Sumner and Krugman on zero MP workers

by on January 16, 2011 at 7:49 am in Economics | Permalink

Scott's post is here, Krugman's is here.  (My first post on the topic is here, my last post here).  Let's start with Scott, excerpt:

This post by Stephen Gordon shows US employment in 2010:3 falling about 5% below its 2008:1 peak, while output seems to have declined only about 0.7%.  This is what Cowen finds puzzling. 

But I don’t see any puzzle at all.  If employment didn’t change, I’d expect US output to grow at about 2% a year, which is the trend rate of productivity growth.  Because we are looking at a two and a half year period, you’d expect output to grow roughly 5% with stable employment.  Now assume that employment actually fell 5%.  If the workers who lost jobs were similar to those who remained employed, I’d expect output to be flat over that 2.5 year period.  Because output fell slightly, it seems like the workers who lost jobs were slightly more productive than those who remain employed.

Do I believe this?  No, for several reasons I think they were less skilled than those who remained employed.  Labor productivity growth (assuming we were at full employment) probably slowed in the most recent 2.5 years, as investment in new capital declined.  Measured productivity continued to rise briskly, partly because technological progress continues in good times and bad, and partly because those workers still employed are somewhat higher skilled, or perhaps are trying harder in fear of losing their own jobs.  So Tyler is probably right that those workers who lost their jobs have a lower than average marginal product.  I just don’t see why zero is the natural starting point for consideration of the issue, as you only get that number by making some fairly extreme assumptions about technological progress coming to a screeching halt after 2008:

A few points:

1. The claim is that some workers have zero marginal product (net of employment costs), not all workers (as Krugman inexplicably ponders for two full paragraphs), and not even all unemployed workers.  Just as a hypothetical example, if unemployment is 9.5 percent and the natural rate is 5.5 and zero MP helps account for half of that difference, that's two percent of the labor force at zero MP.  Try hiring labor for a while and see how crazy that sounds.

2. Zero MP is a property which may hold in an AS-AD equilibrium, it is not a substitute for an AS-AD view.  Krugman mischaracterizes the hypothesis here, by identifying it with "AD denialism."  In my post which Krugman links to (and indeed for years), I've made it clear that demand matters in any coherent account of the equilibrium.  

Oddly, Krugman himself stated one of the coherent versions of the Zero MP view in July 2010, and then he considered it possible and appropriately, he expressed uncertainty about what might be going on.

3. The Zero MP hypothesis is simply another way of talking about "labor hoarding," a well-known and time-honored idea, except that the labor is not in fact hoarded.  It doesn't encounter strange paradoxes and it is more intuitive than when the labor is hoarded (which appears to violate first-order conditions).  There is plenty of very specific and indeed striking evidence that the "previously hoarded labor" isn't being hoarded any more.  That same link implies that Krugman's invocation of 1983 is a red herring and probably not a good instance for finding many zero MP workers.  The "oughties" job market differs in a number of other "real" ways from the 1980s, including the fact that we've had no net job growth over the last decade, not even pre-crisis.  Here is further evidence on how productivity patterns were different during the early 1980s.

4. For another take on #3, during the job-destroying periods of 2009, per hour labor productivity growth is rising at astonishing rates, try 3.4, 8.4, 7, and 6 percent, each quarter, annualized.  That's not just the regular accretion of technological progress (though some of it may be), it is an artifact from dumping lower quality and zero MP workers.  If I look in the second quarter and see labor hours go down 7.9 percent and see per hour productivity rise 8.4 percent, well, that's no proof but I sure go hmm….

5. I would not take it for granted that "normal" productivity growth continues in times of shock and crisis.  Maybe yes, maybe no. Scott's talk of the "trend rate" is assuming that the growth and cyclical components are separable and that is begging part of the question.

6. The zero MP hypothesis helps explain why unemployment is so much more severe among the less educated and the lower earners.  In contrast, Krugman writes: "As Mike Konczal points out, basically everyone’s unemployment rate has doubled, no matter their education level or location."  In reality, that kind of multiplicative relationship is very much consistent with joint AS-AD determination, including a zero MP for many workers in the equilibrium.  I'll write an entire blog post on that question soon, and then we'll see that this result actually discriminates against pure AD theories or is at best a neutral pointer.

7. What does the zero MP hypothesis add?  First, the zero MP hypothesis explains why wage adjustments can't do the trick for a lot of the unemployed, as wages won't fall below zero.  Second, the zero MP hypothesis explains why you need steady real growth, boosting the entire chain of demand, to reemploy lots of workers and reflation alone won't do the trick.  (I still, by the way, favor reflation because I think it will do some good.)  Those predictions are not looking terrible these days.

8. The AD-only theories, taken alone, encounter major and indeed worsening problems with the data.  Year-to-year, industrial output is up almost six percent, sales up more than six percent, but the labor market has barely improved.  How does that square with the AD-only hypothesis?  Has it been seriously addressed?  Arnold Kling also has relevant comments and in passing I'll note that the "increases in the risk premium" factor is being neglected in this discussion of Kling's points. 

9. Krugman (not Scott), in particular, is proposing an alternative view with a) upward-sloping AD, b) downward-sloping AS, c) the implication that huge boosts in the minimum wage would restore the economy and employment, and d) requires a tight liquidity trap when the theoretical literature distinguishes between "interest rates literally at zero" and "interest rates near zero."  His comparison of ZIRP and ZMP does not raise those issues on the other side of the ledger.

I think Scott is underplaying some of the more detailed facts about labor markets, such as mentioned in #3, #4, #6, and #8.  Krugman simply isn't considering the stronger versions of the zero MP hypothesis and thus he is dismissive rather than confronting the very real problems in the AD-only point of view.

Addendum: Arnold Kling has more.

David O January 16, 2011 at 4:10 am

Forgive me if you've already addressed this, but isn't it a question less of *zero* marginal product than it is of marginal product *below minimum wage*? Employers generally can't pay someone $1 an hour.

andy January 16, 2011 at 4:27 am

I just remembered Henry Hazlitt somewhere in the introduction or first chapter mentioning something like 'each of would easily employ two other people to fulfill his wishes'. You mean – it's not true anymore?

Doc Merlin January 16, 2011 at 5:10 am

You can count me as an AD denialist (sort of). In a non-equilibrium setting, demand is not something that can be aggregated meaningfully, but instead provides direction for the micro-level supply to move towards.

You can think of AD and AS as two long, which are only in equilibrium when they have the same magnitude and direction. Keynesian AD theory accounts for the magnitudes but completely misses the angles of the vectors, however, stimulus and subsidies keep the vectors from having the same direction by increasing the angle gap between AD and AS in an attempt to increase the magnitude of the AD vector.

In short, Krugman has a very simple, naive, first order view of macroeconomics, that ignores the realities of the market.

havnaer January 16, 2011 at 6:31 am

I tried to drop this in your earlier post. Some items you've addressed via this rebuttal. I'll comment on that in a bit.

1. "…unemployment is quite low for highly educated workers…"

Compared to what? Compared to the entire general population, it is low but its always low compared to the entire population. The graph you cite shows a median unemployment rate for college educated workers as 2.5% from 1992 to 2008. The current rate is 5%. How is double the median rate for this group considered "low"?

2. "…we have had a recovery in output…"

I wonder how true this really is? Are we producing the same amount of the same type of goods now that we produced in late 2007? Other commenters have referred to the difficulty in measuring the output of service workers (remember when the Service economy was going to replace the manufacturing economy?). Were Administrative Assistants and Massage Therapists being counted in the GDP numbers in 2007? Honestly, I don't know – I'm just an Engineer – but if these difficult to quantify GDP outputs aren't being counted, it creates a huge blind spot in Economic data.

3. "If I…fired ten people, and output didn't go down, (did) those people (produce) anything useful?"

I suppose that would be true if you started out with only eleven employees. But it is more likely you had a lot more employees, say, 20 to 100. A number of commenters have implied that you either have to work the remaining employees harder, or sacrifice intangibles, like quality control and R&D, which aren't measured as output.

Let's presume for a moment that your company has laid off 20% of its workforce. That means you started with 50 employees. Now each employee works an 8 hour day, but typically loses at least an hour to normal human requirements like restroom breaks, social interactions, sick days, vacations, checking stock prices, computer solitaire, etc. So even though you've lost 80 hours of labor per week, 10 of those hours were indeed non-productive, so you've actually gained (10 hrs / 400 hrs =) a 2.5% productivity increase right off the bat. And you're right, that 2.5% is Zero Marginal Productivity.

But that's 70 hours per day of USEFUL productivity that you've LOST by laying off 10 workers. How do you make that back? If you distribute those hours among your remaining workers, that amounts to less than two hours per day of extra work each worker has to contribute. Measured in worker-days, that's a whopping 21% productivity increase. But measured in hours worked, that's no productivity increase at all.

So if you measure productivity in terms of worker-days and simply distribute the lost hours among your remaining employees, you can count EVERY worker you lay off as Zero marginal product workers up to the limit of hours in a day. In other words, you can stipulate 76% of your staff as ZMP as long as you work the other 24% 24 hours a day, 7 days a week. If you add in those non-value added tasks like QA and R&D, you could stipulate as much as 95% of your staff as ZMP.

But even the Chinese are beginning to have social problems with this line of reasoning.

Perhaps using an employee as a unit of measure isn't as accuate as it should be. I suggest it should be hours worked.

havnaer January 16, 2011 at 7:37 am

Dr. Cowan,

Here's my comments on your post today:

1. So ZMP only accounts for some workers, not all. I guess I didn't get that. But I suspect that ZMP is a fairly small and widely distributed factor. In my earlier example, we laid off 20% of the workforce and gained a 2.5% ZMP increase. That's 12.5% of the laid off workers being ZMP. Conservatively, let's double that to 25%. So in your current example, ZMP accounts for one percent of the difference between 9.5% and 5.5% unemployment.

But that 25% ZMP is distributed among all 10 laid-off workers. When you bring back 8 of your workers, you bring back 25% of their ZMP labor as well (probably not at first, but over time as they become accustomed to their environment). All those inefficiencies are part of the human condition, aren't they? That's why I think it might be better to measure AMP in terms of labor hours rather than in individual employees.

2. I read Dr. Krugman's post, but I think what he was referring to is an increase in what I think you Economists call "Structural Unemployment"; that is, that portion of the labor force that does not have the skills to be employed. This group is typically considered a large part of that 5.5% "Natural Unemployment Rate". He later went on at length to state he doesn't believe there has been an increase in Structural unemployment, just that there is a belief that there has been an increase.

So are you saying that ZMP is a part of Structural Unemployment? Or perhaps a precursor to a part of it?

3. I think I understand you. "Labor Hoarding" was a useful concept in the 1980's because that was the practice back then. Now the practice is to simply shed the workers, make do with the remainder, and hire back only when absolutely necessary. In other words, excees employees kept on for future use are hoarded, excess employees laid off are ZMP.

4. Its difficult to argue with Government statistics, but I might just as easily say that the increased productivity is due to fewer workers working longer hours that aren't counted in a 40-hour salaried work week. Or just working harder, not smarter?

5. I intuitively suggest that super-normal productivity growth occurs in times of shock and crisis.

6.-9. Okay, I'll admit it. I'm just not smart enough to address these issues. I'll let you REAL Economists take them on.

Philo January 16, 2011 at 8:18 am

Arnold Kling writes: "[T]he critical value of marginal product does not have to be at zero. 'Z' can mean 'not enough to cover health insurance, office space, training costs, etc., and still exceed after-tax opportunity costs.'" Why, then, do you use the term 'zero'? And even Arnold doesn't mention the increase in the minimum wage.

I wish you would reply to David O and Aaron K, above.

Wimivo January 16, 2011 at 8:31 am

The graph you cite shows a median unemployment rate for college educated workers as 2.5% from 1992 to 2008. The current rate is 5%. How is double the median rate for this group considered "low"?

Unless this is explained in a straightforward and eloquent way, the ZMP theory will be considered borderline incoherent. Which it sorta is.

Andrew January 16, 2011 at 9:05 am

Has someone looked at the growth rates of various industries in the runup compared to the unemployment rates following the peak?

Andrew January 16, 2011 at 9:13 am

Philo and Aaron, Because only economists would care about economic product (to society). Actual people and firms care about profit and loss (to themselves). To someone like me who is not formally trained, it seems really odd that this would appear to be moving the goalposts, so I don't know what sense Cowen and Kling mean it, but I suspect Kling also has the same intuitive understanding.

Bo, Tyler has more interest (in the economic sense) of violent opposition than tacit acquiescence. That's what Krugmen do.

It seems odd that technological productivity would be one of the few things undisrupted, unless it was a cause, and that takes us back to RBC.

Charlie Deist January 16, 2011 at 9:40 am

I saw Edward Prescott present an old(ish) paper at the AEA conference last week, and he seemed to be telling a similar story, but of a boom in organizational capital in the 1990s. In the Garett Jones economy, when was OC primarily being built, and when was it finished?

I haven't had time to sink my teeth into the paper yet, but this is from the first couple pages:

"In this paper, we extend the base model by introducing intangible investment and non-neutral technology change with respect to producing intangible investment goods and find that, in light of this new theory, the 1990s are not puzzling. Intangible investment is excluded from GDP because it is difficult to measure. Examples include research and development (R&D), advertising, and investments in building organizations. Some intangible investment is financed by owners of capital and is expensed rather than capitalized. Some intangible investment is financed by workers who are paid less than their marginal value product and receive some equity in their firm, which we refer to as sweat equity. These investments are made with the expectation of realizing future profits or capital gains when
the business goes public or is sold." –Ed Prescott, 2009, http://www.minneapolisfed.org/research/SR/SR369.p

Andrew January 16, 2011 at 9:58 am

6. "Housing starts peaked in January 2006, and then fell steadily for years"
But housing construction wasn't the bubble, it was the resolution. It was house trading, but not even flipping so much as the distillation of housing into a financial asset. It was the capital flowing into housing causing prices to rise. So Fed Funds rate increases translated into home mortgage rates which filtered into house values which undermined refinancing shutting down equity extraction and closing off the money spigot to the economy. This process would take time and an increase in home construction would have to precede the bursting of the house price bubble.

BenK January 16, 2011 at 3:04 pm

When the cost of hiring and initial entry training (including safety training) increases, the length of time that any given worker is zero marginal productivity goes way up. Adding in the risk that the person may not be well suited to the job (and specialization, as it becomes more extreme, makes future productivity increasingly hard to discern, but the cost of hiring makes repeated rounds of 'trying it out' prohibitive) and the risk of economic uncertainty, such that a future business downturn may cause the person to permanently be in excess, and one has created a situation in which hiring is not a reasonable answer.

CBBB January 16, 2011 at 4:53 pm

I don't buy the argument that the unemployment rate is much better for university educated workers. I think a large chunk of the employment of degree holders is underemployment in fields where they have pushed out non-degree holders. The reason non-degree holders have been pushed out is not due to low or zero MP and higher MP for university-educated workers, but simply because it is much easier for HR managers to thin the resume pile by requiring a university degree for many positions that don't actually need one.

Andrew January 17, 2011 at 3:20 am

It actually says something about Krugman that he doesn't even realize that he is assuming that degrees equate to MP.

He says "everyone's employment has gone up" when in actuality, 90% of people's unemployment did not go up.

Additionally there is the hidden risk of employment due to liability. With various protected classes and the evolution of litigation I suspect it has evolved upward and with the advent of WikiLeaks (or the technology that enabled it) the trend took a great leap forward.

CBBB January 17, 2011 at 11:11 am

Wait a minute it wasn't Krugman who equated degrees with MP it was Cowen – if I'm reading him right.

Check his point #6, he seems to be saying that the lower employment rate of graduates helps support his ZMP hypothesis. But this would imply university graduates are more productive then non-graduates, which I don't believe to be the case.

so dep February 28, 2011 at 4:11 am

jobs pay well above minimum wage, and generally include health benefits and other such "add-ons"
jobs pay well above minimum wage, and generally include health benefits and other such "add-ons"

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