What’s Wrong With Employment

I’d like to draw your attention to an amusing video from Reuters financial columnist Felix Salmon on what to do about the economy. It’s sort of Schoolhouse Rock meets Monty Python meets Business Week in Review. It doesn’t appear to be embeddable or I’d embed it. It’s short so cruise on over there and take a look.

Essentially, his message has the same core message as Federal Reserve Board Member Kevin Warsh’s op-ed in the Wall Street Journal I commented on a bit ago: monetary policy as effected by the Federal Reserve is no substitute for action by the Congress. Unlike Mr. Warsh, Mr. Salmon’s view is that the preferred action would be another spending bill but he’s skeptical that will happen given the likely mood in the next Congress so he’s willing to settle for a tax cut.

That’s essentially the reasoning I’ve been using when pitching the idea of suspending (or eliminating) FICA, what’s usually referred to as a “payroll tax holiday”. The way the tax code is structured at this point people in the two lowest income quintiles don’t pay much in income taxes so cutting marginal tax rates mostly benefits the top two income quintiles, hence “tax cuts for the rich”.

Preserving the “Bush tax cuts” will at best preserve the status quo. Only in Washington, DC would anyone characterize maintaining the status quo as a stimulus.

According to the Department of Labor employment is, essentially, moving sideways.

Suspending FICA would immediately reduce the cost of employing workers earning at or below FICA max (currently $106,800) by 15%. In rough terms that means you could employ seven workers for what you used to pay to employ six workers. I think that at least at the margins that would itself increase employment. But that’s where the critique of those who say that our (only) problem is aggregate demand comes in. Without more sales or the prospect of more sale there won’t be any work for additional workers to perform. Without adequate work for the prospective new workers to perform, employers won’t hire. That’s why the AD boosters, whose dean is Paul Krugman, insist on more and larger federal spending programs. Other than for reasons of their non-economic preferences, I mean.

By nearly anybody’s reckoning the first stimulus package was a disappointment. Only by handwaving and strained apologetics can it be construed as a success: whatever statistics you muster to defend it, it did not have the results that its proponents predicted.

IMO that tepid, at best, success was entirely predictable. Funds that were directed at state and local governments were used to prop up the status quo. Cuts in taxes were saved or used to pay down debt, and what is referred to as “infrastructure spending” mostly went to earners in the highest income quintiles and were saved or used to pay down debt. We don’t build roads and bridges the way we did 80 years ago with large gangs of unskilled and semi-skilled workers and animals. We use much smaller teams of skilled and semi-skilled workers (and a few unskilled workers) and lots of machines. The machines have already been bought and capitalized—we have enormous over-capacity in construction.

The Fed hasn’t fared a great deal better. Interest rates have been near zero for some time and appear likely to stay there for the foreseeable future. The first round of quantitative easing was, at best, a qualified success. The second round may have the perverse consequence of stimulating employment in places other than the United States:

Chairman Ben S. Bernanke and his colleagues appear to be fueling a foreign-investment surge, underscoring the difficulty of stimulating the economy through monetary policy with interest rates already near record lows.

“You’re seeing leakage from quantitative easing,” said Stephen Wood, chief market strategist for Russell Investments in New York, which has $140 billion under management. “That leakage is going into emerging markets, commodity-based economies, commodities themselves and non-U.S. opportunities.”

U.S. corporations have issued more than $1.07 trillion in debt so far this year, according to data compiled by Bloomberg. Foreign companies also are tapping U.S. markets for cheap cash, selling $605.9 billion in debt through Nov. 15 compared with $371.8 billion for all of 2007, before the Fed cut the overnight bank-lending rate to a range of zero to 0.25 percent.

To the extent that QE2 increases commodity prices it may actually reduce employment.

It’s not entirely clear to me what sort of spending program would create jobs here in the short run. There are plenty of ideas for creating jobs in the long run but, as I’ve said before, God send us a cure—the disease is already here. More consumer spending might create a few jobs in retail but most of the jobs created would probably be in China. Boosting business spending might have the same effect.

“Infrastructure spending” (which I think we should start referring to as “mid-20th century infrastructure spending”) won’t create lots of jobs. As people finally noticed there just aren’t that many “shovel-ready projects”, and, worse, there aren’t very many qualified vendors and those vendors have incentives to space the work out so they can execute it with the staff they have rather than taking on new staff.

Healthcare spending won’t create lots of jobs. Employment in that sector is relatively inelastic. Under the circumstances pouring more money into that sector just pays the people who are already in that sector more and may have the perverse effect of increasing the cost of future healthcare.

Wishing that we could return to the days of the housing bubble probably won’t create a lot of jobs, either, if only because wishing won’t make it so.

Kevin Warsh was right: we need to make substantial changes to our trade, fiscal, and regulatory policies. We need to reorient the relationship between business and government so that it’s more productive and less adversarial and cozy by turns.

The preferred solutions appear to be dreaming of winning the lottery, hoping that human nature will change, and phantasizing that the Fed will pull a rabbit out of its hat.

13 comments… add one
  • So, we’re basically screwed.

  • Yes, Andy we are screwed. I pointed out in a post at OTB on how to fix the deficit, that reducing payroll taxes would likely result in a very quick increase in employment since taxes introduce a “wedge” between supply and demand resulting in a lower level of output, in this case labor–i.e. jobs. Remove that wedge and output–jobs–rise.

    My overall post was tagged by one of the more prolific commenters there as ideological. The result I note above is not ideological it is a straight forward result of supply and demand analysis. As a solution to the issue of low unemployment it is a potential “quick”…fix isn’t quite the right word, but…step in the right direction.

    We could also make up the revenue shortfall by phasing in a gasoline tax. To the extent that is encourages fuel efficiency, development of alternative fuels, and reduces GHG emissions its all good. Granted in terms of interstate commerce we might want to consider a law exempting or setting a lower tax for moving goods in big rigs.

    Bottom line is that our policy process is not rational. Never really has been rational. The idea that policy is about finding outcomes that are improvements over the status quo is dubious. So yeah, we’re screwed.

  • But that’s where the critique of those who say that our (only) problem is aggregate demand comes in. Without more sales or the prospect of more sale there won’t be any work for additional workers to perform.

    Not true. If people are making this argument they forgot their basic micro-economics. Removal of a tax wedge, the dead weight loss, associated with a tax results in an immediate increase in output. Granted real world probably wouldn’t be instantaneous, but it would likely be pretty quick.

    IMO that tepid, at best, success was entirely predictable. Funds that were directed at state and local governments were used to prop up the status quo. Cuts in taxes were saved or used to pay down debt, and what is referred to as “infrastructure spending” mostly went to earners in the highest income quintiles and were saved or used to pay down debt.

    Going with just standard neoclassical economics one thing that might have driven down the “not spend tax cuts” response was that many people were looking at the expiration of the Bush tax cuts. If they put a non-zero probability on that occurring they might opt to save some or all of their tax cuts.

    We don’t build roads and bridges the way we did 80 years ago with large gangs of unskilled and semi-skilled workers and animals. We use much smaller teams of skilled and semi-skilled workers (and a few unskilled workers) and lots of machines. The machines have already been bought and capitalized—we have enormous over-capacity in construction.

    This is almost an Austrian critique, not that I’m complaining. Just using statistics to analyze something misses this kind of detail and as such you could look at two time periods that statistically look very similar, but maybe aren’t. Then trying the same solution that might have worked in the first one may not work or make matters worse in the second one. Alternatively you could consider Mankiw’s way of looking at the problem. He called it a “unit root” problem which is statistical term that implies that in some cases changes might be permanent (the ‘L-shaped’ recession). Krugman responded that this was the root of wonkish evil.

    The preferred solutions appear to be dreaming of winning the lottery, hoping that human nature will change, and phantasizing that the Fed will pull a rabbit out of its hat.

    Worse than that. I think it is fair to say that all politicians are small ‘C’ conservatives when it comes to the economy. Nothing radical please. Nothing new please. Lets try what we’ve done in the past, thank you. Why? Special interests, lobbyists, rent seeking, regulatory capture, and desire for re-election. I don’t think that very many politicians see their path to re-election via radical restructuring of government, regulatory systems, and such. They see this as pissing off too many donors, possibly letting some big firms with lots of workers (read voters) lose their jobs and so forth. No politician is going to throw himself on his sword for the good of the country, he wouldn’t be politician otherwise.

    This is why I keep saying rational policy or policy that seeks improvement is a fools dream. It is like hoping to win the lottery.

  • john personna

    Removal of a tax wedge, the dead weight loss, associated with a tax results in an immediate increase in output.

    This is the kind of bullshit certainty that has killed economics as a reputable source.

    Removal of a tax wedge may may reinforce deleveraging, without an increase in output.

  • john personna

    FWIW, I’d accept a reduction in FICA but it better be balanced by something in short order (be that a carbon tax or a elimination of income tax deductions). Otherwise it just becomes another round of “I don’t care, as long as my taxes are cut.”

    By nearly anybody’s reckoning the first stimulus package was a disappointment. Only by handwaving and strained apologetics can it be construed as a success: whatever statistics you muster to defend it, it did not have the results that its proponents predicted.

    The proponents of these plans may be faulted for getting their counterfactuals wrong, but it’s really worse when critics don’t get what we can now deduce about the missing counterfactual.

    If the situation was less than we (and those critics!) predicted, it is not rational to say therefore we should have done less.

  • reducing payroll taxes would likely result in a very quick increase in employment since taxes introduce a “wedge” between supply and demand resulting in a lower level of output, in this case labor–i.e. jobs. Remove that wedge and output–jobs–rise.

    Just as taxes introduce a deadweight loss into transactions so too do regulations. Both produce sub-optimal outcomes. The recently passed financial reform act has mandated racial hiring criteria. There is a cost of compliance associated with that regulation and a loss of productivity when hiring is guided by factors not associated with skill or experience.

    The social engineering mandates imposed onto the business community in regards to battling “discrimination” impose deadweight loss costs on labor productivity and reduce national wealth by about 4%+ of GDP. Compliance requires the creation of more “cost center” jobs in relation to “profit center” jobs within organizations. This cost of compliance makes organizations less competitive in the markets within which they operate, especially international markets. Less competitive organizations lose business to more competitive organizations and this lowers their rate of growth and profitability.

    Optimization, in the long run, yields more beneficial results than continued operation in a sub-optimal state. I’m not sure whether there would be a net job creation in the short term by removing unfunded social mandates imposed on business which reduce their need for cost centers but at some point we’ll need to optimize instead of adding more Rube Goldberg fixes onto an already sub-optimal labor market. The sooner the surgery is performed the sooner we’re on surer footing.

  • If the situation was less than we (and those critics!) predicted, it is not rational to say therefore we should have done less.

    It is not irrational to save that we should have done different things than were done which would be my position.

  • john personna

    If the situation was less than we (and those critics!) predicted, it is not rational to say therefore we should have done less.

    It is not irrational to save that we should have done different things than were done which would be my position.

    My position, as I recall it, was to embrace counter-cyclical spending. If we had plans for future spending, bring them forward. My criteria was “things we were going to do anyway.”

    We didn’t get that, or anything with any such clarity of purpose. We got a middle of the road compromise and grab-bag.

    I won’t defend that as perfect, far from it, but I can defend it as better than nothing. It’s better than the “nothing” that many argued as the preferred course.

    When I speak of “those critics” I guess I’m thinking of those who when opposing the stimuli chose a mild counterfactual, but then flip latter to complain about outcomes.

  • This is the kind of bullshit certainty that has killed economics as a reputable source.

    Yes, and my next sentence pointed out that the theory is not likely to obtain that quickly, and that in reality we’d still get an increase but employment would increase. You are stuck on stupid.

  • Let me explain why you are so stupid…or here I’ll be charitable John, why you are so blindingly ignorant.

    The removal of a tax wedge would increase output, because the imposition of a tax is like reducing demand at all prices levels. Thus, removal of the tax is like an increase in demand at all price levels. That is, in the context of discussion of payroll taxes and demand, the claim that removing the payroll tax would have no impact because demand wouldn’t increase is to in essence deny the validity of demand….demand inversely related to price, increasing in income/wealth. You then go on to offer a tepid defense of stimulus spending which is based on the very same concept of demand.

  • john personna

    And you can prove all that handwaving how?

    Oh wait, I remember now, economics is the would-be science that punts on falsifiable claims.

    Your claim is internally consistent, I’ll give you that, but there is reason to believe it is true, or applicable in this circumstance.

    I actually like and use a lot of economic notions, but i ‘m constantly aware of how many rely on the unstated caveat “all else being equal.”

    Given a real world with real flux, well my confidence in economists is inversely proportional to their certainty.

    (Note that your following line caveat was about pace, not that there could be sinks beyond domestic production. Deleveraging is not a fast path to output, as we see every week. It isn’t the only alternative, either. Flight to emerging markets perhaps?)

  • I actually like and use a lot of economic notions, but i ‘m constantly aware of how many rely on the unstated caveat “all else being equal.”

    This is a bullshit criticism and I’ll explain again why. This same criticism can be leveled against any and all policies recommendations. Stimulus spending? It too assumes ceteris paribus. Were you whining about that assumption back when it was being proposed? All else being equal, with the stimulus unemployment wont go above…..

    You implicitly relied on it here,

    If the situation was less than we (and those critics!) predicted, it is not rational to say therefore we should have done less.

    Your claim here is, “well just because ‘all else wasn’t’ equal doesn’t mean we shouldn’t have done it.”

    Same thing goes for reducing the payroll tax to try and provide a boost to employment. Could there be another economic shock that sends the economy back into recession? Sure, but as you said at November 18, 2010 at 2:03 pm it doesn’t mean it is still a bad policy. What it means is that without unemployment would likely be even higher.

    Or think of it this way. Lets suppose the payroll tax reduction will reduce unemployment 0.5%. Further, there is an external shock of some sort that will raise unemployment 0.5%. They cancel each other out. Your contention is that, “why bother doing it?!?!” But that is the same criticism you just argued against regarding the stimulus spending.

  • john personna

    Yes, I was consistent in my stimulus comments. I backed ““things we were going to do anyway” because they were safest with respect to uncertainty. They had the lowest bar to prove … I mean, they weren’t special funding. They were just time shifted.

    Your claim here is, “well just because ‘all else wasn’t’ equal doesn’t mean we shouldn’t have done it.”

    There you go again, trying to get me to take responsibility for a plan I did not author or support.

    Other than that, it’s really bizarre that you go on about me as an opponent of a payroll tax holiday, when I said in the other thread:

    I wouldn’t have a problem with a payroll tax holiday, if it was balanced by other changes bending that revenue curve upward in the next few years.

    You really don’t argue against what I say, do you? By now you’ve just got me as a mental placeholder for all your bogey men.

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