Winner of the New Statesman SPERI Prize in Political Economy 2016

Monday, 19 October 2015

Employment and category errors

When talking about the Great Recession in the UK, we all know (I hope) that this is still the slowest recovery for at least a century and that we have only just regained pre-recession levels of output per head. I find it very frustrating when some people respond by saying the story is quite different when it comes to employment. The frustration is because the remark reflects a confusion which is not trivial to explain to non-economists, coupled with uncertainty about whether this is a real confusion or just political banter.

I was inspired to write about this again by a very good piece by Larry Elliott in the Guardian. He puts it well by talking about how we coped with recession, but I thought I could try and summarise the point slightly differently. In a recession, looking at output is all about the size of the cake. Looking at employment is about how that cake is distributed.

The recession of the early 1980s involved a smaller decline in output, but a bigger and much more persistent increase in unemployment. In contrast the really distinctive feature of this recession has been the decline in real wages. These differences are almost surely linked: unemployment increases were smaller this time, and unemployment then fell rapidly, because real wages declined. Low wages encouraged firms to first fire fewer workers, and later to take on more. There remains a lot we do not know, such as whether this is all a result of the recession or if other factors were involved, and to what extent is a more flexible labour market responsible. This is really just the UK’s productivity puzzle expressed in a different form.

I think most economists would agree with Larry Elliott that the Great Recession in the UK was distributed in a better way than earlier recessions. The high costs of prolonged involuntary unemployment are, I hope, also well known. Whether any of this better distribution should be credited to current politicians seems doubtful: if any politician deserves credit, the most obvious is Margaret Thatcher.

If you look at this in terms of the size of the cake (output) and its distribution (employment and real wages), then you can see why those who dispute the claims about how poor the recovery from this recession has been by pointing to employment are making a category mistake. It is almost certainly better that a recession should lead to declines in real wages rather than increases in unemployment. But to argue that rapid employment growth excuses poor output growth is just another way of celebrating a disastrous productivity performance.        

30 comments:

  1. And how do you propose to change productivity?

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  2. Looking at employment here in Germany, I am struck by the many categories of employment, to include number of hours a week, possible government contributions & duration. All employment also is supposed to include health care, while contributions to other fringe benefits such as retirement are extremely variable. Then there are the unrecorded & even criminal markets. How does the UK account for this melange?

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  3. I'm not sure if that's a Rylean category mistake. Isn't it more a question of whether you assume the fall in productivity is exogenous, or endogenous and the result of bad policy? If it's exogenous, you celebrate how well policy has succeeded, given the constraints.

    Take a New Keynesian model, stuck in recession (caused, say, by bad monetary policy). An exogenous permanent 10% fall in productivity would leave employment unchanged but cause output to decline by 10%. (I *think* that's right, but I'm not sure.)

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  4. Isn't it logical to have lower productivity with lower unemployment as a result of diminishing returns? In a recession, employers will tend to fire less productive workers und keep the more productive ones. When business looks up they may hope to profit even from less productive workers.

    That is more or less what the French are saying with 11 % unemployment: Their wprkers are supposed to be more productive than Germans with ca. 5 %.

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  5. Can you say a bit about why the average wage is said to be rising?

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  6. One thing missing from these assessments is any recognition of the real value of output before the recession.
    The figure put on 'output' was higher before the recession than after, but did that output have the real value that was being assigned to it?
    One would have to assume not, otherwise the recession would not have happened.
    So it follows that the real value of wages should fall since the value it generated through employment was not that high, really.
    To understand why 'productivity' dropped maybe it would be more instructive to look at what was really occurring before the recession than after.

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  7. Of course you are right that it would be better if the levels of productivity and output were higher. However, we are where we are, with something like full employment - so surely the issue is no longer Mainly Macro (as it was in 1981 or 2009), but Mainly Micro or Structural?...

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    1. This post is really about whether you can claim this recession was better than, say, 1980-82 because the increase in unemployment was smaller. To do so would be a category error.

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    2. I understand. However I think then that the key point is Nick Rowe's - if the poor productivity performance is (mainly) exogenous, the recent recession was 'better' than 1980-82, because the loss of potential output (aggregate years of excess unemployment) was smaller.

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    3. If unemployment is a measure of spare capacity, then still took until this year to get back to potential output. Similar to 1980s. But it should be easier to catch a flat level of potential output than one that is increasing. Anyhow I really do hope we have not permanently lost 15% of our potential GDP.

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    4. There is a significant difference between 80/82, (repeated 90/93), Thatcherism!

      Thatcher came in 79, with the "slash and burn the public sector". The economy slowed down for three years as "austerity" withdrew spending power from the economy. Actual hours worked dropped by 9.5% by 1983, it didn't get back to the 79 level till 1988. Was that a productivity increase?

      Major repeated the slash and burn the public sector bit when he arrived in 1990. The economy responded in the same manner as austerity removed spending power from the economy. Actual hours worked dropped by 7.8% by 1993, they didn't get back to 1990 level until 2001. Productivity or what?

      The Banksters crash of 2008, was (sorry, is still) a different animal. Actual hours worked dropped by only 2.9% and had recovered to 2008 level by 2012. Mr Darling running an 11% budget deficit in 09/10, kept the economy from sinking under the weight of its own banking sector.

      Naturally when Osborne arrived in 2010, with the now familiar slash and burn the public sector, the economy responded by flat-lining for the now, almost statutory, three Conservative government opening years. The flat-line was supported by a still high, but not high enough, fiscal stimulus (budget deficit). On top of the deficit came QE, which has failed to significantly increase spending power in the household economy. QE is very unproductive.

      Productivity is a mystery, there is something wrong somewhere. As far back as the data goes, average actual weekly hours of work in the UK, for all workers in main & 2nd jobs, remains around 32 hours, regardless of booms or busts; somebody explain that to me please.

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  8. How would the increasing minimum wage in the UK affect the recession overall and what would be the effect on the already existing worker surplus?

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  9. I don't understand. You have forgiven Labour for getting the UK into the economic mess because it was a global crisis. Yet you think it is a valid criticism of UK leadership that this has been a slow recovery. As near as I can tell, it's been a slow recovery pretty much everywhere among developed countries. The U.S. is about the only major outlier, and that's because of shale and fracking (not to mention that all the increase in GDP has gone to the 1%, so big deal).

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    1. In terms of output per head Japan was better. So we have the Eurozone, which undertook more austerity than the UK and had a worse monetary policy.

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  10. The lack of separation between money and stuff in economics belies the assumptions underneath it. Economists seem to struggle with the idea that money is desired for its own sake.

    And that everything is saved at any instant in time because by definition nothing in a snapshot is moving.

    Any thoughts Simon?

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    1. What I mean is - they have trouble in general with the time domain. Not trained in it.

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  11. Japan was better than whom? The UK? My point was about the UK here, right? I guess I need to repeat my point. You have excused Labour for the 2008 crisis because the crisis was global, but you are not so forgiving for the Conservatives when you talk of the poor recovery in the UK since they have been in power.. Many countries have had equally poor recoveries.

    You cite Japan. Japan was just another country with poor recovery in output until Abe and the BOJ used massive QE to devalue the yen. Perhaps you don't do so, but other economists like to point out that the solution to the global crisis can't be devaluation, since not every country can devalue. (In dollar terms, by the way, Japan's output has taken a large fall.)

    Also, Japan did not have a 2008 *financial* crisis. So if you can use Japan to say that the UK has had a poor recovery, then I can use Japan as an exception to the 2008 financial crisis.

    So with all due respect, I think you're being inconsistent.

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    1. The point about Labour's responsibility for the crisis is that it wasn't caused by overspending. They can and have been criticised for going along with financial deregulation.

      SWL has harshly criticised the eurozone countries for imposing austerity and crippling their own recoveries, so your suggestion that he's singling out the Tories unfairly is just wrong. He's attacked what he sees as bad macro policy across much of the developed world -- there is no inconsistency.

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    2. @Sam. I'm not saying SWL is singling out the Tories. I'm saying that he forgives Labour for their role in the 2008 crisis by noting what happened to the rest of the world, but he does not give the same allowance to the Tories for the poor recovery in the UK since 2010. No one in the developed world has recovered well.

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    3. Better than the UK of course! Have a look at the chart here:

      http://krugman.blogs.nytimes.com/2015/10/20/rethinking-japan/?smid=tw-nytimeskrugman&smtyp=cur

      It really is very straightforward. Sure, governments should be responsible for their errors (and I do not 'forgive' the Labour government for encouraging financial deregulation before the crisis, or the Tory opposition for saying the government should have deregulated by more!), but there is a big difference between errors that hardly anyone warned you about, and errors where you deliberately go against received opinion. UK austerity in the first two years of the coalition government was of this second type, and therefore Osborne bears a particular responsibility for its consequences.

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    4. @SWL. This is one of the difficulties I find in judging your arguments. You say, "Better than the UK", and you provide a link to a Krugman post which does not compare Japan and the UK. It doesn't even mention the UK.

      From 2013 on Japan devalued massively. One would therefore expect Japan to do well in GDP denominated in yen and badly in GDP denominated in dollars. That's just mechanical when it comes to economic performance after devaluations.

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    5. 1) Just have a look at how quickly Japan got back to pre-recession levels of output per head compared to the UK
      2) Krugman's comparison is with the US. You already said the US was an 'outlier'. So here is a second outlier.
      3) This has nothing to do with 2013 onwards. The key point is that Japan did not go for austerity in 2010/11.

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  12. Simon doesn't need me to defend him but this argument is wrong but more to the point it's silly.

    What S W-L is doing in this post is debunking an incorrect argument, nothing more. He doesn't assign blame for the UK's poor productivity. Simply, the point is that those who argue that the strong employment figures show that the economy is doing well are either lying or not understanding what they are talking about.

    The economy is not growing strongly. What the unemployment figures show is that this burden has been born predominately by lower wages rather than forced unemployment. For the record I think that is a good thing but it does not mean that the economy is doing well. People who say it does are wrong.

    Some work has been done on under-employment. People in part-time work who want full-time work but can't find it. This also masks the underlying problem that the economy is weaker than the unemployment figures suggest.

    AFZ

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  13. Open for discussion: what factor did the minimum wage play during the recession? What was the minimum wage? Was the minimum wage increasing over time? I believe the minimum wage in the UK may have been a big contributor to this recession because as you increase the minimum wage, it creates unemployment for teens because employers look for more skilled workers, but they are not going to want to hire many people because their labor will cost too much money. Any thoughts?

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    1. That is not what the evidence suggests. See for example

      http://www.resolutionfoundation.org/wp-content/uploads/2014/08/Final-Minimum-wage-paper_vFinal.pdf

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    2. So would you suggest that the minimum wage should be raised in a struggling economy in order to incentivize people to work?

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  14. With the difficult tradeoff between wages and unemployment, would it really be better to have lower wages instead of lower unemployment? Your beliefs along the lines that lower wages would be better than higher unemployment makes the assumption that more money should be spent right now in order to get the economy back on track, which is a Keynes belief. Although you also make an assumption that all people will spend all of their money as soon as possible. There is still a strong possibility that people, in order to protect themselves for economic uncertainty in the future, they will be more likely to save a larger portion of their income, aligning with the Hayek belief that markets are very difficult to predict. So would it really be better to have lower wages instead of higher unemployment?
    -BT

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    1. No, my reasoning was different. There is a large amount of analysis which suggests that the impact of unemployment on both well being and future employability is much greater than the income losses involved. Better to share the pain.

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    2. "Share the pain" dosen't sell. What we need is a Job Guarantee.
      No need for low wages or high unemployment.
      We can create "bullshit jobs" in the private sector or work for public purpose in the public sector and buy the output of shiny new machines.
      Which one?

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  15. My name is Matt and I am a high school student in Connecticut. I agree with your piece and was wondering whether or not you believe that minimum wage has a big influence on employment. You said that “unemployment increases were smaller this time, and unemployment then fell rapidly, because real wages declined,” are you implying that as the minimum wage increases, the employment rate decreases? We have been learning about this in class and I was wondering if you also believe the same. As the minimum wage decreases, do you believe that there are more options for employment? Also as minimum wage goes down, how are more jobs becoming available? Hopefully this makes sense to you. Thank you. MP

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