Month: December 2003

Productivity and unemployment

I am growing increasingly annoyed with people who argue that the dark side of productivity growth is unemployment. The Economist, which ought to know better, says we are overproductive. CNN Money discusses the problem of productivity, the President blames productivity growth for unemployment. Even someone as sophisticated as Brad DeLong writes “with productivity surging, it’s hard to be pessimistic about GDP growth, but it’s easy to be pessimistic about unemployment” which seems to suggest that if only productivity growth were lower, employment would be higher.

And yet the “dark side” of productivity is merely another form of the Luddite fallacy – the idea that new technology destroys jobs. If the Luddite fallacy were true we would all be out of work because productivity has been increasing for two centuries. Sure, some say, that may be true in the long run but what about the short run? Even in the short run there is no necessary connection between productivity growth and job loss. In the computer industry, for example, productivity growth has led to falling prices and a bigger not smaller industry. If demand is inelastic then productivity growth can create short-term unemployment, especially at the level of the industry experiencing the growth – less likely but not impossible is that productivity growth leads to short-term economy-wide unemployment.

The more typical case, however, is that productivity growth leads to higher real wages and lower unemployment. Indeed, in the now fairly standard real business cycle models a boom is caused by a positive productivity shock and a recession by a negative shock. Empirical evidence supports the idea that positive productivity shocks lead to lower unemployment.

Why then do we see in very recent data a correlation between productivity growth and unemployment? One reason may be reverse causation. When firms fire workers they tend to fire the least productive first leading to an increase in average productivity. Workers may also work harder when unemployment threatens (an efficiency wage explanation). Thus, an increase in unemployment can cause an increase in productivity per hour. But in such a situation diminished productivity would certainly not lead to higher employment!

Bottom line in my opinion is this: productivity growth and unemployment are mostly unrelated. If productivity growth were currently lower we would have lower real wages and unemployment would be just as high. As a rule – and as a rule to follow – productivity growth is an unalloyed blessing.

The new German economic reforms

Earlier in December Germany passed some much-needed economic reforms. Germany hopes to avoid its growing reputation as the “sick man of Europe.” It has been plagued by slow growth and double-digit unemployment for decades now. The key measures of the reform included the following:

1. An $18.9 billion tax cut, adding $11 billion to a previously planned cut. Note that this is a tax cut, not a spending cut.

2. A weakening of job protection rules, especially for firms of less than ten people. This is the best element of the package.

3. Stronger financial incentives for the jobless to take work. That being said, most of these changes are small adjustments in the numbers rather than a real kick in the pants.

4. Consolidation of some unemployment and social help benefits. Nowhere do I see this described as a real spending cut, although perhaps it will eliminate some costs of administration in the long run.

5. Restrictions on various tax exemptions and a greater unification of the tax code. Read: some small tax increases. This includes an explicit tax increase on tobacco, an elimination of tax deductibility for some commuting expenses, and a tax amnesty designed to raise a burst of revenue. Of course the long-term implications of amnesty encourage more tax cheating.

Here is (not very useful) summary in English of the new policies. Here is a longer and more detailed German treatment, also read this from the FAZ as well.

My take: These measures are better than nothing but they address only a small fraction of the German problem. Looking at who voted for them — the Social Democrats — is enough to illustrate their weakness. That being said, Germany appears to be in the midst of a mild recovery of expectations, so if these reforms get the credit all to the better. It might make further improvements possible.

Perusing the German articles is revealing, whether or not you read German. The country has policies called the “Werbungskostenpauschbetrag,” “Vermoegensbeteiligung,” and of course the “Bewirtungsaufwendungen.” As Mark Twain might have suspected, simply pronouncing and spelling out these words is likely to put a dent in your growth rate.

Competition, Ignorance and Football

Michael Lewis’ “Moneyball” shows how Bill James revolutionized baseball by statistically analyzing players and teams. Josh Levin in asks why this hasn’t quite taken off in other sports like football. The key point is that it’s easy to isolate to isolate the relationship between certain behaviors in baseball and scoring points. In football, it’s a lot harder – people’s actions on the football field are all interrelated, making analysis difficult. Thus, a dependable statistical analysis of football has yet to emerge.

This might be an interesting curiosity about the difference between baseball and other sports, but I think there’s a broader point about competition and knowledge. The success of statistics in baseball created the opportunity for entreprenuerial behavior by some baseball managers. The introduction of statistics into baseball allowed a few team owners to impose high costs on those who refused to believe that statistics was valuable in sports. This was made possible by baseball’s rules – everything centers around a few events (at bats, outs, runs) and it’s easy to attribute individual performance to these events.

One might conjecture that some businesses are like baseball – inputs and outcomes are discrete and easy to measure. In those kinds of industries, the creation of knowledge is a low cost activity and those who have the knowledge can easily compete against others, forcing them to accept your analysis of the situation.

Other industries are like football – messy and hard to relate inputs to outpus. In this case, it would be hard to do what Billy Beane did in baseball. I’d guess that success in such industries is characterized by “judgment” – the intuitive understanding of how the industry works built from years of experience. If you don’t have that, then you’re probably relegated to following “gurus.” Seems like a nice explanation of management fads – organizing people is probably a messy business where everything is interconnected, and it’s hard to come up with easy to implement rules. Thus, a lot of management behavior revolves around business fads. Readers are encouraged to email me interesting examples of industries or economic activities that are very “baseball”-like or “football”-like.

Do we overvalue the difficult?

Experimental subjects consistently value a poem or artwork more highly when they are told it took a long time to produce. See this study by four psychologists. The increase in perceived value is strongest when quality is difficult to judge by other means. Furthermore other research suggests that we value artworks more highly, the more time and trouble it took us to understand them.

What does this mean for the arts? We will tend to overvalue difficult works of high culture, most likely. We also will undervalue that which is accessible. In other words, Seinfeld is better than you think.

The authors note that Jackson Pollock, in his lifetime, was attacked for producing paintings that “anyone could have done.” In reality Pollock’s paintings were the result of a painstaking process, difficult for anyone else to mimic. He often was defended on these grounds. A single painting could require months of hard work. So if you don’t like Pollock, perhaps now you will think more of it.

And this blog, well, this blog just takes forever to write…

10th anniversary for NAFTA

The first of January will mark ten years of NAFTA. There is little doubt it has helped the United States and Canada, but how about Mexico?

Foreign investment in Mexico has increased dramatically. It now stands at $12 billion a year, more than India receives. Exports have grown by a factor of three, up to $161 billion. Mexico’s per capita income has risen 24%, to $4000 a year. All these trends were underway before NAFTA, but NAFTA continued and cemented them. It also is believed that the $40 billion Clinton bailout never would have happened without NAFTA. Finally Mexico has made significant steps toward democratic rule and now holds elections with relative freedom of political entry.

Why then so many complaints from Mexico? First and most importantly, many Mexican exporters have been devastated by competition from the Chinese, who pay much lower wages. To be sure, this is a real problem, but for Mexico to be the high-wage competitor itself says something about how far the country has come.

Second, many Mexican farmers are upset at competition from American pork and corn. Most of these farmers are not mechanized in any way. They push a plow through their fields with a burro or ox. It is hard to imagine how preserving these sectors could benefit Mexico’s future development. I am all for easing the relevant adjustment costs, but trying to keep these jobs would be no different than banning the car to protect the proverbial horse and buggy. The only difference is that many of these farmers don’t even use techniques from the horse and buggy age.

Keep in mind that free trade in food will be a windfall for Mexico’s urban poor. Furthermore many indigenous farmers grow food for their own consumption, not for sale to outside markets. Cheap American imports can’t make them worse off, since they can always continue their current time allocation if they wish. More likely, they will start buying more cheap foodstuffs and look for a different line of work.

NAFTA was far from a perfect treaty, but let us offer three cheers in its favor. It may well go down as the most lasting legacy from the Clinton administration.

A recent World Bank report confirms this positive view: “without NAFTA Mexican exports would have been around 25 percent lower than the actual numbers, foreign direct investment would have been around 40 percent less and the country’s per capita income in 2002 would have been up to 5 percent lower.” Here is a summary of the report.

By the way, did you know the Mexicans are the world’s biggest drinkers of Coca-Cola in per capita terms, exceeding even Americans?

The earlier figures in the post, as well as the Coca-Cola information, come from Business Week.

How much do Freddie and Fannie Mae save homeowners?

Freddie Mac and Fannie Mae receive numerous state privileges, including tax-exempt status for their securities. Many investors believe that the U.S. government would guarantee the debts of the agencies, should a crisis arise. Not surprisingly, there has been recent talk of making the agencies operate on a level playing field.

The agencies, in response, argue that they have lowered the cost of homeownership significantly. But by how much?

Wayne Passmore of the Board of Governors did a study, here is one summary. Here is the bottom line:

The report says that because of their government-sponsored status, Fannie Mae and Freddie Mac were able to borrow at lower interest rates than private sector firms by an average of about 40 basis points from 1998 through the end of this year. However, most of this benefit is passed on to stockholders not to homeowners, the report says. The effect of these two enterprises buying and repackaging mortgages has reduced interest rates by only about seven basis points.

“The GSEs’ implicit subsidy does not appear to have substantially increased homeownership or homebuilding because the estimated effect of the GSEs on mortgage rates is small,” Passmore reports.

Furthermore it is estimated that the legal subsidies account for as much as 81 percent of the value of the traded companies. Not surprisingly, the agecies have been critical of the study.

My take: A common sense understanding of tax incidence favors Passmore’s conclusions. Humongous is the right word to use in describing American capital markets. If you let one entity borrow at lower rates, there are two primary options. First, that entity makes profit without lowering overall rates much. Second, and less likely, that entity becomes big enough to lower mortgage rates by some amount. But to the extent the entity becomes large, there is a significant tax or guarantee cost associated with its size. In other words, the government would be pushing down real interest rates by subsidizing capital accumulation, which cannot generally be done at low cost.

Marriage Brokers

An article in the current issue of Legal Affairs focuses on professional match makers and the difficulties inherent in the business. It’s been estimated that there at least 6000 matches each year and the fee can be about $2000.

How good are the matches? According to the article, a preliminary study conducted by the Department of Justice suggests that mail order brides might suffer less abuse than other wives. However, match makers sometimes fail to inform prospective wives of a future husband’s history of abusive behavior, which has resulted in some cases of abuse and state regulation of the industry.

Of course, regulation of the industry seems plausible – mail order brides don’t have the social networks that enable home-grown brides to learn about their future partner, and they might be susceptible to abuse because they don’t know their new country as well. But there are other ways of dealing with this. Like job applicants, match makers could perform basic screening of candidates – a check of the person’s criminal record might be useful. Match makers who failed to do some basic screening could be held liable for some damages, a proposal to be debated by the legal bloggers. A match maker subject to these professional norms might find better matches than the old fashioned match makers.

The importance of status in business

Gregg Easterbrook directs our attention to the following two anecdotes about business, both taken from Art Kleiner’s Who Really Matters:

Why, for example, does Coca-Cola insist on keeping its original formula in a safe-deposit box that only a few top executives are allowed to open when at this point any cola company could reverse-engineer the ingredients? It’s done, Kleiner says, to make the Coke “core group” feel important. Another great anecdote: When former ITT CEO Rand Araskog published an as-told-to book of self-praise in 1989, ITT public relations panicked on learning that almost all copies were going to be remaindered. Araskog would be furious if he walked past the Strand, New York’s famed used book store, and saw his book on sale for $1. So ITT contracted for another company to buy up thousands of copies of the book and quietly destroy them.

Here is a brief review of the Kleiner book, here is Kleiner’s home page. The remainder of Easterbrook’s post contains brief reviews of other recent books of note.

Video games

I knew video games were big but I didn’t realize how big. According to this article in the NYTimes, the FIFA Soccer franchise earned Electronic Arts over 1 billion dollars of revenue – that’s comparable to what the entire Lord of the Rings trilogy will earn even though the latter is a far bigger cultural event. The average buyer of one of these games will spend 100 hours playing it so the cost per hour of entertainment time is less than a dollar which perhaps explains why the industry is growing rapidly.


There is no doubt that laughter is a social activity. “Laughter evolved as a signal to others – it almost disappears when we are alone,” says Robert Provine, a neuroscientist at the University of Maryland the author of Laughter: A Scientific Investigation…most laughter comes in polite response to everyday remarks such as “Must be going”, rather anything remotely funny. The idea that laughter works as a kind of social glue fits with some other other observations. A baby’s first giggle comes at around three or four months, which also happens to be the time the baby starts to recognise individual faces. And the way we laugh depends on the company we’re keeping. Men tend to laugh longer and harder when they are with other men, perhaps as a way of bonding. Women tend to laugh more [almost fifty percent more] and at a higher pitch when men are present, possibly indicating flirtation or even submission.

Here is a brief on-line summary of Provine’s ideas. Oh yes, by the way, when the boss laughs, everyone laughs. Note also that smiling may be easier to fake than genuine laughter, which would suggest one reason why laughter evolved to signal social bonds.

And how about tickling? It is, according to Provine, the origin of laughter and a way for two individuals to signal that they trust each other. This seems excessively functional to a skeptical economist like myself. By the way I hate being tickled.

Thanks to Robin Hanson for the pointer to the 20 December issue of New Scientist, from which the opening quotation is taken.

Coase and Christmas

The Coase Conjecture says that the ability of a durable good monopolist to price above marginal cost is limited by its own greed. Assume that the monopolist charges a high price today and that all consumers with valuations above that price buy the good. Tomorrow, the only way the monopolist can sell more goods and thus increase profits is to lower the price. But rational consumers understand the monopolist’s incentives and thus delay their purchases until the price falls. No one gains from waiting to sell at a low price so the monopolist lowers price immediately. The argument is subject to a number of qualifications. If consumers are more impatient than the monopolist, for example, the monopolist may be able to maintain a high price for longer. Or the monopolist may be able to commit not to lower price in the future – Disney does this with its Disappearing Classics program.

Christmas ought to provide a good testing ground for the Coase conjecture. A durable goods monopolist knows that high-valuation consumers are likely to want to buy before Christmas. It follows that the monopolist will want to have a post-Christmas sale. Knowing this some consumers will wait to buy – who wins depends on time preference, ability to commit and so forth. By examining which goods fall the most in price from Christmas day to Boxing day and correlating with the characteristics of the goods, the consumers who buy them and the firms that sell them we ought to be able to develop some good empirics on when the Coase conjecture is most relevant. That at least is the Tabarrok conjecture.

Addendum: Vicki Smith reminds me that another method monopolist’s can use to prevent falling prices is a “best-price within 30 days guarantee” – that is, a promise to match their own price within say 30 days. Notice that this seems like a benefit to consumers but in fact it helps the firm commit to not decrease prices since any decrease would go to old customers as well as to new customers.