Tuesday, September 11, 2012

The Great Recession: Why So Much Unemployment?

First of all some clarification about why recessions happen:
Again please forgive the ugly graphic. They will get prettier at some point. 

Now, this recession happened because in mid-2008, Wall Street realized that they had massively misvalued billions of dollars worth of securities, due largely to the misunderstanding of a few schmancy financial tools invented by a bunch of schmucks from JP Morgan back in 1997. Wall Street freaked out and stopped lending, consumers freaked out and stopped spending, demand fell, prices fell, aggregate income fell, firms found themselves short of funding and freaked out some more, and the whole thing just got bad news bears. You don't need this blog to tell that story; here and here are a few of my favorite tellings.

When aggregate income and aggregate output falls in a recession two things can happen:
  1. Everyone earns less. (wage and hour cuts) 
  2. Some people earn a lot less. (layoffs) 
Now here is graphic #2, taken from "Uncertainty, Productivity, and Unemployment in the Great Recession," a paper written by Edward Shaal in 2010.

Don't worry about the numbers on the y-axis; everything is screwy cause of logs, just worry about the trend 

This graphic shows quite clearly that from 2007-2010, the latter, not the former occurred. Output decreased unemployment (2) leaped, and  productivity actually increased, meaning that output actually increased per worker, either because of higher efficiency or longer hours. That implies that wage and hour cuts (1) happened hardly at all, because cutting hours decreases per capita productivity, and cutting wages but maintaining constant hours during a period of decreasing output also decreases productivity. At least that seems to be the story from these graphs; data is tricky and other papers and reports imply slightly different stories. 

The fact that almost all of the recession's impact has been absorbed by unemployment (2) produces scary graphs like this one: 

Graphic Credit: Calculated Risk 

Which actually make this recession seem a lot worse than it is. (It is pretty bad, but not quite as bad as that.)

There are a number of reasons why unemployment (2) is considered to be socially less desirable than salary and hour cuts (1). First, where (1) might mean canceling a vacation or postponing the new car, (2) might mean relocating your family or declaring bankruptcy. Again, you don't need this blog to tell you why unemployment is bad; you can follow the election to hear about that.

So the question boils down to: Why so much unemployment? It's not an easy question to answer. Here is a list of possible reasons:

  1. Deregulation, de-unionization, and changes in patterns of employment have made it easier to fire people.
  2. Regulation, unionization and changes in patterns of employment have made it harder to cut hours and wages.
  3. The onset of the Great Recession (with the Financial Crisis of 2008) was especially sudden, forcing firms to cut jobs to cut costs rapidly, instead of negotiating hours or wags to cut costs slowly. 
  4. The government failed to enact a fiscal or monetary stimulus quickly enough to save jobs.
  5. Productivity increased in spite of hour and wage cuts, and this whole discussion is moot. 
Currently the literature is searching for an answer. The Republicans argue for (4), but they have a social motive to do so. The libertarians argue for (2) but you can't really trust them. Shaal, the author of the paper, attributes the effect partially to (3), and Casey Mulligan (or so I understand from reading his abstract) attributes the effect partially to (5). Tyler Cowen and David Berger argue for (1). 

I'm out of time, but my gut points me most toward (1) and (3). My next post should say why! 

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