Saturday, 25 May 2013

PSST in the labour and housing market

From Arnold Kling on PSST (patterns of sustainable specialization and trade) and the housing market: 
Interesting comment found by Glenn Reynolds. From Jeffrey Levin:
If you dig around and research start-ups you will find that the majority of start-ups are funded by second mortgages or HELOC draws. Due to the housing crash, that equity is just not there for the vast majority of people looking to start up a new business. Its one of the large reasons why commercial credit expansion has been so moribund. Without getting off the ground from seconds or HELOC’s all those startups that would have made it past year 1 and then been able to obtain standard commercial business loan never got off the ground and thus never graduated to commercial loan financing. You have to walk first before you can run. Startups don’t start in the commercial loan department (at least most of them don’t)
Recalculation means discovering new patterns of sustainable specialization and trade. Doing so requires entrepreneurial trial and error. As Levin points out, the stereotypical 20-year-old in a garage is actually atypical. Most entrepreneurs are like I was, forty years old and risking accumulated wealth. If my wealth had suddenly been halved in 1993, I doubt that I would have started a business in 1994.
That's exactly the problem; the huge drop in net wealth of the population (the WSJ cites a 49% drop in net worth for those between 35 and 44) during the housing bubble burst has caused not only risk-averse behaviour, but also a lack of proper initial funding for new entrepreneurial ideas. This is without doubt one of the reasons why the labour market is still not recovering robustly; there are no new productive activities to replace the ones that failed, and hence no new jobs to be taken by those who lost theirs in the past few years.

"Only 23 percent of the 8,381 companies we were able to contact in our sample hired new workers to complete their stimulus project and kept all of them once the project was done. In other words, more than seven out of 10 companies did not hire workers at all or had to lay off the workers they did hire."
Kling calls this "creating unsustainable jobs":
"Of course, this is only microeconomics. Macroeconomics tells you that the stimulus injected money into the economy, and therefore it increased employment. The employment increase would not necessarily show up at companies that were the initial recipients of the money."
Once again, I have to say I align with Kling's view, and regular blog readers will recognize some of the ideas being mentioned often on this blog: 
...I do not subscribe to the Keynesian story, in which spending creates jobs and jobs create spending. I think that comparative advantage is what creates jobs. To put it more carefully, comparative advantage creates the opportunity for people to sell labor and buy goods and services in the market. Entrepreneurs who identify these opportunities create jobs. 
In today’s economy, I believe that the link between spending and jobs is weak. That is because, as Garett Jones put it, today’s workers do not build widgets. They do something fuzzier, which Jones terms creating organizational capital. Whether you like that term or not, I think it is fair to say that there is a large element of investment in a hiring decision these days. You do not want to hire a worker unless you are confident that the time you spend training and acclimating the worker to your company will be repaid in the form of a more effective enterprise. You do not want to let a worker go unless you are confident that the worker adds so little to the effectiveness of the enterprise that you would be better off not having to compensate that worker. [emphasis mine]
Finally, Kling stresses out the reasons for a lack of job creation in the past few years. A link I have tried to explain via a technological shock that the labour market has failed to adapt to in the pre-crisis decade. Out of the four reasons Kling states below, I wrote only about the no.1 and no.4. 
In 2008, the reluctance to fire surplus workers went away, and the reluctance to hire possibly-useful workers increased a bit. So a lot of the decade’s job destruction got telescoped into a short period of time. 
Why have new jobs not been created? Some possibilities:
1. Firms in 2008-2009 did a very good job of discriminating between useful and less-useful workers. The ones they let go were less useful. There has been some back-and-forth between Bryan Caplan and Tyler Cowen suggesting that this has turned the long-term unemployed into a “lemons” market. 
2. The choice of “going on disability” has become attractive. 
3. The “wedge” between wages and compensation has gone up (think of employer-provided health insurance). 
4. Firms that have developed popular goods and services no longer expand by rapidly ramping up employment. They can increase production by using overseas suppliers and automated manufacturing. They can increase sales by using online channels rather than hiring sales clerks.


  1. Vuk, what is your view on sticky wages? Lets say in point four - if there are sticky wages, doesnt it automatically make some alternatives more feasible?

    On the other hand, I was reading a speech by governor of Richmond Fed (i think) a few days ago. one interesting thing he mentioned was the fact that the smaller proportion of job losses was in some low wage service sectors (clerks and such) , but these made almost half of the rebound in employment since recovery suggesting that people are finding it hard to find jobs with same level of pay than before. Also some middle management jobs made a big part of job losses, but were only a smaller part of the recovery in employment. Are they the lemons now?
    Its funny because it reminds me of a money market model (Heider et al)where better banks could find alternative financing leaving the market. Only banks left were the ones that were risky - hence the higher interest rate. So now on the labour market we have lemons (higher unemployment for ex middle manager positions) or the demand for such labour is lower than before?

    1. In what sense do you mean more feasible? And which alternatives?
      I do believe in wage stickiness in the short run, as it makes perfect sense that labour wage negotiations don't adjust perfectly to every shock the economy encounters.

      Going back to the point you made, yes, I would agree that we have more lemons in the labour market now - people whose skills are to become futile in the next decade or so. But I would also say that the demand for such skills has gone down, even before the crisis. It's just that the crisis was a "perfect excuse" to start internal restructuring in firms - think about point 1.

      In addition, have a look at this graph from an earlier text on the blog. You can see people in mid-wage occupations lost many jobs and yet the recovery was mostly based on employment in low-wage occupations (as you have mentioned). So this also confirms the possibility that a lot of labour now possesses skills which aren't necessary anymore, and are forced to accept low-paid jobs, thus driving the low-skilled labour force out of employment. And this in the end brings to additional social ramifications...

    2. Sorry I meant "cost effective", not feasible... - like replacing workers with capital or even outsourced workers/capital. Thnx for the links