Today’s challenge

Today’s challenge is to explain this chart.

It shows that the US economy takes longer to recover from spikes in unemployment in recent times. (It also shows that the current high level of unemployment is really a disaster).

I can only think of two ways to explain this.

The first explanation blames regulation. Under this version of the story, the US economy has become more highly regulated over time thereby slowing recovery.

The second explanation blames a combination of free trade and open immigration (via not enforcing immigration laws). Under this version of the story, the US has been importing lots of unskilled workers while simultaneously exporting lots of unskilled jobs. (This explanation is outside of the realm of possibility for mainstream economics since it assumes that some people are unskilled and therefore different from other people (gasp!) and it further assumes that free trade is not a free lunch (even cheap chalupas aren’t free)).

I can’t think of a progressive explanation for the chart that doesn’t rely on foot-stomping about rising-inequality that – nevertheless – doesn’t create a coherent narrative.

My guess is that both explanations are true. Unfortunately virtually no one would agree with both explanations. The paleo-libertarians are few in number, but that doesn’t mean they’re wrong.


17 Responses to Today’s challenge

  1. red says:

    He’s a wacky idea: We’ve been growing a huge debt bubble since the 50s (both federal and private). How fast things recover might be a function of how much and how quickly we allow bad debts and bad businesses to fail. The farther you fall and the faster you hit bottom the faster resources are moved back into productive areas of the economy. As the bubble gets bigger and bigger and the more we try to keep it growing the slow resources can be transferred into productive areas of the economy.

    Just a guess.

    • Foseti says:

      I was thinking the other day that throughout the time during which I have been cognizant of current events (I’m 30), the US economy has been bouncing from one bubble to another. First it was tech stocks, then it was housing, and now it’s almost certainly something else.

      Maybe bigger and bigger bubbles is all we have to look forward to.

    • Alrenous says:

      The debt thing has a clear causal chain.
      Regulations are probably bad, but it is hard to pin down how. Immigration doesn’t affect the whole country equally.

      Bad debts destroy wealth. For example, if you lend to a farmer who is a bad risk, you waste fuel, fertilizer, pesticides, seed, and wear/breakage of tractors, etc. The farmer can’t pay the loan back because the harvest isn’t worth as much as the inputs – the difference is a good measure of how much wealth vanished due to that loan.

      The Fed artificially keeps interest rates low.

      Put together, a lot of debts are numerically profitable but actually waste wealth. (Specifically, any debt repaid at a value lower than the real inflation rate plus the real risk of default will on average destroy wealth.)

      A huge chunk of GDP is debt funded. (Most, or just many?)

      In fact, a lot of businesses are burning wealth, despite making money for their owners.

      The actual trigger for a crash is running out of stored-up capital due to bad loans. In the end, a bank gives out a loan, but there’s no real stuff left to buy with it – the debtor can’t even pretend to be productive. Essentially, a crash occurs when there’s no available wealth left for bad debts to burn and they’re forced to stop.

      Which means a crash indicates real GWP – gross wealth product – was steadily negative for a long period leading into the crash.

      Our civilization cycles through crashes.
      On balance, our civilization probably spends more time in net negative GWP than positive.

      Capital is required to employ people, and to improve their productivity.

      The slow recovery is probably because the wealth-burning debts are having trouble getting re-started. Our society is actually starting to run out of burnable wealth. The productive sectors – which generally survive crashes just fine – are having more and more trouble regenerating enough wealth to feed into the GDP furnace, because each cycle is chipping away at even their stored capital, and thus their labour-wealth multiplier.

      Real wages have been steady? Then it is lucky innovation has roughly kept pace with destruction of productive machines and resource stocks. And also lucky that knowledge is basically indestructible.

      However…even considering only the low interest rates, unless the problem is fixed, we’re likely to find out exactly how much effort it takes to destroy knowledge.

    • Doug1 says:

      Actually America “paid down” it’s federal debt as a percentage of GDP from about 100% of GDP at the end of WWII, to around 40% of GDP in 1980. We may have actually paid down the debt in absolute terms because we did run some budget surpluses in the 50s and early 60s, but mostly we grew up GDP and inflated the dollar to make the percentage low. The top marginal tax rate in the war years and for a few years after were 92%, then the mid 80s for much of the 50s, and then Kennedy took them down to 70%. However these were rates paid on only very high incomes in the millions in todays dollars.

      The ratio began rising again fairly slowly under Reagan and Bush, more slowly under Clinton, faster under Bush, and really fast under Obama. I think federal debt alone is at about 85% of GDP now but climbing incredibly fast all through Obama’s presidency.

  2. I’m guessing that extending unemployment benefits to 99 months must have some sort of impact …

    • Foseti says:

      That probably partly explains the incredible shape of the current decline, but it doesn’t explain the more general phenomenon of more recent recessions taking longer to clear up.

      • The chart measures relative to peak employment. The pre-2001 peak employment level was a 30 level high. So what looks like a long recovery in the chart, is really just a return to a more normal level of employment.

    • K(yle) says:

      99 weeks…

      I can just imagine the telephone interview after having been unemployed for the last 8 years.

  3. josh says:

    Finance is increasingly following the bureaucratic tendency toward automatic processes. In practice this means its increasingly difficult for new, small, businesses that lack appropriate numbers to plug into the appropriate formulas to get financing, which slows job creation.

    Also, how could you not mention welfare? How many people work (legitimately) a few weeks out of the year to qualify for benefits for the rest of the year. Some of my students get fired from two or three jobs a year.

    • PRCalDude says:

      What do you mean by “automatic” – “automated?”

      A bureaucracy uses automatic processes, but not automated ones.

  4. Handle says:

    You want the long version or the short version?

    • Foseti says:

      Long, naturally

      • Handle says:

        Well, you’re getting the semi-short. 😉 (Sorry, turned out I was a lot busier that I thought).

        Part of the problem is that there is a kind of perfect storm of multiple anti-employment phenomena occurring simultaneously, and so it’s difficult to definitively disaggregate which of the interacting factors is most blameworthy.

        That being said, the basic theory of hiring is that employers will expand employment until marginal cost equals marginal revenue. The only thing that leads to an additional hire is if something occurs to disturb that equilibrium is favor of demand strengthening relative to one’s labor costs. And like vimothy says, the reverse is also true. So if you have a sudden major contraction in demand, followed by a period of stagnant demand, you would indeed expect exactly what we’ve witnessed – a few million folks thrown out of work and little new hiring.

        So the real question is, “Why is aggregate demand behaving this way?”

        For that you need a theory on how people make consumption decisions. The basic idea is “life-cycle consumption smoothing” which is highly-idealized but good enough. So, you go into debt when you’re young, pay it off over the first half of your working life, accumulate savings during the second half, and use those savings to live comfortably in retirement. If you’re handy with math, you can make yourself a little toy model to see how it works, and what happens with different income-paths or interest rates or pension benefits.

        The interesting things to learn about such a model is to see what happens to people’s decisions when a sudden unexpected shock occurs. It’s easy to see it in the positive direction – if, for example, you win a million in the lottery but otherwise keep the same job. Your spending will go up. The same thing happens if you lose a bunch in the stock market.

        Now, what would happen if everyone simultaneously believed – mistakenly – that they had won the lottery, but that the banks believed it too and would loan you money with lottery-winning as collateral so you could spend it immediately? You would see aggregate demand jump and the savings rate plummet and it would appear like economic growth in the statistics, but it would be a facade.

        And then everybody also realizes their mistake simultaneously a few years later and has to retrench and make up for the lost-time when they were living under a delusion of false paper wealth. What you see if artificially boosted GDP “growth” during credit-expansion years, and suppressed GDP during “pay back” years.

        This is actually what happened with “Mortgage Equity Withdrawal” (HELOC loans and Mortgage Refinancings – which at one point) which at one ponit made up fully 9% of Personal Disposable Income – that’s huge. Now people are saving and paying off bad debts and MEW is about -3% of PDI where it’s been for over 2 years now. You can explain almost the entire movement in AD and consumption from this 12% net shift and reversal in the flow of funds from banks to households.

        Here are the links to the two most important CR posts:

        This is from 2007 and shows the MEW impact on GDP. You can see that going into the height of the bubble, the actual real growth in the productive economy minus MEW averaged less than 1%, but MEW-enabled consumption growth made it look like it was doing three or four times better. That’s a massive distortion.

        And this chart shows you how much of an impact on consumption that MEW has as a percent of PDI.

        Now, you may ask, what it’s going to take to get that chart to return to the norm of about positive 1% and stop being such a hindrance to the return of growth in AD (the expectation of which will finally lead to more hiring)? It will take the resolution of the huge remaining pile of bad mortgage debt out there and a return to “normalcy” in the housing market, with few delinquent or seriously underwater loans, few distressed and vacant properties, and slow but steady growth in nominal prices.

        My best guess for when such a thing will start to happen would be 2013 at the earliest, and so it’s just going to be rough sailing employment-wise until then, but by that point the Debt-to-GDP ratio and the entitlement-programs spending path will be so high that anything but truly fantastic growth (which is not in the cards) won’t help make the government solvent. Then something big and important breaks.

      • Foseti says:

        A very nice reply . . . but my argument is pretty simple.

        Even free trade’s defenders would admit that it is most likely to lead to a loss of low-skilled jobs.

        Illegal immigration is likely to be the favored path of relatively low-skilled people.

        So, free trade + illegal immigration should result in higher unemployment, right?

        Your explanations explain the current spike in unemployment, but I suspect it will take us a lot longer to re-adjust.

      • Handle says:

        Just a quick addendum – as if on cue, CR produced the latest quarterly MEW report later on the same day. It got even worse – declining from -2.7% to -3.7% of Personal Disposable Income. Not healthy at all. Not even a sign that healthy normalcy will return anytime soon.

  5. vimothy says:

    Also, is it really so hard to think of progressive explanations for the extraordinary rate of unemployment–What about deficient aggregate demand and hysteresis raising the NAIRU?

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