Paul Krugman attempts to dispel one of the arguments that conservatives are using to explain why unemployment is still high in the US. If one believes that markets are self correcting, and, therefore, that government intervention in markets is not necessary, one must find a way to explain why the employment market has not corrected. One of the conservative answers is that the labor force is inflexible. There are several factors that might contribute to labor force inflexibility. Rapid changes in technology may have may have shifted the demand for skills. The labor force will need to acquire those skills over time, or those with the skills will need to relocate to where the demand exists for those skills. If that were the problem it would be hard to explain several facts. It would not explain why demand for scarce skills had not increased wages for those with the necessary skills. It would also be hard to explain the high rate of unemployment among recent college graduates. Moreover, there is no reason to believe that there has been a major shift in the mix of skills demanded in the labor force between the period of low unemployment during the technology boom in the late 1990's and today. One would also expect that unemployment would be higher is some sectors of the economy than in others. It turns out that unemployment has been high across all sectors of the economy. Labor force inflexibility does not seem to be a good explanation for continuing high unemployment.
Krugman also gives us a history lesson. Economists, who believe that markets are self correcting, were making the same argument during the Great Depression in 1939. Miraculously, the demand for labor turned around during the military build up prior to WW II, and the inflexible labor force became more flexible. The other lesson, that he does not discuss, is that it is easier to win support for military spending than it is to gain support for other forms of government spending. We see that today. The GOP House has proposed a bill that will increase defense spending. They refuse to pay for defense spending by raising taxes, so they propose large spending cuts on social programs to demonstrate that they are fiscally responsible. Fiscal responsibility trumps social responsibility.
If labor force inflexibility is not the best explanation for high unemployment we need to explore other factors that might be responsible. Keynes believed that income inequality was a factor. Lower income households spend most of their income, and households with high incomes spend less of their income. Rising income inequality will decrease consumer spending which is the major component of GDP, and the most important determinant of business investment. It is not good business to increase capacity in the absence of consumer demand. The conservative response to Keynes was the permanent income hypothesis that was developed at the University of Chicago. Households do not base their consumption of current income. They anticipate higher future incomes, and they will use credit to smooth their consumption. The problem with that hypothesis is the households may be less confident about future income, and many are already overloaded with debt. Credit is not a sustainable alternative to growth in income.
Another problem that does affect employment is that business has more flexibility than the labor force. They can source labor anywhere that they choose. If they choose to locate production elsewhere it is not easy for labor to migrate outside of the US. The alternative would be to accept wages that are a fraction of the wages that they need to sustain their living standard. Living standards would need to adjust in the US if that were to happen. This is not a problem that economists and politicians like to discuss. It OK to talk about exchange rate management that decreases the cost of imports from China, but that is not the major source of trade imbalances in the US.
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