Why Unemployment?

Tyler and Arnold both address this quote by Paul Krugman:

And now as then, the whole notion when you ask why, say, a housing boom — which requires shifting resources into housing — doesn’t produce the same kind of unemployment as a housing bust that shifts resources out of housing.

Krugman is noting that Austrian theories of business cycles, involving overinvestment in one industry and then reallocation of resources to another, should produce unemployment going in and going out (or none at all). Tyler and Arnold both argue that their are asymmetries involved. Here’s Arnold:

I would say that answer may be that the dynamics of booms and busts are asymmetric.

Note that the housing boom took place slowly, and it built up over a period of years. Several economists, Krugman included as I recall, were already talking about a housing bubble in 2004, even though in hindsight the biggest price excesses were still to come. So the housing boom must go back even further, to at least the late 1990s. In contrast, the collapse of house prices took less than two years (assuming they have bottomed out, which may be a brave assumption).

I think it is reasonable to generalize this notion that booms are longer and relatively gradual, while busts are sudden. If this generalization holds, then it ought to be harder for the economy to adjust to a bust than to a boom.

It is entirely possible that I’m still not getting aspects of this theory, but it seems to me that this explanation makes the case for stimulus. If you’re saying that the private sector is literally unable to absorb workers during the short time-frame, more or less coincident with recession, then why not pursue an aggressive stimulus? Reducing or eliminating whatever the cyclical portion of unemployment is should make it easier for new growth industries to find a footing. And if not all the structurally unemployed can be redistributed at once, there is no reason stimulus aid needs to stop with support for the cyclically unemployed.

The reason to oppose these measures, I’m guessing, is that they reduce a worker’s incentive to allow himself to be drawn into the new growth industries. But the availability of alternative opportunities didn’t prevent workers from being drawn into the old growth industry, pre-recession.

Arnold repeats Tyler’s statement that aid to state governments is delaying adjustment at the state government level:

One disadvantage of throwing money at state and local governments is that the contraction in that sector has been miniscule compared with the contraction in the private sector, and in fact in the long run we may need some contraction in the state and local government sector.

Again, I find this peculiar. I get that they feel state and local governments may be bloated — they are libertarians — but I don’t understand what this has to do with the recalculation scenario. And even if you really, really think that these governments should slim down, why would you want that slimming to happen now, when you’ve previously argued that markets are already unable to absorb all the refugees from shrinking private establishments?

This all seems to come back to the idea that it’s important for recovery that the people who are “supposed” to be unemployed actually be unemployed and stay that way until markets have a use for them. If they’re trying to tell a story that better describes the world than the traditional macro models they’re looking to replace, or update, it would seem that a failure to recognize the destructive qualities of long-term unemployment is highly problematic.


  1. reason says:

    Overinvestment happens all the time, it only sometimes results in recession, and even less often to recessions like this one. In times of pure resource misallocation, in this case the recession is small, and the excess inventory of housing would, given an otherwise healthy economy have already been reduced. The problem was not that people didn’t want housing – they clearly did. The problem was that they paid excessive prices, that were more than they could afford for it. It is this financial aspect (and particularly a story about the paper asset price inflation – the land deed in this case) that is totally missing from this Austrianesque story.

  2. reason says:

    P.S. Their story would make MUCH more sense if they were talking about the end of internet boom.

  3. OGT says:

    The more Kling tries to defend his Austrian theories the less convincing he is. If booms take eight to ten years to develop, then waiting for ‘recalculation’ is a very high cost to pay. And if every sector suffering contraction right now is due for secular adjustment, we are in for a long and painful wait indeed.

    Further, there doesn’t seem to be a coherent framework as to why some many lives need to be wasted and permanently diminished while waiting for Godot. They just must.

    On the other hand, Kling and Tyler’s posts are a clue, perhaps, where the right will turn now that neo-classical economics has been discredited (Yet again). As such, Tyler and Kling are providing some interesting sociological study, if unintentionally, even while failing to produce anything of economic interest.

  4. richard says:

    “It is entirely possible that I’m still not getting aspects of this theory, but it seems to me that this explanation makes the case for stimulus.”

    I think you need to read Kling’s post more closely. He didn’t argue against stimulus or say that his recalculation theory precluded a stimulus:

    “This Recalculation story does not imply that government can do nothing or should do nothing about unemployment. On the contrary, it suggests that the market is faltering. However, the Recalculation story does say that it matters how the government tries to redirect resources. If it increases demand where demand already is sufficient, or if it increases demand in sectors where the needs are only temporary, it is not helping.”

  5. lark says:

    Why do all the “libertarian” policies seem to come down to policies of hatred?

    Deepen unemployment! Slash state budgets! Unless average folks are totally savaged, we can’t be washed clean by ‘creative destruction’.

  6. Kevin Donoghue says:

    I’m with Richard: you and Paul Krugman are not being entirely fair to Arnold Kling here. He writes: “The Recalculation story does not tell me that we should drop the concept of stimulus and balance the Federal Budget.” He also distances himself from Dark Age macro, so he’s not so far from Krugman on that issue.

    I suspect that AK himself is not really sure where he’s going with this. He seems to be trying to re-think his approach to macro.

  7. Is there any research to determine whether it’s better to stimulate by:
    a) Providing generous unemployment benefits
    b) Provide “make-work” jobs

    I’m not going to consider c) Provide productive infrastructure jobs that will encourage long-term growth, because if they’re truly productive and will truly cause long-term growth then they should be funded no matter what the state of the economy.

    It seems to me that simply providing unemployment benefits is less expensive and will cause many fewer unintended consequences.

  8. Phillip Huggan says:

    Austrian thought is self-defeated as premises tech cycles and offers no suggestion to increase tech spending or decrease tech spending. Austrians should be advocating healthcare cost decreases like universal healthcare and fake meat protein sources in boomer nations, and aren’t.
    Two things I’d note is unemployment is more costly than is symmetrical overemployment/wage-inflation. If you have 25% unmployment, this is more expensive than 125% overemployment is cheap (for PPP) because you starve and lose your home without wages while only buy more consumer crap and earn wife brownie pts while loaded. Your human capital doesn’t increase at working overtime as much as it decreases unemployed. This ideology turns productivity into a measure of efficiency of safety nets and if you are seduced by Austrian though you probably don’t believe in safety nets anyway; probably already terminally inefficent.

    Even ignoring that, on a global level how do you know there aren’t corresponding unemployment/recessions elsewhere? If everyone is moving into USD because of housing booms, those construction workers probably demand extra nurses and extra rippers and you get a shortage of Russian strippers in Moscow and Phillipines nurses in Manila.

  9. reason says:

    richard et al,
    maybe you should read Paul Krugman’s questions and answers. He also thinks it matters where the stimulus is spent (he wants the States and Local authorities supported and infrastructure investment, for good reasons).

  10. reason says:

    6. Doesn’t necessary follow. If the opportunity cost is lower now, provision is not time critical and recessions are inevitable why not do it when it causes less competition for resources?

  11. reason says:

    How generous do you think the unemployment benefits should be? If they are not generous enough, people will still cut back on spending, if they are too generous, people will be discouraged from looking for work.

  12. richard says:

    I think is on a certain level Kling is saying that we don’t really know which sectors in the economy will rebound, which ones will surge, which ones will die and that the government should stay out of that calculus but still try to assist in easing unemployment and general welfare. I think the problem here is that there is considerable tension between not impeding the “recalculation” and attempting to prop up unemployment. Kling views the payroll tax cut as a way to square this circle.

  13. ThomasL says:

    I think richard in 12 summed Arnold’s thoughts pretty well.

    “And even if you really, really think that these governments should slim down, why would you want that slimming to happen now, when you’ve previously argued that markets are already unable to absorb all the refugees from shrinking private establishments?”

    I really don’t see how you cannot fathom what he is saying. I understand why you may disagree, but it isn’t that hard to follow.

    States swelled greatly on ever increasing property tax revenues and they expanded their programs and spending to meet not only those higher revenues, but projected even higher revenues. Now property tax revenues are collapsing, sales tax revenues are collapsing, business income tax revenues are collapsing, and personal income tax revenues are collapsing, and you wonder why he thinks the state and local gov’ts need to contract?

    They over built, and just like everyone else that over built, they need to shrink back to their income level.

    On the “why now?” vein, in a libertarian view states should not be insulated from the need to contract while everyone in the private sector is left to their fortunes (modulo bailouts, which Arnold Kling doesn’t agree with either). In example form, the local Linens and Things hired workers they can no longer afford to pay and so they are laid off. Everyone sees this as unpleasant but I doubt anyone sees it as illogical. Why when a state hires workers and they can no longer pay is is so much more objectionable? Why do you insert the, “Don’t fire them, the Linens and Things workers haven’t found new jobs yet,” angle? Why is the state worker better worthy or protection so that all the tax payers (current and future) have to pony up to keep him in his unaffordable job, but the Linens and Things guy is left to the vicissitudes of the market?

    I guess people of this opinion are all waiting for everything to go back to “normal” so that everyone that has a job in whatever sector they have it in now (but especially if government) gets to keep it. I don’t think that is a terribly likely scenario, and building a special protection around state workers even when the state’s are bankrupt is a slap in the face of all private industry and tax payers. They are, quite literally, second class citizens.

    FWIW, I think Arnold Kling’s explanation of the slow build up and quick collapse is far too oblique. The much shorter version is that people would rather quit bar tending to become a mortgage securities broker (cf. This American Life/NPR) then get laid off as a securities broker and get a job bar tending.

    It isn’t just the timing of up vs. down that is asymmetric, the level of friction is as well. When I quit A to do B because B pays me more or has better potential I know exactly what I’m doing. When I get laid off from B I don’t know what to do next: wait for another job in B and take unemployment, take a crummy job in C and hope B rebounds soon, or do something entirely new, D. Stimulus really doesn’t help any of that.

  14. Bob Roddis says:

    Krugman is either the dumbest man alive or the most dishonest. It’s very simply to understand why there is little unemployment during the boom stage of Krugmanite Fed inspired monetary dilution program:

    Let me spell it out: Suppose we’ve got an economy in equilibrium, with unemployment at (say) 2.5%, with people quitting jobs and getting laid off in small numbers, due to normal changes of preferences, technology, etc.

    Then someone starts printing up crisp new $100 bills nonstop. This guy begins advertising for new workers in his factory, and offers to pay qualified applicants double what they are currently making. Clearly, the number of people working at this factory is going to skyrocket over the months, as the guy continues to print up his new $100 bills.

    Now Paul Krugman wants to know: Why doesn’t unemployment shoot up to 10%, as all these workers get sucked into employment at the counterfeiter’s factory?

    The answer, of course, is that a few people who were previously unemployed take the jobs at the factory, and everybody else simply quit his old job, because of the higher wages. Unemployment actually falls down to about 0.3%, for a year or two.

    But eventually something has to give. It can’t possibly be the case that printing up green pieces of paper makes the underlying economy more physically productive. People thought they were richer for a few years after the counterfeiting commenced, but actually they weren’t, in the aggregate. All that happened was a massive redistribution of wealth, and a consumption of capital as people were fooled into thinking their lifetime (real) earnings were now much higher.

    At some point people realize the factory owner is running a counterfeit operation, and they pull the plug on it. The $100 bills stop flowing into the economy. Everyone at the factory gets laid off instantly, and all of the people who supplied materials to the factory see their business fall off by 50% (since the factory was such a large component of their sales). So they have to lay off a bunch of people.

    The laid-off people are dazed. They can’t believe that they are expected to now take a job paying (in real terms) half of what they were making just yesterday. They decide to wait it out, sending out resumes in the hopes of getting a job that pays, say, 85% of what they are used to. Needless to say, the unemployment rate does not stay at 0.3%. In fact, it shoots above 2.5%, and stays at an abnormally high rate for many months.

    Does Paul Krugman really not get that?”

  15. teqzilla says:

    Here is another good blog posting answering Krugman


    If for any reason you still cant get your head around why the creation of jobs doesn’t cause job losses and the destruction of them does.

  16. reason says:

    Both the last two posters clearly haven’t uderstood Krugmans argument because this:
    “If for any reason you still cant get your head around why the creation of jobs doesn’t cause job losses and the destruction of them does.”
    is 100% wrong.

    Krugman things that the creaton of jobs doesn’t cause job losses, and the destruction of them does, he thinks the argument that sectional imbalance causes BOTH is irrational.

  17. reason says:

    This from Engelhardt
    ” It’s like the government is yelling in the economy’s ear while the economy is trying to sort out what to do. This doesn’t help the thinking process.”
    is just silly. “The economy” doesn’t try to sort out things and it doesn’t think. The economy is the agglomeration of lots of individual actions. And lots of firms trying at the same time to reduce costs in response to a fall in demand, just makes the situation worse. There isn’t a steady flow from “bad” industries to “good” industries, because currently all industries are “bad”. This is also not hard to understand if you think dynamically. Thinking only about the eventual equilibrium outcome, doesn’t let you think about how the adjustment process should work. Initial movements could well be in the wrong direction. Basically cyclical forces are swamping the signal from structural forces.

  18. reason says:

    Bob Roddis
    The problem with your story is of course that unemployment was never anywhere near that low, and even the story you made is incomplete because all prices would rise as a consequence of the conterfeiting operation (so some industries would have to lay off workers because real wages were too high).

    Your story is not actually so different from Krugman’s. Krugman says that aggregate demand can swing automously (in your case due to counterfeiting), and because of sticky prices that can affect unemployment and output. You are saying the same thing. So where is the difference. You say particular sectors are favoured over others, he would say that happens all the time, cosumers are fickle, so what is the difference.

    The Austrian story is always one of capacity constraints, whereas what we actually observe is overcapacity. What is missing from the Austrian story is individual balance sheets, asset prices and debt. (P.S. it is also missing from the standard new Keynesian model that PK usually uses as a base – Steve Keen has a better handle on it.)

  19. reason says:

    So to summarise,
    I will say thanks Bob Roddis, you have just explained the Keynesian argument, now can you explain the Austrian view.

  20. reason says:

    Bob Roddis
    “In fact, it shoots above 2.5%, and stays at an abnormally high rate for many months.”

    If that was all we were worried about, I think Paul Krugman would also not be bothered about the stimulus.

  21. reason says:

    And Bob – you are not doing your story any good at all by picking counterfeiting as your industry being expanded. After all that creates money and Keynesians think they can counteract unemployment by manipulating the availability of money. Well your argument confirms that. Now where is the alternative argument?

  22. Karl Smith says:


    Sorry you moved to a less smart intelligent :'(


    We still have plenty of brand new downtown loft for sale when you are ready to come back.

  23. Konstantin says:

    Maybe you should put aside “me-too” theories for the time being and look at the original:


    And don’t forget:
    “America’s Great Depression”

  24. reason says:

    so another Austrian sekt member pipes up with their holy scriptures! Sorry, I’m an athiest, I think for myself.

  25. Just to come into the game several months late…

    reason (17) – my statement was obviously a metaphor. As you say, the economy is made up of individual actions – I’d add that they are reacting to available signals (to be fair, you obviously understand this – I’m just making the point explicit).

    But, “currently all industries are ‘bad'”? To me, this seems obviously silly – or at the very least quite presumptuous. You’re claiming that there is no industry (including all potential industries that don’t necessarily exist yet) that has signals indicating that it should expand?

    Also, you’re (apparently) making an assumption that everyone is basically backward-looking in reading signals. (We’re taking losses recently – ergo, we should shut down/cut production, etc.) But this is simply not true. One can easily identify times when companies take temporary losses and choose to expand their operations because they foresee good times ahead. (One point I’ll give you: borrowing constraints can stifle this process. So, thinking about balance sheets can be helpful.)

    The fact that cyclical movements are impacting signals may be relevant – but they’re only relevant as long as entrepreneurs don’t adjust for them. Once it becomes obvious that signals are being impacted by cyclical factors, it seems reasonable that skilled entrepreneurs should be able to sort out the structural signals – and they have the incentive to do so, as they can start projects at a reasonably low cost, and sell the product later when the market recovers.

    Anyway, the case for stimulus only really makes sense if we believe that stimulus can wipe out the cyclical “noise” and leave the structural signals basically intact – but it almost certainly doesn’t. Also, incentives suggest that entrepreneurs should try to ignore cyclical aspects of signals – but this is not true for stimulus’s distortion of structural signals.

    Take this for what it’s worth.