Lectures in Macro, No. 2
By Arnold Kling
I continue to focus on the issue of unemployment. In this lecture, I want to emphasize two things. One is the problems with popular intuition that jobs are scarce. The other is the wide variety of jobs, and hence labor markets, in a modern economy.
If you’re paying $12, $13, $14 an hour for factory workers and you can move your factory South of the border, pay a dollar an hour for labor, hire young — let’s assume you’ve been in business for a long time and you’ve got a mature work force — pay a dollar an hour for your labor, have no health care — that’s the most expensive single element in making a car — have no environmental controls, no pollution controls and no retirement, and you don’t care about anything but making money, there will be a giant sucking sound going south.
—Ross Perot, October 15, 1992
Ross Perot’s famous warning that the North American Free Trade Agreement (NAFTA) would produce a “giant sucking sound” still rings in our ears. The implication was that free trade with Mexico would cause significant job losses in the United States. Despite Perot’s warnings, President Clinton signed the agreement in January of 1994. Subsequently, employment in the United States increased steadily and dramatically, with the share of the working-age population employed reaching an all-time historical high in 2000.
The issue of whether trade costs jobs–or whether jobs are intrinsically scarce at all–is one that divides economists from non-economists. Bryan Caplan puts it,
The public often literally believes that labor is better to use than conserve. Saving labor, producing more goods with fewer man-hours, is widely perceived not as progress but as a danger. I call this the make-work bias, a tendency to underestimate the economic benefits of conserving labor. Where noneconomists see the destruction of jobs, economists see the essence of economic growth: the production of more with less.
Caplan has analyzed surveys of economists and non-economists in order to pinpoint differences. A persistent worry of non-economists is that better efficiency will cost jobs. This worry becomes particularly acute when the source of efficiency is trade, which registers with the public as “foreigners stealing our jobs.”
Suppose that there were a central planner for an economy. People have unlimited wants. That is, consumers will always prefer having more goods and services available to having less. The central planner would never prescribe that some people not work. That is, the planner would never say, “We get enough from China. You can go home.” Nor would the planner say, “Since we can now produce the same output with fewer workers, we will have some workers remain idle forever.”
Instead, a central planner would find a use for all workers. The planner will move labor out of sectors where productivity growth exceeds demand growth and into sectors where demand growth exceeds productivity growth.
In the case of international trade, David D. Friedman in Hidden Order: The Logic of Everyday Life offers the illustration of growing cars in wheat fields. That is, instead of building cars in manufacturing plants, we can grow wheat, ship it overseas, and have the ships come back with cars. The car-growing process may require fewer auto workers, but those workers can be given other work to do.
In practice, central planners do not organize economies very well. There is often a lot of disguised unemployment in such economies, because people have little incentive to seek productive jobs.
In a market economy, prices and wages perform the function that in theory could be done by a central planner. When the economy needs to shift employment from manufacturing to health care (because productivity growth exceeds demand growth in the former but not the latter), wages will fall in manufacturing and rise in health care. When the U.S. economy needs to shift employment from customer call centers (which can be outsourced to India) to accounting, wages will rise in accounting and fall in domestic customer call centers.
As we saw in the previous lecture, millions of jobs are lost each month. But each month, millions of jobs also are gained. Some firms expand rapidly, and some firms cut back rapidly. The net differences between total monthly hires and total monthly separations are small.
In the 1990’s, labor market policies in Europe were often geared toward stopping job losses. Ideas included a limited work week or penalizing firms for firing workers. The net result was higher unemployment and a lower share of the working-age population employed than in the United States. It turns out that the anti-job-loss policies make workers expensive to employ. As a result, they reduce new hires by more than they reduce job losses.
The fallacy is to confuse gross job losses with net job losses. A nation can have a large number of gross job losses without any net job loss, as long as additions to employment in expanding companies are at least as large as reductions in employment at contracting companies.
The overall key point is that the common intuition that jobs are scarce is dangerously wrong in many contexts. It leads to a fear of productivity gains. It leads to a particularly strong fear of the productivity gains that come from trade and comparative advantage. It leads to a faith in anti-job-loss policies that is counterproductive.
And yet, there is one context in which economists talk about job scarcity in the same terms as an ordinary layman guilty of make-work bias. That context is macroeconomics. When they talk macro, professional economists speak of the need to create jobs. Economists will grade Presidents on how many jobs are gained or lost during their administrations, rather than on, say, productivity growth during their tenure in office.
I worry that mainstream Keynesian macroeconomics is little more than fancy camouflage for make-work bias. That is, it allows economists to strike a sympathetic chord with non-economists, while maintaining an air of professional sophistication.
On the other hand, I worry that classical economics is vulnerable to appearing irrelevant in the face of episodes such as the Great Depression, the recession of 1980-1982, or the recession that looms at the end of 2008. We need a narrative of episodes of severe unemployment that does not embody crude make-work bias but does not deny the existence of large amounts of involuntary unemployment.
I suspect that a key to thinking usefully about macroeconomics is to shift from thinking in terms of a singular labor market to thinking about plural labor markets. One of the reasons I resist mathematical model-building is to avoid the temptation to specify the labor market, as if there were only one. My guess is that thinking in terms of one labor market puts you off track.
Think in terms of many labor markets, constantly in flux. Demand shifts across sectors, across firms, and across occupations. Even if the demand for accountants or computer programmers is rising on a secular trend, there will be failing firms that fire accountants and programmers.
Substitution mechanisms matter. It may be impossible for the same worker to walk off an assembly line one day and join a physical therapy practice the next. But the same change can be effected if an assembly-line worker reaches retirement age and is not replaced while a freshly-certified physical therapist reports to work for the first time the following day.
Some industries move quickly to add and subtract workers. In retail trade, firms hire for seasonal needs. There are always new stores opening and failing stores closing.
Other industries move more slowly. In manufacturing, the decision to add capacity or to take capacity off line is made cautiously. In law firms, investment banks, and other companies that employ highly-skilled workers, the decision to lay off an experienced professional is not taken lightly.
The economy is radically different today than it was in the 1930’s, when the majority of the work force did manual labor. It is also different from the 1950’s, when autos and steel were so significant that General Motors’ Charles Wilson famously said that “What.s good for GM is good for the country, and vice-versa.”
For further reading, I suggest browsing through the U.S. Department of Labor’s Standard Occupational Classification web site. Particularly fascinating are Katherine Abraham’s historical overview and the proposed structure for 2010, which highlights changes relative to 2000.
Previous entry in this macroeconomic lecture series: introduction