Macro and the Organizational Capital Model
By Arnold Kling
Consider this possibility: after all these months, people start to think it’s time for the recession to end. The very thought begins to renew confidence, and some people start spending again — in turn, generating visible signs of recovery. This may seem absurd, and is rarely mentioned as an explanation for mass behavior late in a recession, but economic theorists have long been fascinated by such a possibility.
Shiller sees herd behavior a lot–it was he who coined the term “irrational exuberance,” which was later made famous by Alan Greenspan. I would point out that in an affluent society, there is a lot of consumption that is deferrable. If everyone scans the headlines and sees “Great Depression,” that could very well cause a drop in consumption. And if everyone scans the headlines and sees “recovery,” they might spend more.
We could also observe herd behavior among producers. I have been talking a lot about Garett Jones’ remark that today’s work force produces organizational capital rather than widgets. It is time to elaborate on this notion.In the 1970’s, for two summers I worked in a factory. We assembled speakers that are used in buildings to provide what is known as “elevator music.” My jobs included brushing coating on to the speakers, attaching padding to the coating, working a rivet gun to attach rivets to the speakers, and boxing the speakers with hardware for shipment. Our work load was proportional to the level of orders for speakers.
Since then, I have worked in two businesses, and in both cases the work force produced organizational capital.
When I worked at Freddie Mac, you could measure volume in terms of mortgages guaranteed or mortgage securities issued. But there was no assembly line where workers stood and stamped guarantees on mortgages or wrapped mortgages into pools to be shipped to buyers. The work involved developing better systems for pricing, managing credit risk, and hedging interest rate risk. The number of workers Freddie Mac needed varied with the scope of business, but not with the scale. That is, if we wanted to buy a new type of mortgage, that required new people. But buying more of the same type of mortgage required no new people.
At any given time, you could have run Freddie Mac with one quarter of the work force that we had. Perhaps another tenth of the work force was doing nothing useful at all. (Some people would have argued that this portion was considerably larger.) All the rest were working on ways to improve the business. For example, right before I left the company, a huge task force was put together to implement a change from human underwriting of credit reports to the use of credit scores. A classic example of investing to build organizational capital.
Next, I started an Internet-based business that evolved into a web site that offered information to workers who were relocating and earned revenue from advertisers of services to people who were relocating. Again, the scope of the business depended on the number of people, but the scale did not. The number of people it took to run the web site depended on the complexity of the business, not on the number of visitors to the site. One major project was to develop a calculator that would match a neighborhood in one city with a similar neighborhood in a different city, based on data supplied by a marketing firm on demographics and other factors. Another major project was to integrate our web site with that of a company with which we merged that had information on schools.
Thus, my experience fits very well with the notion that workers are needed in order to build organizational capital. In today’s economy, the organizational capital often is embodied in a computer system of some kind. Those systems depreciate very rapidly, because of technological innovation and the evolution of business demands.
Other forms of organizational capital are embodied in human capital. For example, an airline needs to have an effective program for training its employees and for ensuring the quality of their work. If your flight attendants are surly, some of your customers will switch to a different airline next time.
The macroeconomic significance of all this is that the choice of when to invest in organizational capital is discretionary. If you read a bunch of headlines that say “economic downturn,” you can cut back your labor force to just the number of people needed to keep today’s business operating. If you read a bunch of headlines that say “recovery,” you may become inclined to invest in projects that make your business more complex or more competitive.
Given this framework, a temporary government spending stimulus may not cause much of an increase in employment. Why build organizational capital to meet a temporary need? Instead, something like a payroll tax cut might increase employment at firms that are otherwise considering new projects, and it might reduce layoffs at firms that are trying to decide how much they need to reduce short-term costs in order to survive.