David R. Henderson  

Krugman's Faulty Analogy

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I promised earlier to post on a couple of Paul Krugman's posts that caught my eye. In a June 10 post, "Unemployment Benefits and Actual Unemployment: An Analogy," Krugman admits the point that unemployment benefits can increase the unemployment rate by making people pickier about jobs. But he says that doesn't apply when the unemployment rate is so high.

First, his admission:

Here's what is true: there's respectable research -- e.g., here -- suggesting that unemployment benefits make workers more choosy in the search process. It's not that workers decide to live a life of ease on a fraction of their previous wage; it's that they become more willing to take the risk of being unemployed for an extra week while looking for a better job.

By the way, it's typically for more than an extra week.
Then his statement that that analysis doesn't apply now:
But all of this is totally irrelevant to our current situation, where inflation is running below target, the target is too low anyway, and the reason we have mass unemployment is that there just isn't enough demand, and hence there just aren't enough jobs, no matter how desperately people search for them.

Then his analogy:
One way to think about this is to say that unemployment benefits may, perhaps, reduce the economy's speed limit, if we think of speed as inversely related to unemployment. And this suggests an analogy. Imagine that you're driving along a stretch of highway where the legal speed limit is 55 miles an hour. Unfortunately, however, you're caught in a traffic jam, making an average of just 15 miles an hour. And the guy next to you says, "I blame those bureaucrats at the highway authority -- if only they would raise the speed limit to 65, we'd be going 10 miles an hour faster."

Dumb, right? Well, so is the claim that unemployment benefits are causing today's high unemployment.

Krugman's analogy is a good one, but it's too inclusive. What's the problem? In the highway case, everyone is trying to go in the same direction. In the employment case, not everyone is looking for, or qualified for, the same job. There are literally hundreds of thousands of potential jobs out there, with various degrees of skill and experience required. So it's likely that (1) there are employers out there willing to hire someone qualified now at a wage that it is just a little too low for qualified people to accept and (2) their wage at which they're willing to accept is made somewhat higher by the fact of unemployment insurance. That's what's wrong with Krugman's statement that the claim that UI makes people pickier is "totally irrelevant to our current situation."

Do high unemployment benefits account for all of the high unemployment? No. Do they account for some? Absolutely.

By the way, here's what Larry Summers said about the effect of unemployment insurance on unemployment.

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CATEGORIES: Labor Market

COMMENTS (8 to date)
Tom West writes:

I don't think there's any serious question that UI increases unemployment rates (except among politicians, where it has no effect on the unemployment rate and keeps people from starving, or conversely, it massively increases the unemployment rate while allowing people to party all day & night 'til the UI runs out).

Paul K is now essentially a politician.

I see the question as:

Is the cost to the taxpayer + the increased unemployment from people who essentially won't seek employment until the benefits run out worth the decreased suffering of those who would lose a lot (i.e. fire-sale their house or be kicked out rental housing) + those who would be trapped in a position that doesn't use their skills (the programmer who takes a full-time job at McD's)?

I believe yes, despite being somewhat horrified to find people I knew in the "don't seriously search until UI is ending" group :-(.

Daniel Artz writes:
Dumb, right? Well, so is the claim that unemployment benefits are causing today's high unemployment."

And so is Krugman's claim that a lack of demand is causing today's unemployment. He completely ignores the very many ways in which the regulatory and tax policies pursued by the Obama Administration has made it costlier and riskier for potential employers to add additional employees, because that would not suit his own preferred narrative. The Employer Mandate in PPACA (i.e., "Obamacare") makes it very costly for a small business to risk growing over 50 full time employees; the minimum coverage requirements increase the cost of insurance coverage for every employer already providing medical insurance; the EPA regulations on Greenhouse Gas Emissions make it vastly more expensive to construct any new power plant, and significantly increase delays and permitting costs for new manufacturing facilities; higher individual tax rates siphon away funds which small business owners might have used to invest in expansion, while the risk-based ratings required by Dodd-Frank make Banks unwilling to lend to any but big, triple A credit companies, leaving small and medium sized businesses essentially excluded from the commercial credit market. Krugman ignores all of these factors, and many more, because he is so completely convinced of the correctness of his myopic Keynesian vision that he thinks all who disagree with him are "knaves or fools." Maybe he's right, maybe unemployment benefits have no impact on the unemployment rate. Maybe, just maybe, the high and intractable unemployment rate is attributable to the fact that our Government's economic policy is being guided by economists like Mr. Krugman.

Charley Hooper writes:

I suppose Krugman is saying that overall demand for labor is the constrained resource and therefore other factors can be ignored.

I don't buy it. As Larry Summers argued in his article, those other factors are important.

To bolster Krugman's analogy, we could add that some drivers had been paid to drive, when they wouldn't otherwise have driven, worsening the traffic jam, and other drivers had been paid to drive slowly, helping cause the traffic jam in the first place.

Chris Koresko writes:

Charley Hooper: I suppose Krugman is saying that overall demand for labor is the constrained resource and therefore other factors can be ignored.

That's how I read it, too.

It seems to me that Krugman's analogy is fine; it's just his economic analysis that's suspect.

Mr. Econotarian writes:

Anecdote: A friend of mine whose unemployment is about to run out has decided that a (rare) job in his previously chosen profession is likely not going to come along soon and that he should start seriously looking for retail jobs.

ThomasH writes:

I wonder by what fraction of 1 retail jobs will go up by as a result of the decision of Econotrarian's friend.

Some, yes some, but probably only an insignificant amount in a situation of demand constrained growth.

Stefano writes:

I think it should be tested with data.

How many unemployed people find a new job around the time their unemployment benefit expires ?

If it is a large fraction, the PK is wrong. Otherwise, he's probably right.

Daniel Kuehn writes:

Do you think it's possible that you are reading "totally irrelevant" more literally than he was intending it? Because that seems to clear this all up.

We've got two options: Krugman doesn't understand or rejects standard labor supply arguments or he was just trying to be emphatic about the conditions around a major decline in aggregate demand.

The latter strikes me as being many orders of magnitude more likely.

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