Recalculation, Normal Churn, and Deficient Demand
By Arnold Kling
Karl Smith looks at gross job flows and ask whether they support or refute the Recalculation Story.
We can think of three reasons for people to lose jobs. First, normal churn, in which people shift out of declining firms and into expanding firms, with no net job loss. Second, deficient demand, where people are laid off from viable firms because of a drop in aggregate demand. Finally, Recalculation, in which nonviable firms have expanded by mistake, they shed workers, and the economy needs to figure out where those workers should go.
How do we distinguish Recalculation from the other two?According to John Haltiwanger, much normal churn is intraindustry. Think of the large, integrated steel mills disappearing from the U.S., while mini-mills grow. Or think of the decline of many local retailers, and the expansion of Walmart and Costco.
A demand-driven decline and recovery ought to see mostly intra-industry (or even intra-firm) fluctuations in employment. The automobile industry and its suppliers lay off workers in a recession, and they recall them in a recovery.
With a Recalculation, the main employment change is across industries. Workers in overbuilt industries lose jobs permanently, and employment gains occur in new industries, with a lag.
Normal churn is not preceded by any imbalance or miscalculation. As a result, flows into jobs and flows out of jobs are such that we maintain full employment.
Demand-driven recessions are driven by inventory miscalculations (failure to forecast sales correctly). Workers are laid off when inventories get too high, and they are recalled when the excess inventory is worked off.
Recalculation is driven by excess capacity that is built up based on unsustainable expectations. Nowadays, excess capacity consists of human capital, not just physical capital.
Remember the Garett Jones point that many workers nowadays build organizational capital, not widgets. In the information age, hiring workers is an act of investing in capacity, analogous to building a new factory in the industrial age. Call the information worker a worker-factory. Old-fashioned workers are assembler-workers. They are part of variable cost. Modern worker-factories are part of short-run fixed cost.
With (temporarily) deficient demand, worker-factories are not affected. Instead, assembler-workers are laid off until balance is restored between supply and demand.
During normal churn, worker-factories at some firms get shut down, but not because they were hired by mistake in the first place. Technological change creates a need for worker-factories in some firms and obsolescence in others.
Recalculation results from big mistakes. In addition to shutting down old, obsolete worker-factories, you have to shut down some of the newest worker-factories. These new worker-factories were brought in as part of an unsustainable expansion (think of the Doctoms of the late 1990’s or the real estate trading and finance industry of 2003-2007). When reality hits everyone over the head, these uneconomical worker-factories get torn down. It takes a long time to rebuild them somewhere else.
Another source of Recalculation may be an acceleration in churning, beyond what “normal churn” can handle. I think this may be part of the story of the Great Depression. The amount of economic realignment caused by the internal combustion engine ultimately was huge. You used to have factories and people in central cities, with farms on the fringe. You wound up with offices in central cities, people in suburbs on the fringes of cities, and farming concentrated in areas far from where the food was processed and eaten.
A source of the current Recalculation is the Internet. It is changing the nature of retailing and advertising, with impacts on newspapers and other media. We may be dealing with a lot more churn than we would have had to deal with prior to the advent of the Internet.
I am sure this description still leaves many questions unanswered. But I’ll stop there.