Sunday, June 12, 2011

Unemployment and Recalculation

There are two ways to think about current deep and persistent rates of unemployment. One point of view is that these merely reflect the poor rate of economic growth, and ought be remedied by stimulus either fiscal or monetary. Another point of view is that high unemployment reflects the degree of economic restructuring that needs to happen to cover the malinvestment of the housing boom; and so easy fixes are not available for the labor market. The first set of views are held by a number of people across the right and left; with the preference for fiscal/monetary stimulus varying by ideology. The second set of views are held by a motley of individuals, from Austrians to Raghuram Rajan, to Minnesota Fed President Narayana Kocherlakota, to Arnold Kling and his idea of PSST (patterns of sustainable specialization and trade).

One point of evidence in favor of the “structural” view is the pattern of hiring and firing — in which many jobs across a range of dying industries are disappearing. According to that school of thought, this indicates that those industries are experiencing a reallocative shock.

Ricardo Caballero comments on this in an interview with the Minnesota Fed:

Q: And should we be concerned about jobless recovery in the United States? Do you think there might now be a higher level of structural unemployment?

This was a time when the important work of Steve Davis and John Haltiwanger in documenting the nature of the process of job creation and destruction in U.S. manufacturing led to an explosion of research trying to explain this process.

One of the key features of their findings was that recessions come with sharp spikes in job destruction. Somehow, other researchers jumped to the conclusion that this spike meant that job reallocation was strongly countercyclical. That is, that reallocation increased during recessions: a sort of Schumpeterian cleansing. Many theories were written about this phenomenon.

Mohamad and I made the rather obvious observation that a spike in destruction in itself does not mean that reallocation increases during recessions, since this would also require that creation increases. Steve and John had already documented that job creation actually falls at impact. We explored whether the initial spike in destruction translated into abnormally high creation during the recovery phase of the cycle, which would be a dynamic version of the countercyclical reallocation story. Not only did we not find this increase in creation during the recovery, but we found that job creation was actually below normal levels. That is, cumulative restructuring is procyclical, not countercyclical.

We then went on to show that a model where financial constraints tighten as a result of the recession could explain such patterns. I think this is the connection with the current recovery. This was a recession which severely damaged the financial sector; hence, it is not surprising that hiring is so muted.

I don’t think this view is inconsistent with the idea that the economy does face long-term structural challenges in adapting to new social and technological changes. However, I’d say it tackles the idea that such reallocative challenges are an argument for weaker stimulative efforts. Rather, this seems to say that proper economic recovery goes hand in hand with reallocation. No need to view AD/PSST as opposed from the policy point of view.

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