Sabotaging the recovery

I wrote last week about how a premature easing of lockdown in the UK would cost many more lives. This post will be about how it is also likely to create a weak recovery where some businesses will go to the wall and many jobs will be lost.

A good starting point in thinking about the kind of recovery we could have is to think about synchronized holidays, like Christmas or the summer holiday in much of France. Most of the economy closes down for a few weeks, but starts up again without any long term harm done. You get a V shaped recovery, which we never notice because it gets seasonally adjusted out of the data.

A few months is not fundamentally different from a few weeks, if the government provides sufficient support to firms, the self employed and individuals? The absence of such support gives us the first reason why a recovery might not be V shaped. Yet the UK government’s support over the last few months has been reasonably good, albeit with some notable exceptions.

After a holiday involving a few weeks, consumers’ preferences will be unchanged. Is the same true of a pandemic? If the virus has disappeared for good, or immunity against the virus is complete (with a vaccine, say), there seems no compelling reason to believe otherwise, although overseas travel will require the virus to have disappeared in other countries as well. Perhaps some consumers might initially not believe the virus has disappeared, but this might be offset by other consumers spending more time on social consumption than normal in celebration that the pandemic has ended. In some sectors this second effect could even lead to a larger recovery than the initial recession.

The main reason a V shaped recovery is not going to happen in the UK is because the virus has not disappeared. Compared to other European countries the number of new infections remains high, and as a result many consumers will be understandably reluctant to resume their normal patterns of social consumption. If the government also withdraws support from social consumption sectors, this inevitably means firm closure and firm downsizing, leading to a large increase in unemployment. Restoring confidence in countries where the virus has largely disappeared will not be easy, but that task is much harder when the risks of catching the virus are non-negligible.

There is a further hurdle in the face of a recovery that this government has created. Whatever the new number of infections are, will consumers trust the government when they are told they should resume social consumption? Almost everything the government has done to combat the virus has been a failure. The latest is withholding until recently Pillar 2 data from local authorities and the public. When people are told it’s their civic duty to resume social consumption, rather than simply being told what the risks of doing so are, they are bound to be suspicious of the government’s motives, and who can blame them.

The continuing high level of infections and lack of trust mean that many consumers will not resume social consumption. This poll shows that people’s perception of the risk from the virus has recently increased. This is the inevitable result of prioritising the economy rather than getting new infection numbers right down.

So what can be done? The government is not going to drive new infections down much lower by opening up pubs! It is not going to get trust back anytime soon. Can the Chancellor encourage reluctant consumers to resume social consumption by some means? A general fiscal stimulus, in the form of a tax cut, is unlikely to do much in this respect, because most of it will be saved. Furthermore what is spent is likely to go into sectors that can make a reasonable recovery, like clothing and consumer durables. Other forms of standard fiscal stimulus, including a VAT cut, are unlikely to avoid large scale redundancies from social consumption sectors.

The Resolution Foundation has a more interesting proposal, which is to give vouchers that are time limited that can be spent in vulnerable social consumption sectors (and which are switched off if a second wave appears and we have to go back into lockdown). This is the kind of sector specific stimulus we need. Another possibility would be a temporary cut in VAT on social consumption goods.

Even with such schemes, we are unlikely to see a full rebound in social consumption for some months to come. In a few specific areas social distancing means venues will inevitably be operating at a loss. Subsidies of various kinds to keep firms going and to avoid as far as possible large scale redundancies will be necessary.

While a general fiscal stimulus will not solve sector specific problems, if interest rates remain at their lower bound there is strong a case for economy wide fiscal support. Aggregate demand may remain low as investment is depressed by Brexit and uncertainty about a second wave. If the Chancellor is looking at ideas for what this stimulus could be, or more generally in how to meet our climate change goals, here is a report from NEF.

However unemployment will inevitably remain too high. As Paul Gregg notes, this prolonged recession will be much more unemployment intensive than the recession after the Global Financial Crisis. But just as fiscal stimulus can be regarded as an opportunity, so job losses can be seen as a chance to reskill the UK workforce, along the lines suggested by Jonathan Portes and Tony Wilson. However some of those working in areas where social consumption is low because of the pandemic may wish to remain in those sectors once demand picks up because new infections decline significantly or a vaccine is developed. It is worth noting that a Job Guarantee, if such a scheme existed, would provide an excellent chance for these people to do something useful in this enforced break in their careers.

These are all policies that will have much more work to do because this government made yet another error in their handling of this pandemic, which was to ease the lockdown while the number of new infections was still quite high. Most experts, and indeed most academic economists, understood it would be an error before it happened. It is an error that could sabotage what might have been something close to a V shaped recovery.

Some thoughts about the Job Guarantee

Mainly for economists

The idea of the state stepping in during a recession to offer some group of the unemployed a job was selectively adopted by the UK Labour government in 2009: see here by Paul Gregg. Richard Layard has proposed it for the long term unemployed. We can think of both schemes as providing a partial insurance policy against the failure of countercyclical stabilisation policy to completely do its job in a downturn/recession. But MMT (Modern Monetary Theory) economists go beyond that to suggest that it could be a permanent feature, which would eliminate involuntary unemployment (IU) without creating inflation.

Given our recent experience, the use of a Job Guarantee as an insurance policy for all unemployed people during a recession seems like a good idea. Unwanted leisure is replaced by labour producing useful output, and paying a wage greater than unemployment benefits would add to automatic stabilisers. The devil is of course in the detail: JG jobs need to be setup to allow job search (many jobs are created even in a recession) or (if necessary) retraining and the JG jobs would need to involve an output that was socially useful [1]. The main problem that Gregg discusses in his paper is the ‘Lock-in’ effect, where those in a JG job reduce their search activity. To combat that and for other reasons it also seems helpful to provide detailed individual advice along the lines of the Swedish scheme described here.

MMT economists have suggested extending such a scheme so that it operates at all times. As I understand it any worker without a job would be offered a JG job. It can be refused with no consequences in terms of unemployment benefit, so it that sense it is not workfare. Many people who were confident of getting another job quickly might want to focus all their spare time on job search, and so might decline a JG job. Anyone who wanted a job could receive one, so the scheme would largely eliminate involuntary unemployment (IU). [2] In the rest of this post I’m going to focus on this idea of JG as being a permanent feature of an economy, rather than just something put in place during an economic downturn.

A key issue is what the JG wage would be. In most MMT literature I have seen, the JG wage would be the minimum wage or better: see Mitchell here for example. There seems to be an obvious consequence of this. Unfortunately many private and public sector jobs are paid the minimum wage. These jobs are risky whereas JG jobs are by definition permanent. Minimum wage non-JG jobs may have compensating advantages like a career structure, but still it would seem probable that the existence of JG jobs paying the minimum wage would attract some workers from private sector minimum wage jobs.

The obvious response would be for private and public sector employers paying minimum wages to increase their pay sufficiently to stop this happening, which in turn would often lead private sector firms to raise prices. How far this ripples through the economy is not certain [3], but it is quite possible that the overall price level rises by a noticeable amount. This higher aggregate price level would reduce the real value of the JG wage. If this reduced wage differentials in the economy as a whole this process might be regarded by some as beneficial, but it is an implication that JG advocates need to acknowledge.

A perhaps more serious concern is the impact of the JG on inflation. What is conventionally believed to prevent policy makers expanding demand sufficiently to eliminate all IU is that to do so would embolden workers to ask for greater pay increases, generating an inflationary spiral. The existence of IU, and the possibility of joining their number. becomes a threat that keeps inflation stable. In a JG economy that threat is greatly reduced, both because an alternative job is always available and it will pay more than unemployment benefit. (JG and the lock-in effect will also reduce geographic mobility, although the other side of that coin is that joblessness would not be a feature of deindustrialisation.)

Suppose we start with an economy with stable inflation, implying unemployment was at the NAIRU, and introduce JG.. As this puts upward pressure on inflation because the costs of losing a job are reduced. the only way of keeping inflation stable is to deflate demand, which of course would reduce output, labour demand and therefore increase the number of people on JG jobs. So if we were to compare two economies where inflation was stable, one with IU and one with JG, the number of JG jobs would exceed IU in the other economy.

That does not mean that output would necessarily be lower in the JG economy, because JG workers are producing some kind of socially useful output while the IU workers are not. In welfare terms you have also eliminated any non-pecuniary costs associated with spells of unemployment, and the distribution of income in the JG economy is more equal than in the IU economy. However in practice the productivity of JG workers will be pretty low, as they need to be allowed time for intensive job search and the turnover in JG jobs is likely to be high. We have a trade-off, and if anyone can point me to any analysis of this particular trade-off I would be very grateful.

Can I end with a personal plea. When I write things like this it is often assumed by MMTers that I am being critical for the sake of it. In other words they think all I want to do is attack the JG or MMT. I don’t. I have far better things to do with my time. I actually find the idea of JG appealing at an intuitive level. More generally I agree with MMT on many things, although not all. But I am also fed up with policy makers implementing bad policies just because they sound good to those policy makers, so I want to subject any policy I intuitively like to rigorous analysis.

[1] JG jobs could be as assistants in police stations, schools and other public sector institutions. Or they could be jobs in social enterprises.

[2] Keynes defined involuntary unemployment as those seeking a job at the going real wage. As JG jobs would be at the minimum wage it would not eliminate all involuntary unemployment defined in this way: as I noted those looking for a higher than minimum wage job who chose to stay unemployed would still technically be classed as involuntarily unemployed. But this is being a little pedantic.

[3] Mosler and Silipo (section 7) talk about the JG wage as a nominal anchor. This captures the idea that movements in the JG wage would influence other wages. However nominal anchors, like the money supply or the exchange rate, are often talked about as being able to control the aggregate price level in the longer term on their own. The JG wage would not be able to do this. As the authors note, active stabilisation policy would still be required to do this, although the number of JG jobs could be a useful indicator of what action was required, just as the unemployment rate is now. Another way of saying the same thing is that the JG does not supplant the need for active macroeconomic stabilisation.

Did the Bank of England cause Brexit?

Suppose that by the mid-2000s, immigration from the EU (and the potential for additional immigration) had led to an important shift in the UK labour market. The possibility of bringing labour from overseas meant that old relationships between the tightness of labour market and wage increases no longer held.

You might think that was bad for workers, but that is not so. It would mean what economists call the natural rate of unemployment (or NAIRU) has fallen. Unemployment can be lower without leading to wage increases that threaten the inflation target, because workers fear that the employer can resort to finding much cheaper overseas labour. It reduces the power of workers in the labour market, but also leads to overall benefits. (This is just an example of the standard result that reducing monopoly power is socially beneficial.)

But it is only good news if the Bank of England recognises the change. If they do not, we get stagnant wage growth and unemployment higher than it need be. The obvious response is that the Bank will know there has been a change because wages will start falling faster than they would expect based on previous relationships. However that effect may be masked by the well documented employee and employer reluctance to actually cut nominal wages. Add in the shock of the financial crisis, and this change in the way the labour market works might well be missed.

Here is the big leap. Suppose the above had happened, and the Bank of England did not miss the change. Monetary policy would have been much more expansionary, bringing unemployment well below the 5% mark. Nominal wage growth would have been stronger, and a buoyant labour market would have generated a feel good factor among workers. With more vacancies and less unemployment, concerns about immigration would have begun to fade. The Brexit vote would still have been close, but would have gone the other way.

You may say how could monetary policy be more expansionary given how close we are to the Zero Lower Bound? If that was the case the Bank should have said they were out of ammunition, and placed responsibility with the government and austerity. But for the last two years at least, the Bank could have cut interest rates and has not. You could blame the relentless expectation in the media and financial sector that rates would increase, but the Bank should be able to rise above that.

Of course the Brexit blame game is easy to play when the vote was so tight. The most speculative aspect of this chain of thought is the initial premise about a shift in the NAIRU created by immigration potential. While the possibility makes sense, whether the data backs it up is much less clear. Yet there is some evidence of a structural shift in the UK labour market in the mid-2000s, as Paul Gregg and Steve Machin report.