Monday, 20 February 2012

As full employment of labour is approached, the economy runs short of . . . . . . . . labour!!!!!!

You might think that was obvious. But there are hundreds of instances of self-styled economists who don’t get the point. But perhaps they can’t be blamed: George Orwell said, "To see what is in front of one's nose needs a constant struggle."

There are three areas where failure to take account of the above obvious point results in mistakes. 1, Bang per buck. 2, shortening the working week as a cure for unemployment, and 3, the marginal employment subsidy idea.

Bang per buck.

That’s a slang expression sometimes used to refer to the idea that government should try to create as many jobs as possible per million dollars of additional spending. The actual reasons for minimising expenditure per job are rarely spelled out, so one can only guess at them. One reason is presumably that more expenditure means more inflation, all else equal, thus the more jobs created per given amount of expenditure the better.

The flaw in that idea is that it’s not spending money as such that can exacerbate inflation. It’s the extent to which such spending puts pressure on the ultimate source of all supply – the labour market – that is of supreme relevance.

For example, if the economy has ample spare capacity, including excess numbers of unemployed, then a spending increase will not be inflationary. And if the economy were at capacity, but the labour force dropped dramatically (say because bubonic plague wiped out 10% of the workforce), then we’d get inflation even if the level of spending were constant.

To explain the relevance of the latter point to bang per buck, let’s take a classic bang per buck dilemma: government can choose between placing orders in a sector of the economy where employees are relatively thrifty, or in contrast, placing the order in sectors where employees are relatively spendthrift.

Obviously the multiplier will be larger in the case of the spendthrift option, thus relatively little “taxpayer’s” money is required per job created. But the inflationary effect depends entirely on the number of jobs created: i.e. pressure put on labour markets. Thus as far as inflation per job created goes, it does not make a scrap of difference whether government goes for the thrifty or the spendthrift option.

A second reason for trying to minimise expenditure per job is presumably that bang per buck enthusiasts think that the money used for stimulus needs to be spent carefully because creating that money involves some sort of REAL sacrifice.

The truth is that under a fiat currency, money is just bits of paper or numbers in computers. Adding to those numbers is costless. Or as Friedman put it, “It need cost society essentially nothing in real resources to provide the individual with the current services of an additional dollar in cash balances. (That’s from Ch 3 of his book, “A Program for Monetary Stability).

Bang per buck: the conclusion.

There is no point in government aiming to maximise bang per buck. In considering which additional jobs to create, government should concentrate solely on creating whichever jobs seem to be the most productive. After all, what is the basic objective in economics? It is to maximise output per head within environment constraints, while trying to produce jobs for those who want work (or something like that).

Labour supply reduction is no cure for unemployment.

“Labour supply reduction” is a name sometimes given to a collection of alleged cures for unemployment: shortening the working week, early retirement, delayed entry into the labour force for youths, etc. These ideas have in common the notion that if labour supply is reduced, with demand for labour being left constant, then unemployment will decline.

And indeed it will. But if labour supply can be reduced relative to demand for labour without inflationary consequences, why not raise demand relative to supply? The inflationary effect is the same, but there’d be the advantage that more people who wanted work would find it, and/or more people being able work the hours they wanted. Doh!

However, the above is a bit of a “broad brush” rebuttal of the labour supply reduction myth. A more detailed rebuttal means invoking the above point about labour shortages. So here goes.

Inflation becomes a problem when the variety of unemployed labour available from the dole queue drops too far: the result is that employers cannot find the labour they want, and thus opt to poach labour from rival firms, or give in more easily to union demands so as to retain their own workforces, etc. And that means inflation.

Now if working hours are artificially reduced, the level of unemployment at which employers experience some specific level of difficulty in finding the types of labour they want REMAINS EXACTLY THE SAME!!!!!! E.g. if the chances of finding an unemployed plumber amongst the unemployed in town X drop to near zero at unemployment level Y, then those chances will also drop to near zero when unemployment is at level Y under an artificially shortened working hours regime!!!!! Put another way, simply cutting hours does nothing whatever for the variety of labour on your local dole queue. I.e. labour supply reduction cures for unemployment do not reduce NAIRU (or the “natural level” or whatever you want to call it).

Marginal employment subsidies.

Another area where there is failure to see the “obvious” point mentioned at the outset, has to do with marginal employment subsidies (MES).

MES is the ever popular idea for raising employment namely that government could reward employers for any NET INCREASE in numbers they employ, compared to some base or “starting date”. E.g. see here, here and here.

And the Obama administration proposed the idea a few months back, though they’ve gone quiet on the idea more recently.

The flaws in the Marginal Employment Subsidy idea.

Two flaws in MES are pretty obvious. First there are the administration costs and second is the fact that MES puts firms that are not expanding or even shrinking (and for perfectly legitimate reasons) at a disadvantage.

But a third flaw is closely connected with the “obvious” point about labour shortages mentioned at the outset, and it is thus.

Given that inflation kicks in when it becomes excessively difficult for employers to source suitable labour from their local dole queue, a subsidy of each additional employee will certainly induce firms to expand numbers employed, but the problem is that it gives them no more incentive to expand by taking on dole queue labour than by poaching employees from rival firms.

To that extent, MES has no effect on NAIRU. At least that would certainly be the case if the subsidy came in the form of a straight percentage subsidy of each firm’s total payroll bill. In the latter case, the subsidy of highly paid employees ‘wage, as a proportion of their wages would be the same as the equivalent proportion for the lower paid. Thus there would be little inducement for an employer to alter the ratio in which the employer took on skilled and less skilled people.

In contrast, the subsidy COULD come in the form of a fixed amount per capita, and that would be more likely to induce employers to take on the lower paid. But in that case the so called “marginal” subsidy only works IN THAT it is a subsidy of the lower paid. And indeed there might be something to be said for a “low pay” subsidy (Edmund Phelps advocated the idea, I think).

Well if a subsidy for the low paid is beneficial, then let’s have such a subsidy. But that is not a marginal subsidy.


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