Do we find sectoral shifts in the job market data?

Menzie Chinn discusses the evidence on sectoral shifts hypotheses.  See also the piece by Valletta and Cleary.

These are intriguing and useful studies but I don't think they get at the core of the matter, mostly because sectoral shifts and aggregate demand shocks are so closely intertwined in this recession.

Here's a very simple story.  The prices of homes and stocks fall, plus there is some panic, so people spend less.  On the surface, that's an AD story, following from an economy-wide negative wealth effect.  But it's also a sectoral shifts story, because people are not cutting spending proportionately on all items.  For instance luxury consumption and debt-financed consumption have been hit especially hard, not to mention real estate and financial services (for other reasons).  And since I do not expect a quick rebound of real estate or stock prices, this is more or less a permanent change in sectoral priorities.  Still, in the data the AD shock might well absorb most of the "credit" for what happened.

We're also seeing job losses in virtually every sector.  It's not for instance a "sectoral shift away from services and into matchstick production and tungsten."  It's a shift out of jobs which are revealed as unprofitable and a lot of people not knowing where the new jobs will be created.

If someone wants to insist that "this is really an AD shock, not a sectoral shift," I'm not so keen on fighting to keep one term over the other.  I would insist, however, on an issue of substance, namely that not all AD shocks are alike.  If we are going to switch terminology, it could be said that this is a real AD shock and not just a nominal AD shock.  (Though there have been nominal AD shocks too.)  A nominal AD shock can be offset more easily by goosing up some mix of M and V and restoring the previous level of nominal demand.  If you want an example of a nominal AD shock, imagine a more neutral change in monetary variables and indeed those have happened in the postwar era.  Or read David Hume's parable of the money under the pillow.  In those cases you don't need to make people feel wealthier in real terms, you just need to get the flow of spending up again.  Today, part of the problem is that people feel less wealthy in real terms and that influences the content of their spending and investment decisions.

When a real AD shock comes, policy still should be expansionary in response, but there is an important difference.  In absolute terms, nominal expansion won't much help the labor market, which still has to reallocate workers from some sectors to others, given the collapse in asset prices and expectations.

You'll see indirect recognition of this from many current Keynesian writers, when they talk of the jobless recovery or fear that the economy will fall back next year after the stimulus money runs out.  In general I agree with those points.  Yet these writers are less willing to consider the implied conclusion that a bigger stimulus won't much help — and may hurt — the longer-run adjustments which are required.  Boosting MV will restore employment only to a very limited extent.  It's still the case that recovery will require a great deal of sectoral readjustment and that will take a good bit of time.

Arnold Kling comments as well.  And again.

Comments

Tyler, in the past 6 years there has been a large change in relative prices--commodities have become much more expensive. As anyone learns in Econ 101, and in this particular case as Raúl Prebish said many times after the Great Depression and Julio Olivera explained in the 1960s when discussing Latin America's structural inflation, changes in relative prices are expected to bring changes in the composition of output. The only relevant question is how fast this change will take place. It's surprising that so far the supply response of commodities has not been as large as one would have expected. Indeed, the discussion has to take account of what is going on in the world economy, not just the US economy.

Right on Bill. The over-stimulation that was applied to the housing sector and the household economy in general made the crash more serious. I don't think it was the govt. spending % of GDP that was the issue, it was the spread between tax revenue and expenditure. We were stimulating government growth via deficit spending. And now, the x10 version.

At some point, we have to accept that trying to recreate the pre-crash world is not good, because that world was not paid for. Housing prices should be lower. Wages should be lower- although putting 5% of people back to work will be a huge raise from $0 to whatever they are making.

The key question is how big is the sectoral shift, for example compared to the shifts due to invention of a car, electric motor, jet plane, computer etc, and why is it so difficult this time.

It is misleading to write that "recovery will require a great deal of sectoral readjustment and that will take a good bit of time," as if the process would eventually be *completed*. Sectoral readjustment is taking place all the time; buggy-whip makers are losing their jobs and having to find other lines of work; "creative destruction" is a constant.

Sectoral readjustment was required when the dot-com crash occurred, but that didn't lead to a near-depression. Why was the housing crash different? You don't give any reason to reject Scott Sumner's answer: the housing crash was followed by a *nominal AD shock*.

What exactly is an AD Shock (I understand what it means from a Macro perspective)? If someone could define that in practical terms(which I suspect can't be done) it would be much appreciated.

Hardly straight forward. Why would people suddenly decide to spend less money? In other words, why the assumption of an AD shock? Do those assumptions tell us something about the effectiveness or ineffectiveness of monetary policy, fiscal policy? What if the AD shock is associated with job layoffs. If so, what caused those layoffs (a supply shock?)

(Don't get me wrong, I do sense biases, some of them he makes plain, some I find incomprehensible to reprehensible, but it's not like he's selling pigs in a poke. Maybe someone out there is selling the recalculation story in the mainstream better than Kling, but not that I can tell. He is single-handedly demolishing the rationale for the establishment.)

Why do people believe what happened in the past two years was a result of a drop in consumer demand? Nothing could be farther from the truth. Demand was stifled by a lack of credit. People stopped shopping when they realized they couldn't make any major purchases.

@Ryann - Why is "why" important? We know quite a lot about what will happen if aggregate demand unexpectedly falls independent of why it fell. In particular, profits will fall while the funds available for investment rise, so interest rates will fall. Eventually the funds available find suitable investments, returns rise and spending increases.

Precisely why aggregate demand falls doesn't affect this general pattern, but it most definitely does effect the specifics - what exactly consumers cut back on, and therefore which sectors shrink, and what investment opportunities eventually lead the recover all might depend on why spending fell. But it also might now. This all depends on the detailed structure of the economy. But the overall pattern - spending falls, saving increases, returns fall, investment increases, spending recovers - isn't affected by the details because it reflects a deeper, larger scale structure in the economy ie. the money and credit markets.

Demand was stifled by a lack of credit. People stopped shopping when they realized they couldn't make any major purchases.

I suspect we are in the middle of a significant shift from the formal sector of the economy to the underground sector.

Maybe Tyler is simply withholding links to people cooler than Kling, and I wouldn't know because I'm not a pro.

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