Jonathan Nails it on Unemployment

Unemployment is not the same thing as a labor surplus. This way of talking about it bugs me to no end, and I've laid out my position in more detail before (here, here, here, and here). Jonathan is making the same points in this post. The key line is:

"If you use a supply and demand graph to show the labor market, then this interpretation is a bad one. You have a supply of labor that exists before the fall in aggregate demand. This supply of labor does not shrink when aggregate demand falls — the number of people willing and able to provide their labor remains the same (or, may even grow, if new laborers are willing and able to enter the market). If we assume full employment at the original level of demand, then the bracket (on the above graph) showing the change in the quantity of labor employed represents the number of unemployed in a depressed market."

Being unemployed means that you are willing and able to work, but not working. In other words, you are on the supply curve, but you are not to the left of the equilibrium point. Basic supply and demand pictures make somewhat more sense if you have a search model attached (then you have some sense that those to the right of the equilibrium point are "searching" and in the process of lowering their reservation wage, so there's some context to this non-employment status), but usually people don't bother presenting it that way in casual or even some formal discussions. Instead, they talk as if unemployment is a labor surplus and so they automatically zero in on high wages as the cause of unemployment.

I also like that Jonathan gets into a discussion about the marginal productivity of labor and its relation to unemployment. He writes:

"During a depression, you have a certain number of workers who are now unemployed (see that supply and demand graph). These workers are able and willing to work, but firms are not looking to buy extra units of labor. Why? Because the costs of employing that labor are higher than the benefits.

Does this not fly in the face of the Austrian claim that in a free market everyone will find employment? Yes and no. Like I said, I think that this disproves the notion that perfect wage flexibility will end all involuntary unemployment. The derivation of the marginal product of labor is based on “everything else being equal.” Austrians are not counting on everything else being equal. Since wants are essentially limitless (as long as people are acting), then there is always opportunity for employment. But, capital and labor are complimentary, and thus for there to be a greater quantity of people employed there must be an increase in the quantity of employed capital — i.e. an increase in marginal productivity.

What this tells me is, that in the study of depressions the most important factor is not necessarily labor, but capital."

Two thoughts.

First, I want to push back on this "wants are essentially limitless" line. Let's grant that they are. Still, that doesn't quite solve the puzzle because when we are talking about demand, we are talking about both willingness and ability to pay. Wants may be limitless, but if your ability to pay is not limitless that insatiability is not going to guarantee a fully employed economy.

Second, I like that he's thinking about the marginal productivity of labor. But I would put it slightly differently. "Labor is not a commodity", after all. When a firm hires a worker, they are looking at that very similarly to the way they look at an investment. They are taking their expected stream of wage payments to the worker and comparing it to their expected stream of benefits from employing that worker. We have a tendency to treat labor as a spot market, but it's not. It's much more like a capital market. (In fact it's more complicated because workers can shirk - machines can't. Workers can break the contract and leave - machines can't. Workers can bargain - machines can't, etc. etc.). So the time dimension comes into the employment decision in the same way that it comes into the capital decision.

Now I'm going to turn Keynesian on the quesiton. Why do we think depressions happen? We think they happen because firms compare the marginal efficiency of capital to the interest rate, and the equilibrium level of capital at that interest rate is not enough to achieve full employment. I would argue (Keynes did not, to my knowledge) that firms also consider a marginal efficiency of labor and also compare that to the interest rate. Labor is unemployed for the same reason that capital is, in other words. The future stream of earnings expected from employing an additional unit of labor is not sufficient to justify employing that labor.

Why?

Keynesians say it's because of insufficient demand and uncertainty about future demand. This particular Keynesian would say that because labor is not a commodity, and because ever since Mincer we know that it acts an awful lot like capital, labor is unemployed for much the same reason that investment levels are low.

Some thoughts on work

I've seen a lot of good stuff on labor/skills shortages/skilled labor issues recently and was going to share a few random musings. I don't endorse all of this stuff (I'm generally skeptical of general shortage claims), but it's worth chewing on:

- First, there's been some good discussion of returns to different majors. I haven't had the time to look at this stuff in detail -there's a lot of self-selection in this sort of thing so I hope everyone is citing good studies that take that into account. This was a particularly interesting post on STEM (science, technology, engineering, and mathematics) degrees by Arnold Kling. I don't endorse the "STEM shortages" claim, but I do think this post and the links in it have some interesting material on grade inflation and college major choices.

- Granted, you have to be careful when you say you don't endorse the STEM shortages claim, because some people then want to lump you into the Lou Dobbs crowd. I've met and had conversations with both Ron Hira and Norman Matloff (both interviewed here by Lou Dobbs). I'm often sympathetic to Ron's high-quality work on the H1-B (although I don't agree with all the policy conclusions he draws from it). I have much bigger problems with Matloff's claims. One of my problems with this video is that they jumble a lot of different labor markets. I do think there are big problems with the post-doc labor market. I think there are trends in the labor market for software engineers that are definitely unfortunate for software engineers themselves. But I don't think you can look at gluts or dynamics in these very unique fields and make broader claims about how we have more than enough skilled workers.

- So I am not a "staple a green card to their diploma" STEM shortage guy, but I'm also not a "we're flooded with foreign labor and Americans will never do science" guy. Another prototypical position to take in this whole debate is the "forget the scientists - we need more skilled blue collar workers" position. Like the other positions, I think there's a grain of truth to this but I can't endorse it completely. We do under-invest in mid-level skills in this country. We have a bifurcated education system with a lot of four year degree liberal arts majors (which is fine - civilized society needs liberal education) that we put a lot of money into on the one hand, and a lot of high school grads, GED holders, and dropouts that need more investment in their human capital on the other. We know solutions that work - apprenticeships, community college, career and technical education. Some of these are on the rise, which is good - some aren't. If there's any truth to the "skills shortage"/"skills mismatch" story it's on these jobs with these skills. Technical, high-value work that does not require a four year degree. Mike Rowe has a great promotion of this issue here (again, I can't endorse everything he says about skills gaps, etc. - but he's focusing on important issues despite those disagreements that I'd have... and yes I'm actually embedding Mike Rowe's video but not Lou Dobbs because I like Rowe decidedly more than I like Dobbs):

- Finally, because the science and engineering labor market holds special interest to me, I've always been interested in the compensating wage differentials literature - a factor that I think for obvious reasons plays a huge role in this market. I was reading some of Einstein's essays last night, and I came across this great passage that really highlights why compensating differentials are so important when we think about scientists. He writes:

"The most important motive for work in the school and in life is the pleasure in work, pleasure in its result and the knowledge of the value of the result to the community." (from "On Education", 1936)

I (obviously) think one of the chief determinants of work is the monetary compensation received for that work and the marginal productivity that firms get out of purchasing labor. Einstein has not swayed me from this view. But I strongly agree with Einstein that that is not the full extent of our relationship with work, and in scientific jobs particularly, there are often motives much broader than earning an income that have to be considered.



Those are some scattered thoughts - I've been thinking about the STEM labor market recently because I'm getting ready to write an application for an IHS fellowship discussing the market for scientific labor. As I've said before - the market works. There's no real evidence of doomsday shortages. There are all kinds of interesting dynamics and adjustment processes in this specialized labor market - and lots of implications for growth and sustainability in general. There's lots of fascinating stuff for an economist to talk about. But the sky-is-falling mentality that a lot of people have is simply not justified.

OWS and the labor market for scientists

Scientific American has an interesting article on scientists and science students participating in the OWS protests in Baltimore.

I wish I had more time to discuss this, because they're talking specifically about biochemists and the market for biologists is actually an interesting and unusual story. My read on most science and engineering labor markets is that concerns about shortages are way overblown - most of these markets are functioning just fine and respond well to price signals. Biology is a little different and has experienced a genuine glut in PhDs, so the concerns expressed here are in some ways unique to that field. A big part of the problem is supply-side policies in the market for scientific labor, which as Ken Boulding pointed out decades ago makes little sense compared to demand-side policies.

Anyway - if you want to learn more about the glut in the biologist labor market the person to read is Paula Stephan, and economist at Georgia State University.

Steve Jobs and Obama on Job Creation

This is a very poorly reasoned article critiquing Steve Jobs for not creating many jobs in the United States. I think it's wrong. I imagine many of my libertarian readers would agree with me. Moreover, I think they'd agree wiht me for much the same reasons that I have for thinking this is a poorly reasoned article.

What I think is less likely is that anyone can explain what's wrong with this article criticizing Steve Jobs without in the process making a case for the value of metrics like "jobs created and saved" used by the Obama administration. Maybe "jobs created and saved" is hard to calculate. I'd agree. But that challenge is just as big for attributing jobs to Steve Jobs as it is for the stimulus.

Ultimately, if you can tell me why this article is wrong about Jobs, you're likely providing precisley the same reasoning about counter-factuals and "seen and unseen" that is used when referencing metrics like "jobs created or saved".

Forget that it's a terrible waste of human capital and a major psychological burden...

...the real problem with youth unemployment is that those people are the ones that end up turning into commies:

"Permanent mass unemployment destroys the moral foundations of the social order. The young people, who, having finished their training for work, are forced to remain idle, are the ferment out of which the most radical political movements are formed. In their ranks the soldiers of the coming revolutions are recruited." - Ludwig von Mises (1922)

Is it just me, or does Jeff Tucker seem completely oblivious to the fact that this quote really doesn't make Mises look all that good?

Sticky wages and unemployment

Yesterday, in response to Tyler Cowen's post, I reiterated that sticky wages don't strike me as the major thing we should be worrying about, and that my theory on why people get so caught up on sticky wages is that we've come to equate labor surpluses with unemployment, which is wrong. Since then a lot more people have jumped into the fray. I haven't even had time to digest them all, but I've seen:

- Arnold Klng: "I think it also makes for a good story for how state and local government employment declines in a recession. I have consistently prescribed wage cuts for state and local government workers as a way of maintaining employment there... This is the biggest problem with trying to fit the current situation into the AS-AD paradigm."

- Brad DeLong: "The old Keynesian line was that nominal wage flexibility--and the union-smashing recommended by Hayekians--was a side issue. In an economy with nominal debt contracts downward-flexible nominal wages were likely to produce deeper depressions as the economy was subjected to much stronger downward shocks from the deflation, debt, and bankruptcy cattle prod. Wage inertia was thus a blessing--albeit a poorly-understood blessing--rather than a curse.

I think that everybody open-minded and nuanced is finding themselves moving rapidly toward the old Keynesian position under the pressure of events and data right now." [He also does a good job showing how Cowen's chief empirical example commits the Mulligan fallacy]"

- Robert Waldman

- Scott Sumner

- Jonathan Catalan

- Alex Tabbarok

*****

Two of the more interesting posts were from Karl Smith, who downplays sticky wages and notes real wage pro-cyclicality and then a response post to him by Scott Sumner which says that real wages are pro-cyclical during supply-shock recessions and counter-cyclical during demand-shock recessions.

Smith's point, I think, is very important. The research he is refering to on pro-cyclical wages is summarized by Abraham and Haltiwanger (1995). They note that real wage cyclicality looks very different when you look at microdata than it does when you look at aggregated data because with aggregated data you're not usually looking at comparable labor forces over time. Sumner points to real wage counter-cyclicality in demand-driven recessions and says "I’d add that real wages rose especially sharply in some of the most easily identifiable adverse demand shocks (1920-21, 1929-32, 1937-38.)". Maybe - but the story here is very unclear to me. 1920-1921, for one thing, has been considered a supply shock since Romer's work in the 1980s. The other thing is he has to be looking at aggregate data for these episodes, unless he knows of some microdata that I don't. I doubt it would reverse the finding given the deflationary pressures, but it makes it harder to assess.

*****

This is actually all right up the alley of what I want to do for my dissertation. In my applications I proposed looking at excess worker turnover as a wage adjustment strategy for firms facing sticky nominal wages. I'm not wed to that specific point, but I want to work on something related to worker flows and wage adjustment.

Tyler Cowen on sticky nominal wages

He puzzles over them here:

"There are good arguments that wages are sticky for (many of) the employed. Observed wage changes cluster in funny ways, indicating an unwillingness of the boss to change the nominal wage at all, and employers testify to morale problems from wage cuts (see Alan Blinder’s work). In terms of the financial crisis, Keynesian theory explains the initial lay-offs fairly well, but it — at least the sticky nominal wage version — has a tougher time explaining unemployment persistence at such a high level.

Why don’t the unemployed lower their wages to find a job? The more tragic you think unemployment is, the greater the puzzle here, and yet the people who stress the tragedy are often least likely to admit the positive puzzle (and vice versa)."

He proceeds to give lots of very good reasons why nominal wages for the unemployed are sticky. But I think it's all a whole lot easier to understand if you realize that:

1. Labor isn't bought on a spot market. Labor is more like an investment good than a consumer good, and

2. Unemployment and labor surplus are not the same thing. You can have lots of unemployment in a clearing labor market.

I'm sure wages are a little sticky for all classes of workers, but that's not the major problem we're facing.

Assault of Thoughts - 8/12/2011 - Apprenticeship and Job Training Edition

"Words ought to be a little wild, for they are the assault of thoughts on the unthinking" - JMK

- Last night I caught some of yesterday morning's Washington Journal discussion of job training in the U.S. and one of the things the interviewee focused on was apprenticeship in the U.S.. This was of particular interest to me because I'm now in the midst of editing a report from the spring and writing a final report on the evaluability of the Department of Labor's registered apprenticeship program as it is used by the long-term care industry. My trip to South Carolina the other week was a site visit to one of these programs. Hirsh recently wrote an article at the National Journal on these types of programs here.

- One of the important points he makes is that while the government can facilitate some of these programs, business needs to be allowed to take the lead because they know what skills are in demand. This is one of the virtues of apprenticeship. Since classroom training is combined with a lot of on-the-job training for apprenticeships, training is by definition relevant to the jobs available for workers. Bob Lerman, an economist I work with at Urban and a professor at American University, has a report here on the apprenticeship program from the perspective of employer sponsors.

- Apparently C-Span has been looking at job training all week. Here are Monday, Tuesday and Wednesday's programs.

- Gene Callahan recently posted a passage from Polanyi on apprenticeship: "It follows that an art which has fallen into disuse for the period of a generation is altogether lost. There are hundreds of examples of this to which the process of mechanization is continually adding new ones. These losses are usually irretrievable. It is pathetic to watch the endless efforts—equpped with microscopy and chemistry, with mathematics and electronics—to reproduce a single violin of the kind the half-literate Stradivarius turned out as a matter of routine more than 200 years ago. To learn by example is to submit to authority. You follow your master because you trust his manner of doing things even when you cannot analyse and account in detail for its effectiveness. By watching the master and emulating his efforts in the presence of his example, the apprentice unconsciously picks up the rules of the art, including those which are not explictly known to the master himself. These hidden rules can be assimilated only by a person who surrenders himself to that extent uncritically to the imitation of another. A society which wants to preserve a fund of personal knowledge must submit to tradition."

- Here's a video about apprenticeships and other opportunities outside of college from CNN yesterday. It also features Robert Lerman, who I mentioned earlier:



- And this is Robert Lerman last year discussing the issue on Bloggingheads:

More on wages, labor surplus, and that wage distribution graph Krugman shared

So the other day Krugman shared a great graph from Barrattieri, Basu, and Gottschalk that appears to show some wage rigidity. If you define wage rigidity as "wages have a tough time falling" it not only appears to show wage rigidity - it actually does show it:


The idea is that given a typical supply and demand graph, if demand falls wages and employment should fall. Since only employment is falling, people conclude (1.) wages are rigid, and (2.) that creates a labor surplus which reduces employment by even more than it would otherwise be reduced. The solution is "let wages fall". One of the easiest ways to do that if you think workers are being intransigent is to raise the price level.

As I said, if we just define "wage rigidity" as this sort of censored wage growth distribution, then obviously we have "wage rigidity". What follows much less clearly, though, is that this creates a "labor surplus" and that that surplus is somehow coterminous with "unemployment".

But consider the possibility that spending, long-term investment, and employment decisions are made simultaneously. Take my wife and I, for example. We're five years out of college. Immediately after leaving school we lived relatively cheaply because Kate went immediately to get her master's degree. She took out student loans and I just had an entry-level salary at a non-profit research group, so we didn't buy a house, we decided not to start a family yet, and we lived fairly frugally. Two years later I had been promoted and got a big wage bump, Kate was out of school and working herself, and our consumption changed. We lived in a nicer neighborhood, ate out more, our wine rack was always full and we would go to wineries in Loudon and Charlottesville regularly. Now I'm going back to school and while I have a stipend it's a big wage cut. So we moved to cheaper neighborhood and are living more cheaply than we did just two years ago.

Right now our labor supply function is fairly elastic because our spending commitments aren't very stringent commitments. But in five or ten years this won't be the case. I expect we'll have a house, a few kids etc. Clearly there are legal (to say nothing of moral) obligations associated with the maintenance of both of those things. Now, at that time (i.e. - prime working age for workers) when I think about making labor market decisions my reservation wage is going to be much less flexible. Most labor isn't bought on a spot market, after all, and it would benefit me to wait a little to get a wage that can actually maintain my mortgage and feed my kids than immediately lowering my reservation wage to get a job. Thus far, of course, this is just standard search theory type stuff.

Now, the point is these sorts of consumption commitments (kids, houses, etc.) are also committed to with specific employment expectations in mind. So if you go through several years of decent labor markets, the labor supply curve to the left of the equilibrium point is going to get increasingly elastic. People get into certain consumption habits - particularly debt-financed consumption habits - that are hard to extract themselves from, and therefore which are going to increase people's reservation wages and increase the value of searching (should they ever lose their job). In a robust labor market, the shape of that labor supply curve to the left of equilibrium doesn't bother us all that much. But if labor demand drops we're going to see the brunt of the labor market adjustment carried in employment.

So why this censored distribution that Krugman shows? Well, different sectors are behaving differently. While they're probably growing slower than they would have otherwise, health and education are actually not doing so bad through the crisis. If you have elastic labor supply to the left of equilibrium because people tie themselves up in consumption commitments when times are good, and if you assume different sectors are experiencing different levels of labor demand, then you can get Krugman's censored wage growth distribution without any (1.) labor surplus or (2.) puzzling questions about why workers won't take lower wages:

So to recap, here's one story on that wage distribution:

1. During tight labor markets, people feel like they can make long term consumption and life plans, so they do.

2. A lot of these life plans are necessarily debt financed - mortgages, car loans, sending kids to school, etc. Those plans that aren't debt financed are still tough to get out of (it starts to get awkward to leave a kid in a basket with a note on it at a church doorstep when they're seven or eight years old).

3. These consumption commitments and life plans make maintaining a certain income level for extended periods very important - so important that it makes sense to forgo employment a little longer and maintain a higher reservation wage than take a job immediately that will provide an income that can't support your commitments. This results in a relatively elastic labor supply curve for those currently employed.

4. During a period of weak demand, when all sectors are weaker than they would be otherwise but there is still some dispersion in growth in different sectors, that will result in a censored distribution of wage growth, a la Barrettieri, Basu, and Gottschalk.

5. No labor surplus.

6. We're at an equilibrium, so no great puzzle around what workers are thinking not taking lower wage rates.

7. Inflation to lower real wages makes less sense here. Inflation to relieve debt burdens does make sense because presumably that would make labor supply less elastic, but

8. It's still not really an answer because while the more elastic labor demand is, the more of an employment boost you'll get from #7, there's still no guarantee you're solving the underlying effective demand problem. A clearing labor market is not the same thing as a labor market at full employment (hell, if it were we could have stopped all this at #6).

Clearing Labor Markets and Unemployment

Bob Murphy has been asking questions about sticky wages (here, here), and Stephen Williamson talks about sticky wages as the primary Keynesian "tweak" to the standard neoclassical growth model that everyone is taught. I personally have a tough time knowing exactly how invested to get in this. Of course wages are actually downwardly rigid, I don't second guess that. Certainly that's going to add to unemployment. But I personally have a hard time understanding how this is a major cause of unemployment.

The implicit assumption is that a clearing labor market is a labor market without unemployment. That just seems wrong to me. We care about how markets clear because we think markets have a tendency to clear under normal circumstances. So it makes sense that we would want to pay attention to (1.) the forces that bring about that clearance, (2.) perhaps the special cases that would disturb a clearing market, and (3.) some insight into where that market clears - where quantity and price settle or at least where they tend towards. If you want to understand market quantities and prices, knowing how markets clear is important.

But unemployment is different. A lot of people sort of implicitly assume that unemployment is the same as a labor surplus, so that if they can explain why firms that would hire labor at a given wage might coexist with workers who would take a job at a given wage, they are "explaining unemployment". But this concept of labor surplus has little to do with the empirical phenomenon of unemployment that ostensibly we're interested in explaining. When people talk about "the unemployment rate" in the United States they are refering to the Bureau of Labor Statistics (BLS) definition: the share of the labor force that wants to work, is ready to start work, and is actively looking for work. Some people also care about those who want to work but aren't actively looking out of frustration, so the BLS also produces other figures to include these workers too. That definition is more or less how we think about "unemployment" in our own lives, right?

Notice what's missing from that, though. The reservation wage. As an empirical phenomenon, we really don't care about the relationship between a person's reservation wage and the market clearing wage when we identify this phenomenon called "unemployment". So why does it play such an important role in how we theorize about the causes of unemployment?

And what is "unemployment" in a simple model of the labor market? The "unemployed" are actually the workers between the equilibrium quantity and the upper right point of the labor supply curve. I've illustrated this here:


So for me, explaining what causes fluctuations in the quantity of labor (i.e. - impact of liquidity preference on investment demand and multiplier effects on consumption) or explaining why people might be in the labor market looking for work but not working (i.e. - search theory) seems a lot more important than explaining how labor surpluses can crop up (i.e. - sticky wages). I don't really know why I should even care about labor surpluses in and of themselves. I'd personally rather have an economy with a relatively high labor surplus and relatively low unemployment than an economy with relatively low (or zero) labor surplus and relatively high unemployment.

So part of me just wants to concede the point on sticky wages. Let's say all this sticky wages stuff is a red herring. Now, with that out of the way and the market cleared, is it cleared at a level where everyone that wants work is working? If not, why not?

Assault of Thoughts - 7/6/2011

"Words ought to be a little wild, for they are the assault of thoughts on the unthinking" - JMK

- Gene Callahan discusses Aquinas on property rights: the Sabbath is made for man, not man for the Sabbath.

- David Glasner is blogging (HT Scott Sumner). He's a monetary economist.

- Rare earth metals, which are essential for manufacturing many electronics, have been found on the ocean floor. Many deposits are comparable to or richer than those currently mined in China. As the price of rare earths continue to go up, mining the ocean floor will become more viable. This is a map of what they found, and this is an article on rare earths published in National Geographic recently.

- And speaking of shortages in specific commodities, Fitch ratings has warned about specific labor shortages despite a generally slack labor market. This happened during the Great Depression as well - in fact the Great Depression was one of the first times you heard people worry about shortages of engineers. Fitch points to the oil and gas extraction industry as a major area of shortages. This is something that my NBER co-author and I have looked at as well. He is authoring another chapter in the engineering workforce volume specifically on recent developments for petroleum engineers (which I've helped him on) discussing the recent spike in petroleum engineer demand and what it's doing to wages and enrollment.

Labor's share of national income

I'm not sure if there's some common underlying motivation, but both David Frum and Stephen Gordon posted recently on a famous "stylized fact" of macroeconomics - the relatively constant share of national income going to labor. Frum's is here and Gordon's is here. Labor's share of national income has been falling for the last couple decades, which is a trend that a lot of people have been speculating on. One of the better known treatments has been this IMF study (cited by Gordon) which attempts to identify the source of the decline for several different groups of countries.

I've worked a little on this issue with Wayne Vroman (recent recipient of an award from NASI!). One of the things we looked at was the change in the components of what's put into "labor share". There's wage and salary, total compensation (which is wage and salary plus benefits), and some portion of proprietor's income (usually set at something like two-thirds). Not unsurprisingly, the major source of decline has been in wages and salary. Non-salary compensation (i.e. - health and retirement benefits) have gone up over the last several decades, so that the total labor share has declined, but not as much as wages and salaries. Wayne and I are specifically looking at the implications for the unemployment insurance program, which is paid for with payroll taxes. As wages and salaries go down (while other benefits go up) the tax base for unemployment insurance is shrinking, even as the importance of a job for supporting retirement and health insurance is growing. In other words - losing a job is getting more costly at the same time that insurance against losing your job is getting harder to finance.

Right now we just have a lot of data, literature, and outlining that I've collected on the trends and their implications for unemployment insurance. We're hoping to write something up this summer on it.

Question for readers on graduate school wage premiums

Has anyone ever heard of an estimate of a graduate school wage premium (i.e. - over undergrad)? I'm calculating wage premiums for engineering graduate school grads relative to undergrads, and then using Goldin and Katz's (2008) basic supply and demand approach I'm trying to work elasticities of substitution out of that. I'm getting somewhat lower grad school premiums than they got undergrad premiums. It all looks fine - that sounds plausible to me - but it would be even better if someone actually produced these grad school premiums before and mine are comparable. I'm not even sure I'll include the elasticities in the paper - I've got plenty of micro-data, but I'm not working off of many years. The relationship is surprisingly strong, but when a kid with a crayon and a penchant for connect-the-dots can do just as well with a print out of my data, I'm a little loathe to call it an "estimated elasticity of substitution".

If I could verify the magnitude of the wage premium with other literature, though, that would be great.

"Glee" and Unemployment as a Social Problem

Kate and I watch Glee every week, and this week there was a big revelation about one of the characters, Sam: his dad lost his job, they were kicked out of their house, and his whole family was living in a motel room.

I thought this was an interesting and good plot development. Glee sometimes comes across as a public service announcement set to music. There's always discussion of social and cultural problems, particularly as they relate to youth. They've covered lots with homosexuality, bullying, different disabilities, teen sex, teen pregnancy, religion, single-parenthood, obesity, etc. I know saying "public service announcement set to music" doesn't sound that great for those that haven't seen it, but it also has another important element: Jane Lynch!

Anyway, all those issues it talks about are important of course, but one thing it never touches on is unemployment, which is a social problem that has been front-and-center "in the real world" for the entire tenure of the show. I think it's great that they've brought that in. And like the homosexuality or the teen pregnancy, I think it's going to be an issue that will continue to receive coverage and commentary on the show through the character of Sam. That's a very good thing.

New Acquisition

I just ordered Rob Shimer's Labor Markets and Business Cycles (2010), and I may be reading it next (it might turn out a semester back in the swing of graduate level economics would help me digest it better, though). I expect Shimer's work to be a jumping off point for my dissertation, particularly the material on wage rigidity. Wage rigidity does not play a big role in my view of macroeconomic fluctuations, but (1.) maybe it should - particularly for the more typical downturns which I'm likely to see more of in my lifetime than more atypical downturn that we're going through now, (2.) even if I stay unconvinced of the importance of wage rigidity, I ought to work on it because this is a quite dominant perspective in the field right now. This may take me into using the sexy LEHD data that everybody loves but I'm concerned that (because it only provides earnings and not wage rates), the plain Jane CPS might end up being more useful for me. Anyway - I have a rough brain storm of the types of ideas I might look into, and reading and familiarizing myself with this book seems like an important start.

The problem of micro-imperialism in economics

A couple days ago, in this blog post, I asked which of three labor markets were in a recession. My answer is - "I don't know, I don't have enough information". Hopefully, this revised figure helps explain why (assume, as the last piece of information, that every one of these economies has 15 people in it):

We have been trained to think that "unemployment" means "labor surplus". It doesn't. "Unemployment" means "the amount of people who want to work that aren't working". That is not the surplus gap between labor supply and labor demand. That is, in micro-speak, every point on the labor supply curve to the upper right of the labor market equilibrium. They don't know that their reservation wage is above equilibrium, and even if they did know that, since when has having your wage above the market equilibrium disqualified you from being considered "unemployed"? This is one of many examples of the intellectual imperialism of microeconomics in economics. Labor surpluses have nothing to do with unemployment or recessions - employment levels do. Labor surpluses tell you something about the likely behavior of wages and employment in the future, and perhaps about social welfare. There's nothing about labor surpluses that is of necessity relevant to the business cycle.

One of the problems with the way macroeconomics is thought about and done is that people have taken "understanding the business cycle" to mean "understanding what causes labor surpluses". This leads them down the path of sticky wages or minimum wages. These things may indeed influence the business cycle, but that is not automatically implied by the fact that they create a microeconomic labor surpluses. Which economy would you rather live in? I'd rather live in an economy with higher welfare, higher dead-weight loss, and higher employment, than in an economy with lower welfare, lower dead-weight loss, and lower employment.

This mentality has even creeped its way into where it shouldn't: Keynesian macroeconomics. Ryan Murphy has a further discussion of my 1920-21 paper and one of the things he says is: "Keynes believed that full employment is the special case, but Keynes didn’t develop IS-LM. One of the most surprising developments in the development of IS-LM was that its “general” case WAS full employment, and it took special things to get you to unemployment. This is really where I fundamentally disagree with Kuehn." He then links to the New School for Social Research's history of thought website which also claims that the Neoclassical Synthesis version of the IS-LM "tended to yield the Neoclassical result of "full employment"". I realize I am going somewhat out on a limb by criticizing the team at the New School on this, but I think it's the wrong interpretation of the model. The IS-LM model tends to microeconomic labor market clearing. That is quite different from saying that it tends to full employment.

I don't think much of "microfoundations", at least as any kind of theoretical obligation. Clearly if we can produce a correspondence between microeconomics and macroeconomics, that's fantastic. But "macrofoundations" are just as important. Even someone interested in "microfoundations" shouldn't pursue that by trying to superimpose microeconomic concepts onto macroeconomic concepts inappropriately. "Labor surplus" has to do with (1.) welfare/efficiency questions, (2.) questions about equilibrating tendencies, and (3.) match efficiency questions (because there is a pool of workers ready to work at a given wage). It has nothing directly to do with the problem of unemployment (although certainly point (3.) in that list will indirectly impact unemployment).

UPDATE: Another good way to think about the microfoundation obsession in economics is to look at other sciences. In physics, for example, we don't say "relativity is inadequate because it isn't derived from particle physics". The search for a unified theory of physics isn't a search to reproduce relativity from particle physics - it's an effort to find a consistency between relativity and particle physics, so physicists don't have to say "we know relativity is true and we know particle physics is true, and we can talk about both of them but we don't know a good unified way of talking about how they're both true". That should be how economics should approach the question. We oughta explore a lot of macrofoundations of microeconomics, a lot of microfoundations of macroeconomics, and also simply some new ideas. In the meantime, it's silly to consider some ideas tentative because we haven't hit on a correspondence. So why do we obsess over microfoundations? I think it's because microeconomics happens at the individual level, so our brains privilege that and assume any knowledge of what happens at the individual level necessarily has a sort of priority over other knowledge. You don't have this in physics because neither particle physics nor relativity happen at "our level". You did have this in biology for a while - it took a lot of pushing to get biologists to stop thinking about the selection of specific organisms and instead think of selection of what was actually being reproduced: genes. We have a bias towards that which we know best: ourselves. That cognitive bias can lead to bad economics if it generates an obsession with microfoundations.

Something I've been thinking about for a little while now...

Which of these labor markets is in a recession? What is the reason for your answer? (Sorry for the blurriness).

Krugman on Bob Hall

Paul Krugman covers a seminar by Bob Hall's paper on search and matching models at the zero lower bound, and writes this:

"So the point, as I get it, is that zero-lower-bound models work very well in practice, but have a problem in theory: it’s not at all clear how to reconcile them with Diamond-Mortenson-Pissarides-type models of the labor market."

I think one of the solutions is to recognize that in a lot of ways a labor contract is more like an investment than a consumer good. Labor isn't bought on a spot market for the most part - it is rented for an indeterminate period of time (as long as both the renter and the rentee find it to their advantage). The marginal product of labor, in that sense, is going to be compared to interest rates in the same way that the marginal efficiency of capital is, and we would expect to see high marginal products of labor with low hiring for the same reason that only high MEC investments are being made right now.

I am not well placed - right now - for integrating this into a search and matching model. But this is precisely the sort of thing that I want to do doctoral work on. I have two main project ideas I've been noodling over:

(1.) Taking Bob Shimer's model that combines wage rigidity with search and matching to describe fluctuations and letting firms react to wage rigidity by increasing turnover (wages for existing labor contracts are rigid, but new contracts aren't - job turnover is a wage adjustment strategy), and

(2.) Precisely the point I made above: the implications of labor as an investment for macroeconomic performance at the zero lower bound.

I'm hoping to do something like "Three Essays on the Macroeconomics of Labor Market Dynamics" so I can treat somewhat disparate topics and get a few papers out of it.

The Economics of Dr. King

From Where Do We Go From Here: Chaos or Community? (1968), by Dr. Martin Luther King Jr.:

The contemporary tendency in our society is to base our distribution on scarcity, which has vanished, and to compress our abundance into the overfed mouths of the middle and upper classes until they gag with superfluity. If democracy is to have breadth of meaning, it is necessary to adjust this inequity. It is not only moral, but it is also intelligent. We are wasting and degrading human life by clinging to archaic thinking.

The curse of poverty has no justification in our age. It is socially as cruel and blind as the practice of cannibalism at the dawn of civilization, when men ate each other because they had not yet learned to take food from the soil or to consume the abundant animal life around them. The time has come for us to civilize ourselves by the total, direct and immediate abolition of poverty.

...There is nothing new about poverty. What is new, however, is that we now have the resources to get rid of it... Today, therefore, the question on the agenda must read: why should there be hunger and privation in any land, in any city, at any table, when man has the resources and the scientific know-how to provide all mankind with the basic necessities of life?... There is no deficit in human resources; the deficit is in human will.

...All men are interdependent. Every nation is an heir of a vast treasure of ideas and labor to which both the living and the dead of all nations have contributed. Whether we realize it or not, each of us lives eternally "in the red." We are everlasting debtors to known and unknown men and women.

...Economic expansion cannot alone do the job of improving the employment situation of the Negroes. It provides the base for improvement but other things must be constructed upon it, especially if the tragic situation of youth is to be solved. In a booming economy Negro youth are afflicted with unemployment as though in an economic crisis. They are the explosive outsiders of the American expansion.

The insistence on educational credentials and certificates for skilled and semi-skilled jobs is keeping Negroes out of both the private business sector and government employment. Negro exclusion is not the purpose of the insistence upon credentials, but it is its inevitable consequence today. The orientation of personnel offices should be "Jobs First, Training Later." Unfortunately, the job policy of the federal programs has largely been the reverse, with the result that people are being trained for nonexistent jobs.

"Training" becomes a way of avoiding the issue of employment, for it does not ask the employer to change his policies and job structures. Instead of training for uncertain jobs, the policy of the government should be to subsidize American business to employ individuals whose education is limited. This policy may be considered a bribe by some, but it is a step consonant with reality. We require a vast expansion of present programs of on-the-job training in which training costs are absorbed by the government; at another level, employers could be granted reduced taxes if they employed difficult to place workers.

...The Freedom Budget of A.P. Randolph is important because it provides a basis for common action with labor and other groups in utilizing the economic growth of this nation to benefit the poor as well as the rich. It raises the possibility of rebuilding America so that private affluence is not accompanied by public squalor of slums and distress.

UPDATE: I apologize for closing comments. I just wanted to share a little of Martin Luther King's thoughts on economics. Some of it I disagree with, some of it I agree with, all of it I think was coming from the right frame of mind. The comment section turned into an argument over whether Progressives are to blame for segregation and Jim Crow legislation. It's not the sort of thing that seems appropriate on this anniversary. I wish we could have comments - but, well, we can't. Sorry.

Very good news

In today's employment report. Unemployment is down to 8.8 percent - a full percentage point in the last four months. Job growth in the last month was 216,000, and private sector job growth is strong.