Friday, July 24, 2009

Okun's Law Failure is not a Mystery

Recently more economists are noticing that the labor market is getting a disproportionate share of the bad news in this recession. Unemployment is much worse then you'd expect from the GDP growth we've had; GDP growth is much better (less bad) than you'd expect from the unemployment we've had.

This is no surprise to readers of this blog. In February 2009 I released a working paper documenting the divergence between GDP and employment, although using real business cycle methodology as opposed to "Okun's law". Since November 2008, I have been saying employment should be especially bad because this recession has especially many government policies that discourage work.


Joseph said...

One again, suggesting that I have laid my workers off because they do not want to work to take advantage of government programs is BS.

I reduced the headcount at my shop because my forecast for demand for my services has changed. Lats August my order flow started to dry up, and all of the cold calling/marketing was not bringing it back.

And that is a similar situation of most other business owners I talk with. Revenue is down, does not look like it will get better, I lay people off.

Interesting aside, last May/June I noticed fewer people looking to join my firm, and current employees staying put...

There were labor market problems before, but now the are unemploymeny problems.

Andrew Oh-Willeke said...

Grossly implausible. The factors you cite in your link to your prior post (which involve the government reaction to the downturn) are:

* the minimum wage hike
* means-tested mortgage modification
* mean-tested student loan modification
* unemployment insurance extensions
* state income tax hikes,
* IRS means-tested enforcement of prior tax debts
* marginal federal tax rate hikes on the "rich"!

This just doesn't fit the facts.

Means tested mortgage, student loan modifications and unemployment benefit extensions don't impact the cost of labor to employers, which are the ones making the decisions. Enforcement of prior tax debts has always been means tested; this is just another way of saying that you can't get blood out of a turnip.

Mortgage modifications have been much more rare than policy makers had hoped, in any case, and student loan repayment adjustment on a means tested basis was available (albeit with a couple of additional hoops to transfer balances involved) at least as far back as the early 1990s.

The reduction of employment, and the rise in the unemployment rate, are disproportionately concentrated in places that either had high construction employment related to the housing boom, or have lots of manufacturing in sectors where purchases are commonly finances (i.e. durable goods) or both. Minimum wage employment (which makes up about 4.5% of the total as of tomorrow) or near minimum wage employment in these industries is rare -- minimum wage employment is heavily concentrated in the child care, personal care and hospitality industries, which have seen a less pronounced employment shock.

Two of the hardest hit states, Nevada and Florida, don't have a state income tax to hike, California didn't increase state income taxes, and while Michigan did increase its state income taxes in 2007, it is manifestly obvious to any observer that Michigan's problems have far more to do with national automotive market which thrust major state employers like GM, Chrysler and Delphi into bankruptcy and brought Ford to the bring (although its latest quarter was remarkably good) rather than any local policies -- Toyota which doesn't have Michigan plants lost just as many sales percentagewise as GM.

Also, neither state nor federal income tax hikes increase the cost to employers of hiring workers in the labor market, and taxes on investors have not been increased. Corporation profits are not a function of employee income taxes, and shareholder income taxation levels in big busineses (either through capital gains or dividends) have not gone up. Moreover, the money losing companies that have been laying off the most workers, pay neither state nor federal income taxes at the corporate level because they have no corporate level taxable income.

Joseph is much closer to the mark in his demand driven/revenue expectation hypothesis driven by his personal experience which match mine in the practice of business law. Beyond the level of anecdote, one sees confirmation of this theory in measures like record low utilization levels in the manufacturing industry, record low architectural billings, historically high vacancy rates in all forms of construction, massive inventories of unsold motor vehicles, and more.

Our economy right now is in a situation similar to that of the Soviet Union near the end of a poorly done five year plan -- we have immense capacity to generate supply, but it makes no sense to use that capacity, because you don't add economic value to the economy when you add to the supply of something that nobody wants or needs those goods and services at a price that covers your variable costs of production. There is no point in building a new hotel when existing hotels have never been emptier; there is no point in building office buildings when office parks are full of empty suites; there is no point in building gas guzzlers when people want subcompacts.

Aggregate supply is a necessary cap on demand. But, demand does not automatically arise from aggregate supply.

John Booke said...

I would add to your "list" one more future possibility: A big jump in the Social Security retiree "Cost of Living Adjustment" (COLA) next year instead of "no" increase as projected. So many of the leading edge of the "baby boomers" are taking early retirement this year because of the big jump in last year's COLA increase (5.8%) that a zero increase next year would create a fire-storm for congressmen and the president. By the way the spike so far this year in new Social Security retirees is breath-taking and record-breaking.

Fishsticks said...

I believe what Mr. Mulligan is not arguing the causes of unemployment but instead is suggesting is that the unemployed will be more selective and more reluctant to accept a lower quality/paying position. This is because of the increased benefits that are being given. Paying benefits and lowering costs of unemployment will discourage the labor force adjustments necessary and therefore prolonging the recession. The policy reaction is making unemployment "sticky" similar to how prices are sticky.

You even noticed fewer people looking for employment in recent months at your firm. This is the symptom of the problem Mr. Mulligan argues for.

Two further symptoms are the duration of a bout of unemployment has reached new records as well as record numbers of people exhausting benefits.

Anecdotally, I see friends "holding out" for jobs that pay the same or more than the previous job - I view this as unrealistic. They also tend to not apply to jobs they view as below their (unrealistic?) expectations.

Benefits provided that support the unemployed, on the margin, will discourage employment.

Joseph said...


As an owner, I will not hire people who I deem are overqualified. They usually leave for better work ASAP, so why hire them if my expectation is they will leave as soon as it gets better. And many are looking to continue a career..not flip burgers at Mcds...

All of these people are(were) six figure plus earners in NYC; A few lousy dollars in mortgage relief or the pittance that is unemployment insurance are not going to make a difference, especially when you are paying COBRA for a family.

And none of them enjoys being unemployed because of the immense peer group/personal pressure that you feel; Your jib tends to define who you are, and the destruction of this identity is immensely demoralizing.

How does a few government programs make these people unemployed? The real problem is there are fewer jobs. Like I said, we reduced head count because our revenues were DOWN, like many other businesses.

J said...

Correct me if I am wrong, but realistically the bulk of any unemployment statistic will be made up of workers with less training, less experience, and less education, who usually earn less. It is largely irrelevant if former NYC financiers cannot find work, because even if a large percentage of them loose their job, it will not equal the magnitude of the jobs lost by factory workers and lower class citizens.

And it is precisely these lower income workers who are greatly benefited by the issues Dr. Mulligan brought up- Social Security COLAs for those near retirement, Unemployment benefits, etc.

Even if workers keep their jobs, it is very possible that the presence of generous unemployment benefits will reduce worker motivation and hence reduce productivity. Workers are less likely to give it their all if they know there are plenty of reasons to not have a job.

Don said...

Here's me from your NY Times post:

December 24, 2008 4:40 pm Link

I take the rising productivity and rising unemployment to show that many people are proactively and needlessly being laid off out of fear and aversion to risk. There is rising Productivity because the Demand is still the same, yet there are fewer workers. And there are fewer workers because of the layoffs are due to the fear and aversion to risk.

The reason that the fear and aversion to risk mimics the behavior of an increase in the supply of workers, is because workers are being proactively and needlessly let go, not due to the fundamentals of supply and demand. It is a case of employers misreading and misdirecting the supply and demand now prevailing. After all, in order for supply and demand to work, it has to be perceived by acting human agents.

So, my thesis is that letting people go because you assume that demand will decrease, when demand doesn’t decrease, leads to a rise in productivity and a seeming rise in labor supply, which it is, only not because the workers don’t want to work, but because the employers have proactively and erroneously let them go, from misperceiving the demand.

It would follow that things might be better than we think, and that employers might soon realize the need for extra workers. At least that’s the hope.

Conversely, some kind of stimulus of demand would work, since employers would soon perceive the need for more workers. I leave the details of the stimulus for another time.
— Don the libertarian Democrat

With all due respect, based on Fisher, I said that this would happen in October. From the WSJ:

"By Sudeep Reddy

We’ve found plenty of ways to say the job market is in the dumps. Alliance Bernstein economist Joseph Carson today offers one more.

In a research note, Carson says job losses in prior downturns have been roughly proportional to the decline in gross domestic product. But in the current recession, the proportion of jobs lost is running about a third greater than the drop in real GDP."

With all due respect, my point seems closer to what happened than yours.

Joseph said...

How is a well trained finance worker any different from a well paid highly specialized worker in any industry?

There are larger structural problems at play in the US economy, and having to say would you like fries with that every day is not a suitable second career.

Maybe it will be when we destroy every industry in the US, becuaes burger flipping is one of the few jobs that is hard to outsource (You couls always allow them to hire a mass number of immigrants to keep wages VERY Low).

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