Unemployment rates have doubled in most sectors — what does that mean?

by on February 14, 2011 at 7:07 am in Economics | Permalink

Paul Krugman makes this observation, which I believe dates back to Rortybomb and perhaps earlier.  Rortybomb, Krugman, and others have cited it as evidence for demand-based, non-structural theories of unemployment.  I believe this is not exactly the correct inference.

Let's say you have the iPad sector, where unemployment is one percent (990 of 1000 are employed), and the typewriter sector, where unemployment is twenty percent (800 of 1000 are employed).  AD falls across the board, and that means there is in effect a proportional real wage mark-up, relative to what conditions justify, on both sectors.  Let's say that in both sectors real wages are suddenly five percent too high, again because of the whack to AD, which you can view as insufficient inflationary pressure.

To continue with this deliberately artificial example, let's also say we have equal and unitary labor demand elasticity in each sector.  So if the real wage is five percent too high because of the deflation, the quantity of labor demanded should fall by five percent.

In the iPad sector, employment falls five percent, or 49.5 workers, I will call it fifty even, to 940 workers employed, or the rate of unemployment goes up from one percent to six percent.

In the typewriter sector, employment falls by five percent, which leads to 760 employed out of 1000, or the rate of unemployment rises from twenty percent to twenty-four percent.

The two rates of unemployment, in the two sectors, do not go up proportionally or even close to proportionally.  It is harder to boost up the unemployment rate in the typewriter sector; the intuition is simple, namely that it is easier to double the unemployment rate when that rate is starting at the very low figure of one percent.  You can set this problem up in many different ways, but it's hard to avoid that core intuition.

If the rate of unemployment is going up proportionately in both sectors, it means the downturn is administering an especially strong shock to the weaker sectors.  It is a "final death blow tip them over the precipice kind of shock."  It does not signify AD irrelevance, but rather that negative AD shocks and preexisting structural problems somehow magnify each other.

Yet numerous times I have seen proportional changes in unemployment rates cited as evidence for a pure AD approach.  That does not follow.

As a final point, please note that not all non-AD theories imply excess demand for labor in a significant number of sectors.  There are plenty of non-AD theories, such as an increase in the risk premium, where there is a big negative employment move pretty much across the board.  I continue to see this point misunderstood.

The Keynesian bloggers are correct to argue against AD denialists, but when it comes to their arsenal of counters they are overreaching.

Andrew February 14, 2011 at 3:20 am

The actual denial of the primacy of AD is not that it doesn't exist (at the very least, you can in fact add numbers) but that it is not the actual problem.

The AD side is if you take 10 years to fix AD while talking about how bad the AD problem is, then the structural problem will probably have worked itself out by then and you can claim victory.

david February 14, 2011 at 4:07 am

Of all the diagrams I was was expecting that link to show, I wasn't expecting an actual, you know, precipice…

david February 14, 2011 at 4:23 am

Because it was consistent with non-accelerating-inflation levels of (low) unemployment?

It's too bad Friedman isn't alive any more, really.

rjs February 14, 2011 at 4:57 am

your inference assumes there was structural unemployment before the recession started…

Mark February 14, 2011 at 5:15 am

I find this a strange line of argument. Your structural approach predicts something we don't see, yet you take this as evidence for your structural approach. Following ris, which of Krugman's 11 one-digit sectors was structurally weak before the recession?

Lord February 14, 2011 at 5:43 am

This would imply the economy was nowhere near equilibrium before. Where is the evidence of that?

Jay February 14, 2011 at 6:10 am

The statistics Krugman cites are not specific enough. When construction contracts you can expect the manufacturing, wholesale, and retail trade of construction materials to tank (see QCEW data). Professional business services will be hit when architects lose their jobs. Finance job losses will occur because of real estate brokers downsizing.

Ryan Vann February 14, 2011 at 6:29 am

"This would imply the economy was nowhere near equilibrium before. Where is the evidence of that? "

Where is the evidence that an equilibrium exists? It's just a convienient thought organizer.

Floccina February 14, 2011 at 7:32 am

As others have noted, basically unemployment doubled for every industry, every occupation, every state.

My current guess is that it is mostly an AD problem but if it was purely an AD problem would you not expect the change to be closer to the same percent of all employees in all industries.

George February 14, 2011 at 8:40 am

"AD denialists?" Economists are hilarious.

IVV February 14, 2011 at 9:43 am

What is the mechanism by which unemployment, and not employment, is the scaling lever? I'm afraid I don't follow that.

john February 14, 2011 at 11:59 am

Suppose that around 1977 someone convinced the Carter administration that "anti-trust" should be enforced for "efficiency" rather than to prevent sectoral domination. The reasoning being that so long as ever larger and more concentrated industries are driving prices down, the consumer wins. Then suppose that around the same time someone else convinces Paul Volker that the NAIRU is rising and so one shouldn't worry about the unemployed so much.

This would create a condition in which monopolists could concentrate industries and push down both prices and wages, but in so doing, because there is no competition making investments to attack margins earned by the monopolists, investment becomes stagnant in the concentrated sectors. Because there is no competition for the monopolist and because higher rates of unemployment are normalized, wage earners loose the ability to command any share of the productivity gains from what improvements the monopolists do in fact make and wages become flat despite productivity growth.

In this situation demand begins to slacken, but at the same time monopolist profits have soared because there is no competition and wage earners have been denied any benefit of productivity gains: capitalists have a lot of idle money on their hands. They encourage wage earners with stagnant wages to "benefit" from student loans, low car payments and credit card debt to sustain or enhance their living standards, improvements in which wage earners were encouraged to expect in the greatest democracy in the world. Now monopoly profits appear to recycle themselves in ever renewed demand. And with the march of technology that demand does in fact call into existence new sectors of economic activity.

But these sectors quickly succumb to the monopoly bias built into the efficiency prejudice of anti-trust enforcement. WallMart dominates retail distribution of consumer goods, Pepsi, Coke, Nabisco and a few others dominate manufactured foods and food distribution through both supermarket and franchise business models that eliminate non-corporate competition, while new industries like micro-chip manufacture, software design and internet services almost instantly embody the monopoly form. New industry invention is required at an accelerating rate to maintain job opportunities commensurate with the displacement of wage earners by industry concentration.

All the while monopoly profits are piling up while wages remain flat. Wage earners spend most of their income. This quotidian activity is the source of most demand. Monopolists "invest" most of their income but find it increasingly difficult to find investment opportunities that meet the profit creation criteria defined by Jerome Levy a hundred years ago because wage earner expenditures are essentially flat, like their wages. Instead monopolists settle for rents in the form of loaning out the profits to wage earners who have been deprived of this very same money by an inappropriately low NIARU for some forty odd years and are now acculturated to debt. We have taken to calling this "financialization".

Having more or less saturated consumer debt by the 1990s, after the dot.crash monopolists begin to flog mortgage debt in a new rainbow of forms. The great thing about the housing market is that it has its own multiplier effects: once you purchase the house you have to get the drapes and then the carpet and then the tv and the toaster and the furniture. It never really ends and if marketed correctly into a self reinforcing bubble, re-fi's and second mortgages can fund additions and pools etc. It keeps a lot more people employed than just the construction workers. But then the bubble bursts.

What looked prudent with regard to debt burdens in the boom, when you were making say $90K or maybe $110K looks rather different when all of a sudden you are unemployed for six months and then find a job at $55k. All this BS about deadbeat borrowers ignores this dynamic: the borrowers who were true deadbeats were actively recruited by sub-prime predators for the benefit of John Paulson and Magnetar who were looking to create risk free shorts for themselves. The rest of us just got pushed in front of the bus by artificial demand banks were flogging everywhichway in the form of easy credit even after the decline set in.

AD is bled dry by the Minsky cycle. It leaves huge idle capital and equal amounts of idle wage earners. What AD there has been has been artificial since the late 70s when wage earners quit getting any benefit in wages from their productivity gains. I'm not proposing that they should monopolize the gains any more than monopolists should, but without income gains from increases in productivity all growth in AD is borrowed from those who do get the money gains from increased efficiency: it converts income into rents and ultimately destroys demand.

Ken Rhodes February 14, 2011 at 1:15 pm

"…negative AD shocks and preexisting structural problems somehow magnify each other."

That simple sentence seems so obvious that it is hard to imagine disagreeing with it. Yet were are beset by bombastic simplistic arguments saying there is one problem.

The world just isn't as simple as many folks wish it were.

ryan vann February 14, 2011 at 7:07 pm

""…negative AD shocks and preexisting structural problems somehow magnify each other."

That simple sentence seems so obvious that it is hard to imagine disagreeing with it. Yet were are beset by bombastic simplistic arguments saying there is one problem.

The world just isn't as simple as many folks wish it were."

Indeed. Furthermore, I'm not aware of any financial crisis that doesn't have both AD and AS implications.

NC February 15, 2011 at 12:41 am

mulp:

And let's not forget that the increase in the risk premium also begs the question…what made it increase? The fall in financial and housing wealth (demand – fall in C and savings => fall in investment) and the perception of the risk of investment (demand – fall in I ceteris paribus) are two possible reasons. They're all demand side.

Andrew Fischer Lees February 20, 2011 at 7:56 pm

"The statistics Krugman cites are not specific enough. When construction contracts you can expect the manufacturing, wholesale, and retail trade of construction materials to tank (see QCEW data). Professional business services will be hit when architects lose their jobs. Finance job losses will occur because of real estate brokers downsizing."

upvote for Jay. The devil, as always, is in the details.

Three cheers for all the economists at the BLS/Census for ensuring that empirical questions are left to theory!

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