Friday, December 26, 2008

Labor Market Distortions are Real

Some of the commenters have put up a "perfectly efficient markets" straw man as an argument against the use of supply and demand to understand today's economy. It is probably my fault for not previously elaborating on this point.

I think there are many distortions in the labor market. See, for example, my A Century of Labor-Leisure Distortions or my Public Policies as Specification Errors. Supply and demand continue to be useful in this setting, as long as you recognize that multiple prices exist in the marketplace.

Suppose, for example, that a distortion existed because of an inefficient intermediary. For example, the price of oil might be $50 in Illinois, but $45 in Texas, because oil comes from the Middle East to Illinois via Texas. We can still talk about supply and demand for oil in Illinois. We just have to be careful that the supply of oil to Illinois embodies more than just the behavior of Middle East oil producers and trans-Atlantic shippers -- it also involves the behavior of the Texas intermediary. Or we might analyze the demand for oil from the Middle East, in which case we have to recognize that it is not just Illinois behavior, but Illinois behavior is intermediated by the Texas middle-men. So the Texas middle man appears on the supply side in one analysis, and on the demand size in the other.

Now back to the labor market. None of my posts refer to "wages" -- that is intentional. I refer to PRODUCTIVITY. This means that a whole bunch of things in the labor market appear on the supply side! That includes everything from sticky wages to employer taxes to (hypothetically -- don't lynch me!) worker laziness. You might say that makes the analysis without content because it has an excessively narrow concept of demand -- it might in principle but in practice it has enabled me to distinguish this recession from several others -- other recessions did have labor demand reductions, even under my narrow definition.

One commenter said that bad employer incentives (I guess an employer tax would fit in that category) have to be considered "demand". That comment is incorrect if the analysis treats, as mine does, the "price" as productivity. In my analysis, a payroll tax owed by employers would properly appear on the supply side of the labor market.

Because I have put a variety of behaviors on the supply side of the market, the productivity and employment numbers by themselves do not tell us whether sticky wages, employee preferences, bad working conditions, taxes, or some other factor outside the production process caused the "Labor Supply Shift of 2008." The next phase of the analysis is therefore to investigate some of the specific distortions (get a preview of this here, here, here, here, here, here, here, here, and here.


Richard H. Serlin said...

Here is what I see as your argument, based on your description of it in your New York Times article:

1) If there is a drop in supply of workers (that is, for whatever reason, workers want to work less), then the firms will be short handed, and will have to work the remaining workers harder (less downtime, less sitting around waiting for something to do), and so worker productivity will go up. There will be more goods produced per worker.

We have seen a recent rise in productivity, thus, there is strong evidence that the supply of workers is down, that is people want to work less (at least the way you wrote your New York Times article, you either intentionally or unintentionally -- and it looks intentional to me -- made it really sound like you thought this was strong evidence.)

2) If, on the other hand, there is a drop in demand for companies products, and thus for workers to produce those products (people don't want to work less; it's just many can't find jobs), then the firms will not be short handed. On the contrary, they will have more workers than they need, and so there will be more downtime, more sitting around waiting for something to do, and so worker productivity will go down. There will be less goods produced per worker.

Because we have not seen a recent drop in productivity, there is strong evidence that it's not the demand for products and workers that's down, rather it's the supply of workers that's down. That is, people want to work less.

And in two previous severe recessions, the 1930's and early 1980's, we did see a drop in productivity, but in this recession we see a rise in productivity (um, what about all of the recessions besides the two you choose to mention?).

So, that appears to be your argument. Please let me note that I think it's very weak because, for one, there are other very plausible ways productivity can go up in a recession without there being a decrease in workers desire to work. And for two, the other evidence and logic regarding recessions is overwhelmingly against your hypothesis that in the current recession unemployment is due mostly to people's desire to work less (see Nobel Prize winning economist Paul Krugman's current book, The Return of Depression Economics and the Crisis of 2008 for details). This is why the vast majority of top economists don't agree that a decrease in the supply of workers, the desire to work, is the primary reason for the recent high unemployment (for example, see here and here).

In previous comments I've given other reasons why productivity could go up in a recession, but I'd like to go into a little more detail on one: Consider again 1) and 2) above. We have a measuring period for unemployment and productivity, say a quarter, or a year. Now, in that say year, suppose there is a desrease in demand for products and thus workers (so it's not that workers want to work less); there will then be two major effects: Effect 1; Immediately, the workers have less to do and so there's more sitting around and less productivity. But, Effect 2: Eventually, some of the workers are let go, and this increases productivity, partly because now there is less sitting around, with more to do per worker, partly because those let go will tend to be the least experienced and productive, and partly because there is now more capital per worker.

Now, if employers are very reluctant to lay off workers, because there is a strong culture of concern for workers and not just the bottom line – a culture like we used to have a lot more of in the 30s and early 80s – then for most of the year, or measuring period, we would see much more of effect 1 than effect 2. There'd be a lot more extraneous workers sitting around, and a lot less laying off. With effect 1 dominating, we'd see a productivity drop.

But now let's fast forward to the late 2000s, where there is much less of a culture of concern for workers and much more of a culture of concern for the bottom line. In this culture extraneous workers may not be alowed to sit around with little to do, producing little, for very long at all. They may be swiftly laid off, so that for only a very small portion of the measuring period, the company has too many workers, and for the vast majority of the measuring period, it is running lean, with only the most experienced and productive workers remaining, and each having more capital to work with. In this case effect 1 would be small and effect 2 would be large, and productivity would go up.

By contrast, let's again go back in time to the 1930s or early 1980s, where there was much more of a culture of concern for workers and much less of a culture of concern for the bottom line, the extraneous workers may then be alowed to sit around with little to do, producing little, for a long time before managers reluctantly lay them off. They may not be swiftly laid off at all, so that for a very large portion of the measuring period, the company has too many workers. It may only start to get lean at the end of the measuring period, if at all, laying off enough workers so that effect 2 is stronger than effect 1 leaving the firm lean and with only the most experienced and productive workers remaining each having more capital to work with. In this case – where firms are very reluctant to lay off workers -- effect 1 would be big and effect 2 would be small over the measuring period, and productivity would go down over the measuring period.

Thus, we see one mechanism (and there are others) which could lead to productivity going either way in the face of a decrease in the demand for goods and workers.

A decrease in the demand for goods and workers does not have to lead to a decrease in productivity as you intone.

Anonymous said...

But, Professor, are these distortions relevant at "cyclical" frequencies? If market clear they are efficient, constrained on these distortions.

It's hard to see how fiscal distortions can explain fluctuations.

datadave said...

Really as a long term participant in the labor market as a 'tradesman' (but with a college degree in poli-sci.) I see the reality close at hand. Your scenario is a gross distortion of the what workers are experiencing. Also the decline in demand for (adequately paid) labor matches what the left of center economists such as Krugman, Reich, Galbraith have been saying.

One:" the Bush 2 recovery only benefited the upper 10 percent of income earners (approximately) and this decade is the first decade since the Great Depression where average worker's income has gone down (even when there was a recovery from the 9/11 downturn). So-called Discouraged workers aren't included in the wildly optimistic USA stats which are quite lower than the reality.

2nd.: You ignore income inequality which is also a reason for growing worker apathy and some 'underground' workers (not paying taxes) who are avoiding the growing payroll taxes forced upon them by conservative orthodoxy (such as the latest insistence that they pay their own health care insurance whether they can afford it or not..)

3rd: As in last statement: the 'unprotected worker, underground worker, 'free agency worker, is a growing segment unaccounted by labor stats....who is usually underemployed with lower wages than before.) Employers are more and more passing on risks to the employees and forcing them to work w/o unemployment insurance, all benefits and workman's comp. Since the present conservative federal govt. does little enforcement of labor regs more and more workers are forced into 'underground' undocumented work. (this is a general condition of native and immigrant labor in the construction trades btw often called 'subcontracting' even if the employee isn't really a separate 'trade' than the owner's. Other example...a big one is FedEx's use of subcontractors forced to Not be employees even if they would rather be. They are not given a choice. Either work or 'starve' i.e. experience extreme privation.

4. retirement might account for some loss of supply but that is only due to some retirement policies still available....but that supply of retirement funds is rapidly being depleted in the so-called real losses in retirement income did occur if you haven't noticed. Also that is a age specific quality not at all due to the rising layoffs now occuring.

5. Productivity gains are more and more due to Technology increases done by fewer and fewer sectors of people and designers who as a small group of people who are doing more with less.

Finally: Once again you seem to be using a Blame the Victim argument prevalent with Right Wing Political pundits. Such as the pithy "supply and demand (in that order)" statement. Supply-side theories are indeed the reason for Paulson/Bernerky's huge infusion of money into the Supply side of Monetary funds...and like Reagan's trickle down such supply-side theories are causing greater deficits and more income inequality that is causing the deflationary decline of a majority of incomes and a continued spiraling of deflation and lowering of demand.

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