Reply to Arnold on PSST
By Bryan Caplan
My last post critiqued Arnold’s PSST (“patterns of sustainable specialization and trade”) alternative to the conventional aggregate supply/aggregate demand model:
In Arnold’s story, firms and workers violate the First Law of Wing Walking: Never let hold of what you’ve got until you’ve got hold of something else. If you can find a new PSST, great. But until you do, the smart move is to cut wages so you can stick with what you know.
Arnold replies here. For the rest of the post, he’s in quotes. In response to my “cut wages” objection, Arnold says:
That is true for small changes. Mathematically, it assumes continuous functions.
It may not be true for large changes. Suppose that somebody brings a
tractor to a farm, so that the farmer can do the work himself without
the help of hired labor. The marginal product of the worker might now
be below the subsistence wage.
Tyler Cowen uses the acronym ZMP to stand for Zero Marginal Product.
The point is that new production methods can drive the marginal product
of existing workers way down.
Yes, it’s conceivable for new production methods to suddenly drive millions of workers’ productivity down to zero. But why on earth should we believe that this has occurred? This is an extraordinary claim requiring extraordinary evidence. If lots (say 25%) of old economy firms saw their revenues fall by 80% I might believe it. If wages fell 50% and the unemployment rate didn’t budge, I might believe it. All I’ve seen this recession, however, is that nominal GDP sharply fell, and real GDP fell almost proportionally. That’s how recessions in low-inflation economies usually work.
Even with discontinuous changes, the phrase “drastically enough” can be
invoked to suggest that wage cuts could cure unemployment. But suppose
that “drastically enough” means 25 percent or more. If you want to say
that the PSST story of unemployment depends on wage stickiness because
such a large wage reduction could take care of things, then fine. You
have scored a debating point without practical significance.
I heartily disagree. Suppose low-skilled Americans used to produce $20,000 in value per year, and now produce 25% less – “just” $15,000 per year. That’s not “approximately zero” productivity. $15,000 per year is enormously high by world and historic standards.
No practical significance? It’s the difference between (a) a world where much of the healthy population faces a choice of welfare, charity, or starvation, and (b) a world where the unemployed can resume independent, productive lives once workers swallow their resentment and take a pay cut. It’s the difference between (a) a world where 99 weeks of unemployment insurance is a wise adjustment to economic turmoil, and (b) a world where 99 weeks of unemployment insurance is a major cause of the problem it purports to solve.
Arnold’s position genuinely puzzles me. He’s skeptical of stories based on nominal wage rigidity. But nominal wage rigidity is both introspectively plausible and has decades of empirical research on its side. What’s his substitute? Discontinuity and/or ZMP – two introspectively incredible stories that, with all due respect to Arnold, have almost no empirical research to back them up.
Question for Arnold: What’s the best available “Guide to Discontinuity/ZMP for Skeptics“? Non-economists have always been quick to believe stories about technological unemployment. Economists have been ridiculing this popular fear for centuries. What happened in the last three years that ought to make economists reconsider?