The PSST Just-So Story
I will put this below the fold. It is from an essay that I am drafting.
PSST emphasizes the effect of technology on employment. In any industry where productivity rises faster than demand, employment will decline. This will be the case when the elasticity of demand is not sufficiently high to absorb the increase in productivity, so that labor resources are released from the sector where productivity is rising. In the long run, this should be offset by increases in employment in other industries where demand is rising faster than productivity. However, entrepreneurs have to discover which industries to enter, they have to design jobs within those industries, and workers have to adapt to fill those jobs. These adjustments can take many years.
The PSST story might be based on the pattern of diffusion of what economic historian Paul David calls general purpose technologies. The dynamo (small electric motor), the computer, and the Internet would be examples of such technogical innovations.
The first phase of diffusion might be dubbed the Solow phase, after Robert Solow’s famous 1987 quip that “We see computers everywhere but in the productivity statistics.” During this phase, firms experiment with new technology in order to learn. However, because the technology is in a relatively primitive state and its most effective uses have not yet been discovered, early adopters show little gain in productivity from the new technology and laggards see little threat. Thus, we get gains in employment in firms that are bullish on the new technology, with little or no displacement of existing workers. This might describe the 1980s with personal computers and the Internet boom of the late 1990s.
In the second phase of diffusion, which we might call the job-loss phase, the productivity gains kick in. Firms that have adopted the new technology gain market share without having to add workers (think of Amazon, the online book seller). Firms that lag in employing the new technology are driven out of business (think of Borders, the large bookstore chain that went bankrupt in 2011). This is the phase in which many workers suddenly become superfluous. Expanding firms are less labor-intensive than failing firms. Overall, the economy experiences a surge in unemployment.
In the third phase of diffusion, which we might call the renewal phase, entrepreneurs develop new firms and new industries to employ the surplus labor released by the productivity gains. These new industries, along with the adaptation of the labor force, foster a return to full employment.
The foregoing is something of a “just-so” story for the Great Depression and the most recent slump. For the Great Depression, the 1920s would be the Solow phase of the internal combustion engine and the dynamo, the 1930s were the job-loss phase, and the decade after the second World War the renewal phase. In the more recent cycle driven by the Internet, the 1990s would be the Solow phase, the current period would be the job-loss phase, and we have yet to experience the renewal phase.
In both of these episodes, the job-loss phase coincided with financial distress. In the AS-AD story, the financial distress is the causal factor. In the PSST story, the financial distress would be somewhat of a byproduct or symptom that accompanies the real adjustment. Financial euphoria in the 1920s and 1990s might have served to amplify employment growth and perceived wealth during the Solow phase of these cycles. The financial euphoria that accompanied the housing bubble might have helped to delay the onset of the job-loss phase of the current cycle.
Indeed, the phenomenon of financial euphoria followed by financial crisis is important to address in either AS-AD or PSST. Economic historian Charles Kindleberger argued that euphorias tend to take place following what he calls “displacement,” such as major wars. In our terms, displacement creates a disruption in patterns of specialization and trade. New trading opportunities, like new technologies, can trigger a cycle. Perhaps if we look at these episodes, we can find evidence of the three phases, with the initial trading forays having little effect on productivity (“we see voyages to the New World everywhere but in the productivity statistics,” so to speak) but eventually having disruptive effects.