretty much) ultimately made with labor. Payments are ultimately payments to income earners, who are mostly earning labor income. So complete wage and price* flexibility would allow "wing-walking", in the empirically relevant cases.

*I don't think much of New Keynesian arguments for (non-labor) price inflexibility as a source of unemployment. The old Classical model never required prices to adjust instantanaeously; that was a Keynesian caricature. Yet they still had good reason to expect roughly full employment.

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