Friday, December 26, 2008

Rising Productivity with Falling Employment

Everyone seems to think it is so easy to explain why productivity can rise when employment falls. It is -- IF labor demand is stable. The observation that "marginally" productive workers are the first fired is exactly what it means to move ALONG the labor demand curve.

The real question is how do you modify your prediction for the previous severe recessions -- when productivity FELL?! Here's what I say: that's when demand shifted more than supply.

This is why I have spent a whole week asking: why does the labor demand curve shift so little in this recession, and so much in previous (severe) ones?

24 comments:

portlandian said...

This is just an example of productivity drop: Suppose you have 2 guys working: A VP and a Junior lackey. Suppose when the VP has the junior lackey xeroxing and getting coffee, together they produce 200 widgets a day. Alone, the VP produces only 80 widgets (It won't surprise most people that the junior folk account for higher marginal production).

Now, suppose demand drops from 200 widgets to 50 widgets. Junior Lackey gets the sack. Productivity drops. Profits (at the 50 widget demand level) increases versus keeping both people employed. Marginal utility isn't the deciding factor.

This is kind of decision making is clear when you look at capital expenditures. Buy the new machine and productivity would dramatically increase. But if there isn't demand to support it, you don't buy the machine.

Angry at the Margin said...

If we're to entertain some old macro prejudices, I would suggest that quantity rationing in the labor market should play a part here, given that we might also want to be able to explain "involuntary" unemployment, if one believes in such a thing, but also why recessions are "bad" from a welfare point of view. If everything clears, why should we bother?

Richard H. Serlin said...

Here's what I say: that's when demand shifted more than supply.

This is why I have spent a whole week asking: why does the labor demand curve shift so little in this recession, and so much in previous (severe) ones?

But what strong logic and evidence can you present that "the labor demand curve shift[s] so little in this recession"? All you've presented so far is very weak. It makes me very suspicious that like most on today's right, who aren't just ignorant or incompetent, you are very willing to intentionally mislead for your cause, whether it's economic libertarianism even at the expense of much higher economic growth and total societal utility, plum jobs from the Republican machine, or whatever.

Everyone seems to think it is so easy to explain why productivity can rise when employment falls. It is -- IF labor demand is stable. The observation that "marginally" productive workers are the first fired is exactly what it means to move ALONG the labor demand curve.

You move along the labor demand curve if the wage changes. But one of the crucial causes of recessions is sticky prices and wages. If the wage stays the same, a shift left of the demand curve will cause a decrease in workers employed, and clearly firms will tend to layoff their least experienced and productive employees first. Moving along the demand curve is not the only way to lose the least productive workers, a shift left of the demand curve can do it too.

And, of course there can be a combination of things going on. There has been some decrease in real wages even in the short run, but there may also have been a strong shift left in the labor demand curve. You have not presented strong evidence to the contrary.

The real question is how do you modify your prediction for the previous severe recessions -- when productivity FELL?!

First off, your "previous severe recessions" is a sample of two, at least that's all you mentioned in your New York Times article. A sample of two, or even one, can be compelling if a priori logic and evidence support it strongly. If my hiking partner eats two berries and immediately keels over and dies, I don't say, "Oh, but the sample was just two". Other information about biology tells me that it's extremely likely that the rest of the bush's berries are poisonous too. However, here you don't provide compelling supporting logic and evidence. In fact, the supporting logic and evidence in economics is strongly against your hypothesis, and this is why the vast majority of top economists don't support it. For a good exposition of this logic and evidence I recommend Nobel prize winning economist Paul Krugman's new book, The Return of Depression Economics and the Crisis of 2008.

As I wrote in a comment two posts ago: A decrease in demand and involuntary layoffs – with no decrease in the desire to work – does not have to lead to a decrease in productivity. There are many strong factors here that move in different directions, most of which your argument wrongly assumes don't exist. If firms are very reluctant to lay off workers in the face of a demand decrease they may keep some on who have little productive work to do, and spend a lot of time just sitting around waiting for something to do. This would decrease productivity. It does fit your argument. But, there are also ways productivity could increase, like if firms are less reluctant about laying off workers in the face of a slowdown -- something you would expect with today's less worker concerned culture [a clear change from the two earlier recessions you mention] – then layoffs will be swift abundant, and the first let go are the least experienced and productive workers. This raises substantially the average productivity of the workers left. Also, those left will have more capital per worker, raising their productivity. And then there are other factors which can raise productivity, like the coincident great technological advance in computers, communication, and globalization. And what about underemployment? the engineer forced to take a job at Wal-Mart. This is grossly inefficient, but it would result in a lower official unemployment rate and an increase in the average productivity of Wal-Mart workers.

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