Tuesday, November 24, 2009

What Does It Cost to Buy a Recession?

By Oct 2009, U.S. labor usage was more than 10 percent below trend. Even if it returned to trend by the end of 2010, that would put labor usage about 20 year x percentage points below trend (i.e., an average 6-7 percentage points below trend for each of three years). A year's labor income is about $10 trillion, so that's $2 trillion that labor income has been reduced over the three years.

How to Purchase a Recession
Suppose for the moment you had a lot of $ to bribe people not to work, or employers not to hire. What method of allocating the bribes would reduce employment the most? How much would it cost you to purchase a recession like this one?

If you simply paid people not to work, shrinking the labor usage by that much might cost about $3 trillion.

It can be a $3 trillion task because people who would not work anyway may take you up on your offer not to work. If you could target your bribes, you would want to target them to the weakest employment relationships -- those for which supply is closest to demand. With very well chosen targets, you could make a recession like this for a mere $100 billion.

But do not expect that you could target so well in practice, because it's difficult to know which employment relationships are the weakest, and once you started paying people for what appeared to you to be weak employment relationships, others might put on the appearance. But at least you could try to target the types of people who are generally expected to be working soon, such as persons searching for jobs (interestingly, that's what unemployment insurance does).

All together, you would be hard pressed to make a recession like this for less than $1 trillion.

UI is an Illustration, but not the Major Force
Unemployment insurance (UI) reduces the employment rate, by increasing the pay someone can earn while not being employment, and reducing the after-tax pay earned while employed. But I raised the question above to demonstrate that UI cannot be the only, or even a major, reason why employment is so low.

Recall that UI benefits are voluntary: nobody forces you to take them. Thus, even if UI had the purpose of reducing employment (which it is not), it could not be much more effective per dollar of expenditure than the hypothetical "recession purchase" discussed above.

UI will spend something like $300 billion for 2008-10, and obviously that $300 billion is not for the PURPOSE of minimizing employment. To make this recession by itself, UI would probably have had to spend more than $1 trillion. (this is the same argument I made in "Public Policies as Specification Errors" for why UI was not a major factor in the Great Depression, either).

Mortgage modification is almost a big enough operation by itself to make this kind of dent in the labor market (whether it actually does is another question). For example, if the Obama Administration achieved its goal of modifying 9,000,000 mortgages and each mortgage were written down an average of $75,000, that would be a total of $675 billion.

If you took the combination of mortgage modification, UI, big parts of the "stimulus" law, and other anti-employment policies, we probably are looking at over $1 trillion worth of spending that encourages people to have lower labor incomes.

Bottom Line
Although it's easy, and at least partly appropriate, to say that government spending of various sorts has reduced employment over the past couple of years, note that buying a recession is no cheap enterprise, and buying a recession of this size may be beyond even what governments can afford.

2 comments:

Joseph said...

Professor,

My firm just went bust, 15 people out of work earning no income. We ran out of projects; ie our clients were no longer purchasing our services. I am out of work due to a lack of demand, but I am glad to know that I am not working because I want to collect UI, try and get my mortgage modified, and draw down my savings, without regard to the incredible stress that being without work places on a family. Also, while looking for employment I have learned that employers (demander of labor) are waiting for the perfect candidate to come along and be thankful to have meaningful work for 50-60 hrs a week. They are sure they will and they are sure they can get them for cheap, an dthey can be sure the right one will not jump ship once times get good again.

W.E. Heasley, CLU, LUTCF said...

Professor Mulligan:

Very interesting article from a very interesting perspective.