Sunday, 26 September 2010

Von Mises and whether U.S. unemployment is structural.

One of the main claims made ad nausiam by the Von Mises brigade is that recessions are needed so as to rid the economy of what they call “malinvestments”.

The first flaw in this idea is that in any medium size or largish economy, even in periods of full employment, thousands of firms go bust per week and thousands of new firms start up per week. That is, there is a continuous process of disposing of “malinvestments”. Thus the mere existence of malinvestments does not justify recessions.

Second, every economy is stuffed full of malinvestments in that about 25% of industrial capacity is normally unused.

Third, it is a bit of a mystery as to why the existence of thousands of empty houses going to rack and ruin should stop a country’s workforce being employed in non construction type activities. Moreover, the construction industry has not DISAPPEARED as a result of excess house building: it just halved in size, or thereabouts.

Fourth, if excess demand results from easy credit, this will result in excess investment in a WIDE RANGE of industries, plus it will result in inflation. Now inflation in the U.S. was a percentage point or two above target just before the credit crunch: a negligible problem. In contrast, the REAL problem was the grotesque inflation in house prices and ludicrous mortgages being offered, like the famous NINJA mortgages.

This leads to a more plausible argument which might be the basis for thinking that the economy cannot bounce straight back to where it was pre-crunch. This is that a large excess supply of former construction employees amongst the ranks of the unemployed might mean that it will take time to retrain those people, hence hindering a return to full employment as quickly as we would like. So does the evidence for this phenomenon stack up? The answer is “possibly, but it’s a bit doubtful”.

First, if the latter were a significant problem, one would expect to find significantly more former construction employees amongst the unemployed (relative the size of the construction industry) than former members of other industries. This does not seem to be the case if this Roosevelt Institute study is anything to go by: see charts on page 8 here.

In contrast to the above study, and study done by “Oregon Business Report”, paints a slightly more gloomy picture. On the other hand, according to this study, the expansion in numbers employed in the Oregon construction sector between 2001 and 2009 was identical to the contraction 2007 – 9. Now if the workforce are flexible enough to move INTO construction from a variety of other sectors of the economy, presumably they are flexible enough to move back again (though admittedly the contraction was faster than the expansion).

In contrast to the Oregon study Also this study claims that construction workers have no more difficulty finding alternative work than the national average. Since the latter study covers the naton as a whole rather than just one state, it is presumaly more reliable.

As to strictly theoretical considerations. Suppose the level of unemployment at which inflation becomes excessive is 4%. Suppose the proportion of the workforce employed in construction at its height two years ago was 6%. Suppose numbers employed in construction halve, and that of those becoming unemployed, a half have serious difficulty finding other jobs without retraining. That means the proportion of the workforce who are seriously difficult to place is (6/2)/2 which is 1.5%. That in turn means the overall level of employment at which inflation becomes a problem rises from 4% to (4 + 1.5) = 5.5%.

That is an insignificant rise compared to the actual rise over the last two years. Conclusion: there isn't a huge "structural" problem.

1 comment:

  1. How good is this, to point finger at Construction industry and say that there is more job loss in this sector.


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