The Ambrosini Critique

Its so much fun to accuse a Nobel Laureate of getting basic economics wrong. Paul Krugman confuses levels with rates.

The unemployment “rate” is the number of unemployed divided by the labor force. This is not a rate in the rate vs. levels sense. Its a level. Just like the real money supply is a level, the unemployment “rate” is a level. It has just been normalized.

Suppose there’s a bathtub with water flowing out through a leak and water flowing in from the facet. The water level is constant if the amount of water poured in is the same as the amount poured out. You will notice, though, even if the water level is constant the water itself is not. In such a dynamic system, eventually all the water will be replaced by new water. The water level tells us nothing about that.

The number of unemployed is like the water level in the bathtub. There’s always newly unemployed workers being poured into the unemployment tub and there’s always workers leaking out when they find jobs.

Ryan Avent (somehow people discovered the true identity of The Economist blogger) and Paul Krugman are wringing their hands over the slow pace in the reduction of the unemployment during recoveries. Similarly, Brad Delong is always talking about a “jobless recovery”.

But do high unemployment rates mean people can’t find jobs? No. This is like suggesting that because a bath tub is full there’s no leak. Would you pat a plumber on the back and tell him “good job” because he “fixed” the leaking problem by turning on the facet?

Despite the headlines and the breathless way some bloggers write about it, people don’t care about the unemployment rate, they care about whether or not people are finding jobs.

From the JOLTS data, it looks like unemployment in this recession is being driven by an unusually low hire rate (firing rates are more or less the same as normal). Suppose the recession ended and the job finding rate immediately resumed its usual, non-recession value. How long would it take for the unemployment rate to get from the current 9.8% to normal levels? Doing the math, it would take about nine months. On the other hand, if it takes about a year for the hire rate to get back to its normal values, we wouldn’t see normal unemployment rates for a year and a half. So the longer it takes for the hire rate to get back to normal, the longer it will take to see normal unemployment rates.

That last sentence might have seemed obvious, but consider the implications. With improving hire rates, the average amount of time spent unemployed would be dropping. This answers Avent’s questions about the political economics of persistent unemployment. If people are finding it easier to find jobs, they’re less likely to throw fits in the ballot box, no?

Also it suggests we shouldn’t care much for how fast the unemployment rates get back to normal after recessions.

Here’s the density of temperature changes over centuries. I used these data and calculate the average change in temperature per century.

Last century’s temperature increase of 0.8 degrees C was an outlier (but not an extreme outlier). About 95% of temperature changes were slower than last century’s temperature change. If the climate models are correct and the world sees a 2.5 degree increase, this would be an extreme outlier. Only about 1 in a three or four hundred centuries sees that dramatic of temperature changes.

This, of course, doesn’t guarantee catastrophe, but it suggests we should at least insure ourselves against the possibility of catastrophe.

Sumner:

Because the growth that comes from rising AD strikes our intuition as a sort of “something for nothing” process, we are especially likely to fall into the mistake of thinking in zero sum game terms whenever examining international economic linkages. Common sense suggests that a low yuan cannot help both China and the rest of the world. One country’s trade balance improvement is offset by another’s deterioration. But when you remember that an exchange rate is also a price of money and that the price of money affects both domestic and world AD, things look much different. If during normal times the US suddenly adopted an ultra-tight monetary policy, then the US dollar would appreciate and we’d go into a deep recession. But the rest of the world wouldn’t boom, they’d also suffer an economic slowdown despite the fact that their currencies depreciated against the dollar.

Angus Deaton on the “project evaluation” craze:

Randomized controlled trials cannot automatically trump other evidence, they do not occupy any special place in some hierarchy of evidence, nor does it make sense to refer to them as “hard” while other methods are “soft”. These rhetorical devices are just that; a metaphor is not an argument… thirty years of project evaluation in sociology, education and criminology was largely unsuccessful because it focused on whether projects work instead of on why they work.

and

The wholesale abandonment in American graduate schools of price theory in favor of infinite horizon intertemporal optimization and game theory has not been a favorable development for young empiricists. Empiricists and theorists seem further apart now than at any period in the last quarter century. Yet reintegration is hardly an option because without it there is no chance of long term scientific progress.

and after listing a number of papers that he thinks have a good mix of theory and data, he says:

In all of this work, the project, when it exists at all, is the embodiment of the theory that is being tested and refined, not the object of evaluation in its own right, and the field experiments are a bridge between the laboratory and the analysis of “natural” data.

Science is about finding underlying mechanisms. Its not about testing hypotheses and

[H]eterogeneity is not a technical problem, but a symptom of something deeper, which is the failure to specify causal models of the processes we are examining. This is the methodological message of this lecture, that technique is never a substitute for the business of doing economics.

I use the “project evaluation” and “experiment” rhetoric in one of my papers. I might have to rethink the organization of that paper…

I’m waiting for them to realize where Prof. Delong found the citation for the monkey research.

I know. I know. I’m thinking I misunderstood her in some way. She says:

When the unemployment rate is up around the 10% line, the problem is not people waiting around for perfection; it’s that there aren’t any jobs for them to take. Increasing peoples’ incentive to take a job offer will not do anything to increase the number of job offers; at best, you’re just shuffling the unemployment around some. Indeed, at a time when aggregate demand has collapsed, more generous unemployment benefits could plausibly make the unemployment rate lower.

The way I parse this paragraph — and I’m very suspicious of my parser given what its forcing me to conclude — she’s saying the labor supply curves for the unemployed don’t slope up and she’s saying UI is a more efficient policy than straight transfers (the alternative policy to UI) or normal aggregate demand policy.

Let me first state the obvious: because there are few job openings out there, doesn’t mean there are no job openings. Can we all please get aboard the marginal analysis bus?

Consider the decisions an unemployed person has to make regarding finding a new job. He must decide how hard to work at finding a new job and he must decide which job offers to take. Now, I have a very loose definition of job offer. The help wanted poster outside McDonald’s is very likely a job offer even though no one explicitly offered the job to the unemployed person. The harder he looks for a job the more implicit and explicit offers he will get.

Working backwards in time: will the unemployed worker be less likely to take a random job offer if UI benefits increase? Yes because the cost of taking that random job offer goes up as he has to give up more UI benefits.

Will the unemployed worker search less hard due to increases in UI? If he has no control of the quality of offers he gets (which is likely given the loose definition of a job offer), because random job offers are less likely to be taken, the expected benefits of searching are reduced. Looking harder for new jobs, for example, will produce more offers but those offers are, on average, worth less. With the same cost (loss of leisure time and searching for jobs is a pain in the neck) but less benefits, he’ll reduce his search effort.

How would either of these decisions depend on the business cycle?

(It would be interesting to see if people in their last week of UI benefits find jobs at higher rates than the rest of the unemployed. This is true in “normal” times, but I wonder if its true now.)

The increase in UI is inefficient because if you gave that money to the unemployed person but didn’t make that payment contingent on finding a job, you’d have more people employed quicker, thus more production, with the same cost of the policy. If you’re trying to manage aggregate demand, UI is a terrible policy instrument.

UPDATE: In comments I mention a study by Card and friends that used a UI extension in New Jersey as an experiment to see its the effect on unemployment. They find extending UI by 13 weeks increases average unemployment durations by a week and increases the number of chronically unemployed by 7%. I messed up the calculation to see what this translates to in unemployment percentage points. The answer, as it turns out, is very sensitive the separation and hire rates (the percentage of the employed that become unemployed and the percentage of unemployed who become employed). In normal times, these are about 1.3% per month and 28% per month respectively. The Fed says unemployment duration is about 26 weeks as of last month. This suggests a hire rate of 15%. You can infer the separation rate if you assume we’re in the steady-state (alarm bells!). Anyway, if you plug in the “normal times” separation rates (1.3%), you get about 1.5% additional unemployment from the UI extensions and if you plug in the implied rates using steady-state assumptions (1.6%) you get 0.2% additional unemployment from UI extensions. A big range.

Kenworthy responds to the core of Wilkinson’s argument. Kenworthy says income inequality matters because outcomes are determined by luck. Its not fair that two people of equal talent, who both worked hard in school, etc, etc should have different outcomes because one was lucky enough to “have a friend in the business” or won the lottery.

To me, this is an argument for a social safety net not for income redistribution. Most people I know are happy for the people that win lotteries. Nobody bemoans others’ good fortunes. However, most people I know dislike when people hit dire straights because of bad luck. It is unfair for people that have worked hard to be knocked down too far.

Good thing that you don’t have to believe “most people I know”. Experiments have shown that people have preferences for efficiency not for equality.

The difference matters for policy because policy makers should give more weight to policies that increase growth rates even if they increase inequality and less weight to redistributive policies.

I just read The Chapter Five (in this book) and I’ll go as far as to say the critics don’t even have a point.

The chapter motivates geo-engineering without saying anything outlandish about the science (as far as this semi-informed lay-person can tell). There’s not even as much as an implication in the whole chapter that global warming isn’t a big deal. In fact, such a level-headed discussion of solutions to the problem actually bumped up my subjective probability of global warming being an issue to worry about. There’s no use fretting over something we can’t, practically, do anything about. It appears more likely to me, now, that we can do something about global warming.

The authors haven’t given up on marginal analysis, they seem to get that people respond to incentives and they appear to be aware of Pigovian-type taxes. They explicitly address the problems with carbon pricing and move the discussion forward with their description of one alternative policy (i.e. subsidized research in bio-engineering).

The reaction to this chapter was just plain strange.

Elizabeth Anderson points to this video suggesting its proof about how truly terrible is status seeking (ergo inequality is bad!).

In it, kids are quoted saying they divide themselves up, not by race, but by wealth. Its not “this kid is black or Mexican” anymore its “this kid is rich or poor”.

These sentiments are a bad thing only when you set them to forlorn music and pictures of deserted parking lots. Whoa is us who have given up centuries of racial hatred and division to go shopping at the mall!

I really, really want someone to tell me why concerns about status seeking are so easily conflated with concerns about inequality. I’ve read Robin Hanson enough to believe we’re built-in status seekers and we’d be so whether or not the gini index rose last year.

In a response to Wilkinson’s essay, Elizabeth Anderson quotes Adam Smith:

A linen shirt, for example, is, strictly speaking, not a necessary of life. The Greeks and Romans lived, I suppose, very comfortably, though they had no linen. But in the present times, through the greater part of Europe, a creditable day-labourer would be ashamed to appear in public without a linen shirt, the want of which would be supposed to denote that disgraceful degree of poverty, which, it is presumed, no body can well fall into without extreme bad conduct.

and then writes:

The consumption of the better-off thereby raises the cost of living for the worse off.

While conceding the point that consumption inequality is what really matters, this clearly does not follow. The better off in Adam Smith’s day didn’t wear linen. They wore fancy, silky stuff from the Orient. Linen is what other laborers wore. A laborer would be ashamed to not live up to the standards of other laborers, not the rich.

I’m tired of the sociology on this issue. I’ve seen enough examples of status seeking to know it exists. I want to know about its mechanisms. Do laborers have higher standards overtime because they are trying to emulate the rich? or some other group? Who do people choose to emulate? Why do people care about their status relative to classmates but not relative to poor Africans? How many people actually participate in status seeking to the pathologic levels sociologists and documentary film makers dwell on?

Why is this at all related to wage inequality?