I don’t usually post on Sundays, but this letter to the New York Times from the indispensable Don Boudreaux is too priceless to pass up.
Edited to add: I don’t always read Krugman’s column, but since Don’s link sent me there today, I can’t resist noting one more outrage: Krugman thinks that extending estate tax relief to the top .25% of estates is a policy “on behalf of” that .25% of the population, as opposed to a policy on behalf of everyone who benefits from capital accumulation, higher wages and economic growth.
Or more precisesly, he doesn’t think that. But he says it.
Disclaimer: I don’t know too much about economics. Most of this comment was taken from the WSJ website commenting on the discrepancy mentioned in the letter, and I was just hoping you might address it (“it” being the comment).
From the letter: “Paul Krugman says that the idea that unemployment benefits reduce people’s incentives to find jobs is “bizarre” and at odds with “textbook economics.”
From the comment: “Here’s a more complete quote from Krugman: ‘In Mr. Kyl’s view, then, what we really need to worry about right now — with more than five unemployed workers for every job opening, and long-term unemployment at its highest level since the Great Depression — is whether we’re reducing the incentive of the unemployed to find jobs. To me, that’s a bizarre point of view — but then, I don’t live in Mr. Kyl’s universe.’
Krugman certainly would agree with the statement in his book that in a healthy economy too generous unemployment benefits can slow the economy by blunting incentives to find new work. His point in his column is that in this economy, “with more than five unemployed workers for every job opening,” our problem is not insufficient incentive to find work it is insufficient available work. In this situation giving benefits to the unemployed will tend to increase market demand and lead to job growth. Of course Krugman also talks about this in his book (see Ch 13 – Fiscal Policy) and discusses why this might be a more effective method to stimulate demand than, for example, tax cuts on dividends.”
Anonymous: It is fair to point out that Krugman qualified his statement with the observation that these are recessionary times. But why would job search be any less important in a recession than at any other time? If for some reason this is an unusually difficult time to match workers to jobs, then I’d expect we’d want to encourage more effort by both demanders and suppliers in the labor market to find each other.
Suppose your kid can’t find a summer job, and that part of the reason is that jobs are (for some reason) very scarce this summer. Do you think he’s more or less likely to eventually find a job if you promise him a weekly allowance until he finds one?
OK, the kid is less likely to find a job. But someone else will surely take the job that might otherwise be his, since jobs are so scarce. No change to the unemployment rate compared to the no benefits alternative.
Lack of effort from the large number of unemployed people is not a constraint for employment growth at the moment, and still won’t be if you temporarily extend benefits. That’s exactly Krugman’s point.
I truly dislike Krugman. His political columns, held against how brilliant of an economist he actually is, are an embarrassment to anyone in the field. BUT, on this issue, I don’t think he is saying anything outlandish. His policy recommendation is conditioned on a set of other parameters (recession driven by insufficient demand, massive over supply of unemployed workers, etc….) which justify it.
Krugman is essentially saying there is tradeoff with unemployment benefits: they decrease the incentive to work (which is bad), but they also increase aggregate demand (which is good). His point is that, in our current state, the benefits of the increase in aggregate demand outweigh the costs of the decrease incentive to work. You may disagree with this, but it is not, in principle, bad economic reasoning.
I can understand someone saying something such as “The disincentive effects of extending unemployment benefits are outweighed, in recessions, by the stimulative effects that Keynesians point to – leading, therefore, to potentially lower unemployment.”
That claim might or might not be correct (either as a matter of theory or in practice in any particular circumstance). But even if we grant that that claim IS correct in today’s economy, it still does not follow that concerns over the disincentive effects of unemployment benefits are “bizarre.”
If the Keynesian point is correct – although it’s hardly one that enjoys a consensus among economists – the debate here becomes an empirical one: does the pro-employment stimulative effect of unemployment benefits outweigh the anti-employment effect of those benefits? To suggest that they do not cannot fairly be dismissed as “bizarre.”
For a prominent economist to label that concern “bizarre,” and to suggest that it flies in the face of some consensus among economists, is inexcusable.
Bryan, Krugman is claiming that his THEORY is established truth (more like a law) in economics. That isn’t so. Do unemployment benefits actually add to aggregate demand, or do they simply transfer it from one group (the employed and their employers) to another?
Further, he’s ignoring the disincentives on the supply side. UI is–at least in my state–a tax on employers. The extensions will increase those taxes, and, at least on the margin, add to the reluctance of businesses to offer more job opportunities.
Then, there is the matter of evidence. Casey Mulligan produced such recently in this post on Feb. 26th
Steven Landsburg: But why would job search be any less important in a recession than at any other time?
When wages align with the equilibrium wage level, there are a lot of people who only barely want a job. A small incentive to not work means that now they slightly don’t want a job.
But wages are sticky, so during a recession, the current level of wages is below the current equilibrium level, as evidenced by the unemployment rate. This means lots of people very badly want a market-level wage and still don’t have a job. After their unemployment is incentivized, they will still want a job. So disincentivizing work is lowering the non-limiting factor on employment levels.
With that in mind, what Krugman finds bizarre is not the idea that there would be a non-zero disincentivizing effect on employment, but that it’s “what we really need to worry about right now.” I think the effect is non-zero but small, which means I agree with Krugman.
Some clarification from Krugman:
http://krugman.blogs.nytimes.com/2010/03/07/supply-demand-and-unemployment/
I agree with Anonymous and Jeffrey. Krugman isn’t stating that it’s “bizarre” to say that unemployment benefits reduce incentives to find work, he’s stating that it’s “bizarre” to think that that should be the dominant factor in policy-making right now, when cutting unemployment benefits would likely cause more hardship without increasing the rate at which new job openings get filled.
To use your summer job example: Suppose you decided that to incentivize your kid to find a summer job, you were not just going to cut off his allowance but cut off his room and board until he found paying work. Certainly this would increase his incentive to find a job, but wouldn’t you still call it “bizarre”?
What I think would be helpful would be to actually enforce the requirement that while you’re on unemployment, you’re supposed to be looking for a job. It probably wouldn’t matter much now during a job shortage, but during less recessionary times, I knew people who lived off unemployment for over a year without making much serious effort at job-hunting.
I once considered going on unemployment after a layoff, and called the unemployment office, who told me about the requirement that you’re supposed to look for three jobs per week. I asked, “Why couldn’t you just look for CEO job openings and other things that you know you’re obviously not qualified for, and apply for those to meet the requirements while still getting benefits?” The lady on the phone sounded rather amused at the touchingly naive notion that in order to scam the unemployment office, you actually had to fulfill the formal job-hunting requirements at all, instead of just lying.
Jeffrey, in a recession, the stickiness of wages means that prevailing wages are above the market clearing level, thus creating a surplus of labor. People want jobs, but the wage level keeps employers from hiring the surplus labor as it wouldn’t be profitable at those wage rates. Paying unemployment insurance perpetuates this disequilibrium in the labor market. If the stickiness of wages is absolute (i.e. nominal wages can never, ever fall) that doesn’t matter. But as we have seen, competitive pressure can succeed in lowering wage levels, and your assumption that there are no marginally unemployed people in a recession is unwarranted.
>Jeffrey, in a recession, the stickiness of wages means that prevailing wages are above the market clearing level
Yeah … I got that backwards. But the rest of my argument assumes that I had spoken correctly.
>But as we have seen, competitive pressure can succeed in lowering wage levels, and your assumption that there are no marginally unemployed people in a recession is unwarranted.
While my short-run argument points toward no effect on employment, I do agree that it’s an imperfect argument for the reason you give, and thus there is at least some effect. My point is that it is a smaller effect than it would be without a recession.
Tracing the thread of the conversation back to the beginning:
Anon: But Krugman qualified with “during a recession.”
SL: “But why would job search be any less important in a recession than at any other time?”
… and so I gave my answer.
First of all, somebody like Krugman should make sure that nothing he writes makes him look silly without creative editing. Krugman did not make sure, so he is fair game in my book.
Second, I think that Don Boudreaux makes a strong case, but since I am not much of an economist, I say this purely for the record.
Third, in my immodest opinion unemployment benefits are nothing but a fraud. Workers would be better off if they put their unemployment contributions into saving accounts. That is before we start considering the humiliating charade of showing that you are looking for a job, just to recover the money that you paid into the system. The reason unemployment contributions need to be paid is that bureaucrats need to take their cut.
Fourth, I tend to turn more and more to the wisdom of earlier ages. In this case, to Tocqueville’s Memoir on Pauperism.
Say whatever you will. In my own family the fraudulence of this Progressivism is very clear. I have a brother who formerly earned $300k per year as a Wall Streeter, now out of work. When he lost his job 2 YEARS ago, he enjoyed the 6 full months of benefits, during which time he joined another brother of mine at the Burning Man festival, tooks his family on some nice vacations and otherwise unwinded from what was clearly a stressful job.
I have brother in law who barely finished high school, and earns roughly $20,000 per year as a starter assembler in a manufacturing plant in one of the poorest parts of New York State. He never misses work. He took an hours reduction AND a pay cut (remember that sticky wage theory?) just to make sure he held onto his job. He continues to pay into UI ’till this day. My poor in-law, in short, is paying off my wealthy brother. I am not indicting my brother, after all, he paid into the same system, and if someone were offering you “free” money, you might be persuaded to take it.
Aside from the questionable belief that the stimulative effects from my brother’s spending are there (remember, he is consuming while not working when very clearly he could have found work for half the salary as an industry consultant – and been able to consume the same things WHILE working), is it never proper to raise the moral issue with such a program? Furthermore, my brother in law is paying social security taxes and income taxes too (small amounts for sure) and some of these no doubt were funneled into the very Wall Street firms that were bailed out, and which likely will rehire my brother when the dust settles.
Unemployment insurance is just that–a form of social insurance. Like many forms of insurance, it can cause moral hazard–in this case, insufficient job search activity. This certainly can cause inefficiency, so the benefit time is limited to contain it (and employer premiums are experience rated also.)
However, it makes economic and common sense that the there is greater need to contain moral hazard when jobs are readily available than when they are not. Thus, letting the benefit time depend positively on level of unemployment in the economy would be a feature of an ideally structure UI system. (Not to imply that the current system is in anyway ideally structured.)
Neil: Thus, letting the benefit time depend positively on level of unemployment in the economy would be a feature of an ideally structure UI system.
This depends entirely on what you think is causing the unemployment. If in recessions it becomes temporarily more difficult to match workers to appropriate jobs, then you might want the insurance system to encourage more search during recessions.
Yes, quite right Steve. But it is not clear to me why, in recessions where unemployment results from a temporary fall in aggregate demand, it would be harder to match. Employers can and do become more “picky” during recessions, so presumably matching is easier.
Wow. I read Krugman’s columns, and it seems blindingly obvious to me that what Krugman claims is “bizzare”:
– Is NOT the idea that unemployment benefits can be a disincentive for seeking employment.
– IS the idea that this aspect of unemployment benefits is the salient one to focus on during a deep recession.
Yet here I see a lot of otherwise smart people writing as if Krugman said the first, rather than the second. Furthermore, they’re then pointing out that Krugman has previously said the opposite of the first one … and instead of realizing that this suggests that first interpretation ISN’T what he means here, they assume this means he’s contradicting himself.
Color me confused and flabbergasted.
… and here’s a response from Krugman that I found on his blog:
http://krugman.blogs.nytimes.com/2010/03/07/supply-demand-and-unemployment/
It’s perfectly consistent with the most obvious common-sense interpretation of his earlier column: Sure, unemployment benefits can reduce incentive to seek employment, but that’s not a relevant factor in today’s depressed economy; right now, unemployment benefits will increase employment.
Unemployment checks are not a disincentive to find work. I was on unemployment for awhile — do you know how much I got? $300 per MONTH. It’s like you can retire on them; your bank account is still dropping substantially every month. All they do is protect you (in a best-case scenario) from complete financial ruin, allowing you perhaps a little extra time looking for a decent salary so that you don’t have to immediately start at burger king just to stay afloat.
Of course, that was not – from my understanding – Landsburg’s original point. He apparently was extolling the virtues of trickle-down economics, as it relates to the estate tax? Are you kidding me, Steve? Most of the money that we’re talking about taxing is presumably already in the market, which means it should already be “trickling down.” Oh, but when rich white guys die, the government is taking some of the money out of the market (and charging lower taxes as a result). If only rich old dudes would quit dying long enough for the economy to recover!
Neil: how do you know that in recessions, unemployment results from a temporary fall in aggregate demand?
Aaron:
Most of the money that we’re talking about taxing is presumably already in the market, which means it should already be “trickling down.”
I haven’t the foggiest notion what this means.
Steven Landsburg: “Neil: how do you know that in recessions, unemployment results from a temporary fall in aggregate demand?”
Presumably it does not come from a sudden reluctance to work?
Apologies for the confusion. My idea is:
1) Reaganomics (and apparently you) argues that a lower estate tax will keep more money invested in businesses and eventually we will all prosper as a result.
2) Since there are lots of rich people who haven’t died yet, and the estate tax affects not that much our nation’s wealth anyway, there is lots of money that should be already funding said businesses as we speak. And “trickling down” to the rest of us.
So I guess you would say that when someone’s estate is taxed, some of this invested money will be removed from the economy, making our situation even worse. That logic would mean that removing the estate tax will stop things from getting worse — but won’t actually make it any better than it is today. I don’t see how that’s very alluring.
Harold,
So, the only two possible explanations of recessions are a sudden reluctance to buy and a sudden reluctance to work?
In fairness, I’m not entirely sure there is in fact any theory of recessions that can’t be phrased in a way that sounds absurd (e.g., RBC can be phrased as “sudden outbreak of incompetence”). I’m just saying that those aren’t the only two theories (or the only one theory, since no one has ever claimed the latter).
It may well be that different recessions have different causes. But the fact of the matter is that the current recession is the result of uncertainty caused by financial crisis. All the evidence is consistent with this hypothesis–flight to safety in financial markets, etc. Uncertainty causes reluctance to buy and cash hoarding. Consumers are reluctant to spend and employers are reluctant to hire. It seems silly to debate other causes given the situation at hand. The question is what to do about it. The best cure for uncertainty is stability and predictability.
Aaron:
First: You keep talking about “money removed from the economy”. I don’t know what that means. The goal here is to get to rich people to consume less, which will leave more resources available to fund the entreprises that make workers more productive. The estate tax encourages rich people to consume more, and therefore runs counter to that goal.
Second, you are, of course, absolutely right that changes in the estate tax policy cannot retroactively change the consumption behavior of rich people who are dying today. And you are therefore absolutely right that there are no immediate benefits.
Third, however, those changes certainly *can* change the behavior of rich people who are still around making consumption decisions. Therefore there are considerable future benefits. Most people seem to care about the world their children will live in. Of course, if you care only about the present, then you’ll have very different priorities—presumably you’ll be more likely to favor a high estate tax and less likely to care about things like environmental conservation.
Sorry to spoil your weekend party, but Don Boudreaux is totally dispensable. A guy who spends his day to screen the US media for news which violates his “Austrian” religion so he can pontificate people about the “real” truth revealed by Mises, Hayek et al. This primitive “Austrian” jihad is only boring. What’s the point of it, if the only presumed valid answer is: Do nothing. The market will sort it out.
But well. I must say I was astonished to read: “How do you know that in recessions, unemployment results from a temporary fall in aggregate demand?” This is only embarrassing. Sorry!
If it’s so embarrassing then I’d like to hear you prove it.
Stephan,
I’m genuinely interested in the answer to that question, and you appear to be certain of the answer. Could you please enlighten all of us? Thanks!
I was actually somewhat surprised that Landsburg does not read every Krugman column/blog post. I know in the past he has mentioned that what frustrates him about Krugman is that he’s often unable to see the model behind Krugman’s words, so perhaps he’s grown weary of that struggle.
Josh,
Sorry for the late answer. I’m sitting on the other side of the pond. Anyhow your question is a good reason to dig out the General Theory again ;-)
“If the propensity to consume and the rate of new investment result in a deficient effective demand, the actual level of employment will fall short of the supply of labour potentially available at the existing real wage, and the equilibrium real wage will be greater than the marginal disutility of the equilibrium level of employment … The insufficiency of effective demand will inhibit the process of production in spite of the fact that the marginal product of labour still exceeds in value the marginal disutility of employment.” (GT, Chapter 3)
Is there a output gap? The CBO certainly says so. Of course if you subscribe to the Austrian business cycle (better credit-cycle) then this is all very unfortunate, but ultimately nothing can be done about it. The only thing we can hope for is that the invisible hand is doing the math quickly and recalculating and reswitching the economy, causing resources to be reallocated back towards more efficient uses. And “employment benefits” will only hamper Mister Market in doing his calculations properly and swiftly.
Stephan: So your reason for believing that recessions are caused by drops in aggregate demand is….that it’s written in a book?
Yes, Stephan. You are simply quoting a hypothesis. The million dollar question is how do you test that hypothesis? What evidence supports it?
More generally, if the standard for advancing an argument is to simply quote an untested hypothesis, you may as well quote Marx and argue that the revolution of the proletariat is on the horizon.
Steve,
Good point ;-) Unfortunately most theories are written in a book or in a paper. I hope you agree that once they are written in a book we’re able to look for evidence in the real world.
Now my impression was that Josh asked about “How do you know that in recessions, unemployment results from a temporary fall in aggregate demand?” The question wasn’t what caused the recession, but what happens to employment while a recession is causing havoc. But I might be mistaken on that?
And I think there’s lot of evidence available that in a recession unemployment increases due to deficient effective demand. You can plot Okun’s Law for the ongoing malaise and it will fit nicely with the developing output gap. I think the Freakonomics guys did a nice job on that a while ago. Good for Okun bad for the economy.
Now because you lauding Robert Barro in a previous blog entry for his ridiculous WSJ article I’ve to assume you are a neo-classical cheerleader. So I do understand your objections, because for your ilk there’s no such thing as “involuntary unemployment”. In this regard it might be worth a try to leave academia and talk to real people.