Friday, June 3, 2011

PSST and downturns - more from Kling

Arnold Kling has another post up, highlighting how PSST can lead to economic downturns. He writes:

"The consequences for employment depend on how resources move from declining to expanding industries. Three possibilties:

(E) Excessive Expectations. Resources move too quickly to what are perceived as expanding sectors. Think of the Internet Bubble, or perhaps the 1928-29 boom in electric utilities. People over-estimate the speed with which new industries can attain profitability, and investors in these industries over-estimate their wealth.

(D) Displacement Downturn. Resources move out of what are perceived as declining sectors before new sectors can absorb them. (The human and physical capital in declining sectors in fact may not have productive value in the new industries. As Tyler Cowen would put it, Zero Marginal Product.) People perceive the wealth decline in displaced sectors before they can realize the gains in new sectors. Alex Tabarrok points me to a literature on this, exemplified by Greenwood and Jovanovic.

(G) Goldilocks Growth. Resources move effortlessly and synchronously from declining sectors to expanding sectors. For example, within telecom in the 1990s, we lost jobs related to land lines and gained jobs related to cellular, and it all seemed to go pretty smoothly

One way to look at this may be to identify sectors and occupations that are thought to be going through a transition, and look at their separation and rehiring rates relative to workers in other industries and occupations, and then decompose our unemployment problem into two groups: those losing jobs in transitional sectors that are not able to adjust, and those losing jobs in non-transitional sectors that are not able to adjust. Much of this would have to be done after the fact to identify which sectors are truly going through a PSST transition or at least a popped bubble.

I expect you'd find that the non-transitional jobs make up a substantial share of the problem, which would suggest that even if we think PSST sparked the downturn, other mechanisms are really driving it; a housing crash causes a sharp fall in the marginal efficiency of capital (the discount rate you require to invest); declines in house prices reduce spending, etc.

This brings me to another point, then. Is PSST an actual "regime change", or is it just another word for "housing bubble". If it's just another way of talking about bubbles, it seems less interesting to me. We know a lot of bubble psychology, and sustainability is the last thing we want to attribute to bubble patterns. If, however, PSST refers to the macroeconomic import of genuinely transitional periods in genuinely (previously) sustainable activities, that could be interesting although I still have serious doubts that that is the primary causal mechanism here (perhaps a spark, as I said - although I think it's more likely the spark was just an old-fashioned bubble). It certainly influences me that the crisis of my formative years seems so clearly to be a Keynesian crisis. If I was in the position in life I'm in right now during the early 1980s, I'd probably come out with a slightly different view. The causal mechanism here seems to me to be fairly clear - and I feel more confident because a lot of very smart people seem to agree with me. But this is still an interesting thing to think about, and it's certainly a viable way of describing "how the economy works" if not "how the economy breaks".

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