Category Archives: Labor Economics

Southern European Labor Markets in Perspective

Left Behind (Edwards)Over the last fifteen years the Latin American nations have made very little progress in deregulating labor markets. Labor laws in the region resemble those of the older social welfare era in Europe. According to the Fraser Institute, Latin America ranks lower on average than most of the comparison nation groups in terms of labor market flexibility. The only group with more regulated labor markets is the southern European nations — Greece, Portugal, and Spain.

— Sebastian Edwards, Left Behind: Latin America and the False Promise of Populism (Chicago: University of Chicago Press, 2010), pp. 97–98.

By the way, while I had my reservations at first, if you’re interested in the economic history of Latin American this book is both easy to read and interesting. It has a clear free market bent, which may be a good or bad thing depending on who you are.

Warren’s Mistake?

The other day, Senator Elizabeth Warren found herself assailed for, citing a CEPR study, arguing that had the real minimum wage tracked productivity it would be set at roughly $22. She then asks what explains this ~14 dollar gap between the current Federal minimum wage and her hypothetical. I don’t think she’s (more accurately, the study) claiming that the marginal productivity of a minimum wage earner is $22. Rather, that in 1968 the real minimum wage was M and productivity was P, and that if this ratio were maintained then today’s minimum wage would be $22.

The most important issue is probably that the CEPR study uses a measure of total productivity (output per hour for all persons), rather than looking at the marginal productivity for minimum wage workers specifically (or some proxy). At an extreme, for example, it could be that their figure hides a bifurcation between the wages of unskilled and skilled labor. It may just be the case that the productivity of the minimum wage worker hasn’t risen much. On the other hand, the productivity of the minimum wage worker could have risen, but this could have just offset the relatively higher real minimum wage of 1968. In other words, if the 1968 minimum wage had a large impact on unemployment, rising productivity would simply help reduce the deadweight loss created by a wage floor. I suspect, though, that the issue is with the data used and that using the marginal productivity of the minimum wage worker would show a much smaller gap.

But, if CEPR’s argument is legitimate (which depends on changes in the marginal productivity of minimum wage labor) then I think the question of whether or not the minimum wage ought to be $22 depends on the impact the 1968 minimum wage had on unemployment. If the data suggests a relatively benign impact, then a $22 minimum wage shouldn’t be an outlandish claim for a progressive (not that I think it’s a reasonable position to hold).

Edit: I wrote this last night, but it appears as if Daniel Kuehn and, in the comments, Bob Murphy have beat me to the punchline.

Positive Expectations?

Total Discouraged Workers

[Ed. I had to write this for class, and since I have an exam today I thought I’d post this instead of writing something else.]

Unemployment remains an enigma. That in 2012 the unemployment rate fell by less than half a percentage point may be concerning. Further, 7.9 percent of the labor force remains without jobs, and it has been like this since October 2012. I, however, remain an optimist, basing my case on the discouraged workers data published in the recent Bureau of Labor Statistics (BLS) report.

Discouraged workers are a subset of what economists refer to as people “marginally attached to the labor force.” The latter, broader category includes all those who are willing and able to work, but have not been actively seeking employment for the past four weeks for whatever reason. Discouraged workers are a narrower range of elements: unemployed individuals who are pessimistic about the employment outlook. They aren’t actively seeking work because they don’t think there’s any available, perceiving their time as being better spent in alternative activities. Many think that the most basic unemployment rate (U-3) ought to reflect the discouraged, believing that the discouraged workers data makes the unemployment situation worse than typically reported. But, there’s reason to believe the opposite.

Counter intuitively, the U-3 statistic reflects these improvements by making conditions seem worse. The latest BLS report shows that unemployment remains unchanged at 7.9 percent, despite an increase in total nonfarm payroll employment. If the private sector has contributed to net job growth, how can the unemployment rate remain the same? The answer is that previously discouraged workers have begun actively seeking work, re-entering the U-3 unemployment measurement.

The graph above shows two lines. The thick blue line tracks monthly changes in the total number of discouraged workers. The thinner black line is a “rolling average” trend line, and is useful for illustrating trends that may be hidden by the short-term volatility of the data (which may be exaggerated, since this data is not “seasonally adjusted,” which manipulates figures to place them out of specific contingent contexts). Note that, on average, the total number of discouraged workers has fallen since its mid-2010 peak. Since the decision to become discouraged essentially rides on one’s expectations of employability, that less people are discouraged suggests that expectations for the labor market are picking up. The unemployed themselves think the employment situation is improving.

In this economy, growing confidence amongst the unemployed is certainly a good sign.

Labor Productivity and Wages

The recent discussion of growing corporate cash holdings is pushing me to explore the relationship between cash holdings, wholesale lending by non-financial firms, and inequality. I’ve spent part of my weekend figuring out which statistics are best for the analysis I have in mind, but the only consolidated source I’m regularly pointed to is the Bureau of Labor Statistic’s major sector productivity index. If anybody can point me to a better source (and which data to use), I’d be much obliged. (Also, if I’m misrepresenting what the data means don’t hesitate to tell me.)

I’m trying to find evidence for the theory that an increasing volume of wholesale lending by non-financial to financial firms has sacrificed, to some extent, investment aiming at increasing workers’ productivity. Slower productivity growth implies slower wage growth, and if we assume that returns to industry are heterogeneous amongst sectors then it’s possible that the financial sector has seen higher returns at the expense of wage earners. If one were to ascribe to the Mises–Hayek theory of industrial fluctuations, as I do, (or even Minsky’s financial instability hypothesis), then this would be a secondary consequence of an excess supply of fiduciary media (i.e. a bubble).

I don’t know if my hypothesis is supported by the data I’ve been looking at, but the data is nonetheless interesting,

Productivity and Compensation (Nonfinancial Corporate Sector)

We see in the graph above the empirical evidence for paradoxical inequality. The black line follows productivity, referred to by the BLS as “output per hour.” The solid blue line plots real wages. Notice the relative stagnation of real wages between ~1970–2000. While productivity growth during that period certainly doesn’t seem stellar, the evidence suggests that real wages have risen less than productivity. But, looking at the broken blue line, nominal wages have risen with productivity.

What does this mean? I have no idea. My guess is that the data agrees with me that whatever has shifted the distribution of income between wage earners and capitalists is to be found outside of the nonfinancial firm, having more to do with a macroeconomic phenomenon. It also suggests that looking at wages can be too narrow of a scope, and that factors outside of the control of the firms themselves have eroded the purchasing power of wages. Also, although this is almost completely unrelated, one interpretation of the numbers between ~2007–12 is that the rise in productivity, without a rise in employment, is most likely the outcome of a growing substitution of capital for labor, because of nominal wage growth stripping productivity growth. The fact that real wages have stagnated despite the disproportional rise in nominal wages may mean that the real value of the non-financial firm has eroded along with real wages.

The empirical relationships are interesting, but I’m struggling in putting the pieces together.

Minimum Wage Economics

Don Boudreaux, at Cafe Hayek, discusses the various reasons why economists don’t find it persuasive to argue against the minimum wage by sarcastically asking why the minimum wage isn’t set even higher. Here is a shorter route to illustrating why the argument can be a bad one (although not always),

Minimum Wage (Inelastic Demand)

The downward sloping curve is the firm’s demand curve for labor and the upward sloping curve is the supply of labor. Notice the steep slope of the demand curve. It suggests that the firm’s demand for labor is inelastic. Elasticity refers to how much a change in price will affect the quantity demanded (or supplied, if we’re talking about the elasticity of the supply curve), and the more inelastic demand is the less effect changes in price will have.

Why not $90 instead of $9? $90 could have a huge impact on the quantity demanded for labor, while the elasticity of the curve between $7.25 and $9 could be steep enough such that the change in quantity demanded would be miniscule. Does this reflect reality? This isn’t a theoretical question, but an empirical one — the seminal study by Card and Krueger suggests that the negative effects of minimum wage are often overstated (but, their work is not without controversy).

But, to look only at labor might lead one to underestimate the costs to minimum wage hikes. Suppose the firm’s quantity demanded for labor remains the same, despite a minimum wage increase that ends up costing it, say, $100,000 per year. An advocate of minimum wage might correctly assume that this money will come out of profits. But, I suspect that those who think this isn’t important are those who equate profits with management incomes. This isn’t necessarily true. Retained earnings are also invested. It’s possible that the costs of minimum wage are seen in places other than the labor market, including foregone investment into increasing productivity (which also may suggest foregone wage increases — meaning the minimum wage can be superfluous as well as damaging). Just because the same amount of people are employed after an enforced wage hike doesn’t mean that the theoretical costs have been averted.

Boudreaux brings up another good point closer to the end of his post. The minimum wage isn’t the only piece of legislation the hurts employers. There are various ways that the government can increase the costs of hiring and therefore reduce the quantity demanded of labor. By itself, an increase in minimum wage can have a minimal effect, but in concert it can be particularly damaging. If other Obama programs will raise the costs of hiring, is it smart to also raise the minimum wage? I think it’s a good question and deserves attention.

Productivity and Unemployment

Does productivity growth lead to relatively higher unemployment? According to David Beckworth,

Boom and Bust Banking (Beckworth)Starting with Galí (1999),* there have been a number of studies that show positive productivity shocks lead to a  temporary decline in hours worked. The interpretation given to these findings is that given sticky prices, firms initially respond to productivity gains by using less labor. Only as prices become more flexible (i.e., the SRAS curve shifts right) do firms employ more labor and push the economy to its full economic potential. Thus, these studies imply that a productivity boom of the kind experienced during 2002–2004 should initially lead to some slack in resource utilization.

— David Beckworth, “Bungling Booms: How the Fed’s Mishandling of the Productivity Boom Helped Pave the Way for the Housing Boom,” in David Beckworth (ed.), Boom and Bust Banking (Oakland: The Independent Institute, 2012), pp. 38–39.

* (Jordi Galí, “Technology, Employment, and the Business Cycle: Do Technology Shocks Explain Aggregate Fluctuations?,” American Economic Review 83 [1999], pp. 402–15.)

I’ll have to read the literature, but suffice to say I’m not entirely convinced. The above excerpt is also in the context of negative outputs gaps caused by productivity shocks (a rightward shift in the LRAS curve, but only a gradual rightward shift in the SRAS curve), which I also don’t find convincing as a real world causal explanation of productivity growth. If an economy is in a full employment equilibrium, I don’t see why changes in technique, technology, et cetera, which allow the firm to expand production at the same costs would disrupt full employment, and I don’t see why sticky wages would be relevant. This being said, I can see why firms would initially reduce the amount of labor employed: positive productivity shock can change the marginal products of both labor and capital, making the latter initially more economical than the former (to the point of re-arranging the amount of labor and capital employed) — especially at first, when firms are building up the capacity to maximize production.

I wanted to corroborate this with data from the 1873–94 era, but unemployment figures fluctuated wildly due to various financial crises and mild output contractions. Also, if we hold “boom” logic, where unemployment is temporarily below its “natural” level, then using the era’s lowest figures might also be misleading. But, the average unemployment during those years was 4.7 (using unemployment figures from J.R.Vernon, “Unemployment Rates in Postbellum America: 1869–1899,” Journal of Macroeconomics 16, 4 (1994), pp. 701–714).

Jasay contra Stiglitz

Anthony de Jasay reviews Joseph Stiglitz’ The Price of Inequality. I haven’t finished reading the book, so it’s difficult for me to comment; but, it’s true that the book comes off as extremely biased. De Jasay sums up the book’s argument succinctly: it boils down to “deregulation” and legislation that favors the rich, at the expense of everyone else. He offers a few reasons why this may not be the case, and then advances his own thesis: globalization. Both probably have some explanatory power, but I lean towards a more reasonable reformulation of Stiglitz’ broader case — we live in a market deeply distorted by government interventionism, and some of the rising inequality can be attributed to these distortions.

Both de Jesay’s and Stiglitz’ arguments deserve more attention and analysis than I am affording them here, but since I’m strapped for time I just want to take advantage of the situation to publish two graphs that illustrate my own thesis: the monetary regime is most responsible for rising income inequality. The graphs, on their own, don’t explain much, but I think they’re interesting to look at — interpret the data how you’d like. Neither is the data perfect; in fact, it’s probably extremely non-rigorous. The money supply data is taken from the Fed’s M2 series. The “income inequality” data is taken from the census website, specifically “mean household income.” The specific figures are a result of this equation: [(top 5-percent income) – (avg.{bottom four quintiles}).

We’ll call it an ongoing project at its beginning stages.

Money Supply (M2) 1959–2012 (Qrtly., S.A.); source: St. Louis FRED

Income Divergence, 1967–2011; source: Census H-3 (All Races)

Structural Misunderstanding

In an effort to emphasize the “demand side” nature of the current recession, many economists have drawn clear lines of distinction between “structural” unemployment and that caused by “inadequate demand.” The attempt to distinguish caused some to lose sight of what “structural” unemployment really means in the context of the current business cycle. The truth is that “structural” and “demand driven” unemployment are two sides of the same coin. This also means, however, that “structural” advocates should stop stressing the relevance of concepts like “skills mismatch” and “zero marginal productivity” (ZMP), because the core of the problem is not lack of employability.

What brings me to make this argument is Peter Lewin’s comment on Edward Lazear’s WSJ op-ed. Lazear points out that, while the bulk of cyclical unemployment impacted a tight range of industries, it’s these same markets that have been seeing a rise in the pool of labor as unemployment falls. He suggests that the culprit is lack of growth, not the inflexibility of movement of labor between industries. Lewin is somewhat skeptical, because his explanation of the cycle is “structural” and there is evidence that resources had been misallocated during the boom.

If they were debating, I’d say that Lewin and Lazaer are talking past each other — but, this is essentially what’s occurring within the profession. I agree with Lewin that the cycle is characterized by the re-allocation of resources, responding to a previous period of malinvestment. But, this doesn’t mean that long periods of high unemployment are caused by large quantities of labor not having skills in demand. If this were the case then we’d also have to ascribe the same degree of rigidity to the use of capital goods, where capital goods in current form provide no use for what firms are looking to produce. Production decisions, though, have to consider income expectations and weigh these against the costs of production. If there is a “skills mismatch” the entrepreneur has to decide whether it’s worth the cost to re-train (much like she has to decide whether it’s worth the cost to scrap a certain capital good and manufacture the one she needs). Oftentimes, entrepreneurs simply have to choose to produce between a range of outputs dictated by the current state of inputs.

Both Lazaer and Lewin are right. Entrepreneurs have to allocate resources, including attracting labor. The allocation decision is made on the basis of profit and loss. This causes a lot of entrepreneurs to invest where there already exists a willing and able pool of labor. The question is, why hasn’t this investment taken place?

Here, the more traditional explanations for unemployment come into play: wage rigidity, ZMP, et cetera. All these probably have some influence on the rate of unemployment. I think that another proximate cause has much more explanatory power in this current recession, though: an “underemployment” equilibrium. That is, where a “fixed” (used in a relative sense) stock of firms, which prefer to higher less labor at a higher price, because they expect higher productivity (rather than more labor and a lower price). If I’m right, then Lazaer’s argument holds a lot of weight. If there were more investment — more entrepreneurs, more (or larger) firms, et cetera — then there would be higher demand for labor.

Why is there “inadequate demand?” I blame an illiquid banking sector.

In any case, we can apply the same argument to comment on the recession, in general. It was caused by a misallocation of resources, led on by “phantom profits,” and as such the recovery is characterized by changes in resource allocation. In this sense, we’re talking about a “structural” problem. At the same time, the decision to invest is a decision to demand, and an economy where the necessary re-allocations aren’t taking place is an economy beset by “inadequate demand” (more accurately, depressed production).

Voluntary Mass Unemployment

I’m currently writing my review of W.H. Hutt’s The Theory of Idle Resources — slowly but surely, since I’m swamped with other work. While I think Hutt’s 1939 monograph is a great contribution to the literature, I feel as if he didn’t adequately address the concerns brought to the forefront of economics by J.M. Keynes’ The General Theory. I recently came across something that embodies my reservations: Pavlina Tcherneva’s ‘economists for Romney’ critique. Specifically, her words on R. Lucas’ rational expectations model and its implications for the labor market,

Perhaps no one bears more responsibility for the general apathy among mainstream economists towards the problem of unemployment than Robert Lucas. He is the economist who argued that there was no point in distinguishing between voluntary and involuntary unemployment because agents were ‘perfectly rational’ and the jobless essentially ‘chose’ their condition (1978, 242).

I haven’t read Lucas’ 1978 paper, “Unemployment Policy” (linked in the excerpt above), so I’m not commenting on the truth of that interpretation. But, it’s a similar argument that Hutt implicitly makes. In The Theory of Idle Resources, Hutt essentially blames labor unemployment on three things: ‘pseudo-idleness’ (imagine a wage-earning remaining unemployed expecting to find a higher wage elsewhere), preferred idleness (leisure > work), and monopolization. The latter tends to get the most blame when free-market economists try to explain phenomena such as unemployment-levels during the Great Depression, but growing amounts of evidence are suggesting that this isn’t the ‘proximate cause,’ as Hutt likes to write, of much of prolonged cyclical unemployment.

The closest thing that does come to a critique of what we may call the ‘sticky wages’ theory of idleness, although this isn’t Keynes’ unique criticism of classical employment theory, is what I interpret as a confusing critique of monetary disequilibrium theory. Somebody who knows W.H. Hutt’s work better than I do can comment and explain the relevant section to me, but this is how I understood pages 80–82 (even though here the context is monopoly). But, Hutt doesn’t really address the possibility of an ‘underemployment equilibrium.’ I don’t necessarily mean in the sense Keynes’ meant it, but maybe in the modern sense: where all firms’ employment needs are met at wage prices higher than those which would ‘clear’ the market in the classical sense.

Hopefully, I’ll go into further detail in the review, but it just doesn’t make sense to me to blame only either monopolistic regulations or workers’ preference (or the notion that unemployment insurance significantly aggravates the existence of ‘preferred idleness’). Situations of high unemployment, recessions, are characterized by the capability to recover given changes elsewhere — credit markets, for instance —, such that the employment situation can be resolved. By blaming unemployment on preference or interventions (including monopolies), we take away from other causes and aggravating variables. I suppose the unemployed person can employ herself manufacturing hand-made train models (‘disguised unemployment,’ as Joan Robinson would say?), but if productivity weren’t depressed due to a broken financial system maybe she’d find more favorable terms elsewhere.

Rigid Productivity

Why do neoclassical economists oftentimes blame only two factors on unemployment:  (i) wage rigidity or (ii) a rise in the disutility of labor?  What year are we in, 1936?  Alternatively, others might blame it on “skills mismatch,” citing evidence that individuals with “lesser” education are increasingly being out-competed by those with advanced degrees.  There’s not much respect for the sacred position labor occupies in the division of labor: that of the scarcest resource — think about it, productivity’s natural limit is the availability of labor.  Few economists look at the more complex causal factor: inadequate productivity.

Elaborating on why lack of education might not play as big a role in unemployment as some suggest, imagine the labor market from a Hayekian perspective.  There is a total supply of labor with heterogeneous skills.  The labor supply is drawn from by firms looking to achieve some rate of income, but there is an ambiguous degree of inflexibility in the ability to mix labor and capital.  Two simple alternative ways of looking at this problem include having to demand capital goods that are complimentary to labor or training labor to become complimentary to a given stock of capital goods.  In reality, both may occur, as well as other methods of mixing the two.  What this means, though, is that entrepreneurs have certain expectations and understandings given the available stock of capital, labor, and the expectations they hold on the future state of demand (relative to their output).  This suggests that the structure of production will have to, in part, be shaped around the specificity of labor.  Otherwise, we would see a permanent historical trend of discoordination between entrepreneurs and the supply of labor.

Neither do I think falling back on the increasing complexity of of the economy, including the growing intricacy of the products being manufactured and the services being offered, is very useful.  The easiest reason to avoid doing this is that universities and public higher education don’t really teach the relevant knowledge (although, community colleges have tended to offer “blue collar” courses and there are, obviously, trade schools).  Additionally, the potential outputs that can be produced are essentially limitless — bounded only by human creativity and the means of production —, and so even despite a scarcity of high intellectuals there are plenty of products that can be produced with any given skill level of workers.

What about the empirical fact that “low education” workers are being gradually replaced by “higher education” workers (I quote those terms, because a level of education is relative to what exactly your occupation is — a plumber is better educated at plumbing than an economist or psychologist is)?  When interpreted correctly, these trends support my argument, not the education one.  There’s fewer jobs available, and firms are opting to hire those with greater general skills.  In some sense, this also supports Tyler Cowen’s “great stagnation” thesis, which in some respects goes hand in hand with the “inadequate productivity” I’m referring to.

It might help to see more sense in the productivity argument if we first explore why it might not be rigid wages which are causing high unemployment.  The fact is that wages are not so much flexible or non-rigid, but that there are no “forces” operating to push them down to a level that would allow for “full employment.”  There is a growing amount of literature that supports the empirical case that many firms prefer to maintain high wages and shed excess labor during a cyclical fluctuation (see Kuehn [2011], pp. 448–450, for a short survey).  The clear conclusion one should derive from this is that entrepreneurs expect greater productivity from fewer higher paid workers than from more lower paid workers.  In other words, given stagnant productivity there can exist what we can tentatively and illustratively call an “underemployment equilibrium.”

What is holding back productivity?  For starters, a moribund banking sector with excessive levels of unproductive debt.  The unemployment problem is necessarily tied to the state of the rest of the economy.  These are all complimentary factors and a general economic recovery will entail a recovery in all these different sectors — this should serve to question the validity of the idea of a “jobless recovery.”  Taking whatever steps necessary to jolt the economy back to life would be sufficient to increase employment, with the additional caveat that since the early 1970s we’ve seen “growth” with falling relative wages and growing income inequality — different economists have different explanations, but most would agree that some sort of reforms are necessary (regulatory on one side and “freer” markets on the other; I think both would agree with something I recently read in Steve Keen’s Debunking Economics, which is along the lines that the “banking class” has caused the re-distribution of income towards them away from both the capitalists and wage workers).

Without a doubt, a productive, growing economy would shape production — whether of manufactured goods or non-manufacturing services — around a given supply of labor and capital, gradually shaping it to meet certain needs.  There’s no reason to suppose that there is a permanent divide between our economy’s need and the education of any given individual.1  Of course, there will always be a need for a specific skill — our world is one beset by the elementary element of scarcity —, but this shouldn’t be seen as the cause of our unemployment and inequality woes.


1.  Although, one should not deny that the past decades have seen a rise in the volume of degree holders.  What this has often meant, though, is that people have gained skills that are incongruous with “real world” demand.  As such, we find business degrees working at Kmart, and philosophers having to go to a technical school to attain a different set of skills.  In other words, we have also seen an increase in the volume of malinvestment in human capital.  These people have been able to find jobs in fields usually unrelated to their degree, at the expense of others.  Bluntly put, higher education oftentimes results in a large waste of resources.