Economic growth would be a socially easier process if it was smooth and even across society: that is, if most people could just get steady raises for doing their same jobs a little better each year. When growth benefits some and not others, or even benefits some while imposing losses and costs of transition on others, then controversies arise.
Arnold Harberger offered a nice metaphor thinking about this difference in his Presidential Address to the American Economic Association back in 1998, entitled \”A Vision of the Growth Process\” and published in the March 1998 issue of the American Economic Review. Harberger discusses whether economic growth is more likely to be like \”mushrooms,\” in the sense that certain parts of a growing economy will take off much faster than others, or more like \”yeast,\” in the sense that economy overall expands fairly smoothly overall. He argues that \”mushroom\”-type growth is more common. Harberger writes:
\”The analogy with yeast and mushrooms comes from the fact that yeast causes bread to expand very evenly, like a balloon being filled with air, while mushrooms have the habit of popping up, almost overnight, in a fashion that is not easy to predict. I believe that a \”yeast\” process fits best with very broad and general externalities, like externalities linked to the growth of the total stock of knowledge or of human capital, or brought about by economies of scale tied to the scale of the economy as a whole. A \’\’mushroom\’\’ process fits more readily with a vision such as ours, of real cost reductions stemming from 1001 different causes, though I recognize that one can build scenarios in which even 1001 causes could work rather evenly over the whole economy. Personally, I have always gravitated toward the \”mushrooms\” side of this dichotomy. I remember being impressed, when I first saw some early industry estimates of TFP [total factor productivity] improvement, by their tendency to industry concentration.\”
To put this another way, a lot of the policies for encouraging economic growth–like investing in human capital, technology, infrastraucture, and a supportive institutional environment for innovation–seem to suggest the possibility of broadly shared economic gains. But the economic growth that results will often be often mushroom-like and disruptive, affecting certain industries, localities, and kinds of workers more than others.
Paul Romer, who recently accepted the position of Chief Economist at the World Bank, recently offered on his blog a summary of the social problem that then arises in a pithy aphorism: \”Everyone wants progress. Nobody wants change.\”
From an economic point of view (and doubtless from other points of view, as well), the French present a puzzle. France is often perceived as having a government that practices heavy-handed intervention into the economy, sometimes known as dirigisme, but it is also obviously a high-income economy and has been a high-income economy for decades. So does this mean that France is less heavy-handed in economic interventionism than its reputation suggests? Or that the French have discovered an especially growth-friendly version of heavy-handed interventionism? How does France manage this balancing act?
Both Lemieux and Blanchard point out that concerns about how the French government has a tendency to overcentralize its power and decision-making go back a long time. Lemieux points out that his was a theme of Tocqueville\’s back in 1856, in The Ancient Regime and the French Revolution. He also mentioned that in 1970, French sociologist Michel Crozier published The Stalled Society. In 1976, Alain Peyrefitte wrote Le mal français (“the French disease”). Blanchard pointed out that in the year before his 2004 article, two books that made the estseller’s list in France were La France qui tombe (The fall of France), by Nicolas Baverezm and Le desarroi Francais (The French disarray), by Alain Duhamel. Lemieus refers to a book published last year by Gilbert Cette and Jacques Barthélémy published Réformer le droit du travail (Reform the Labor Code).
As a starting point, here\’s some evidence on the higher degree of regulation in the French economy. Lemieux notes: \”Public expenditures amount to 57% of French gross domestic product, the fourth-highest percentage in the OECD, after Greece, Slovenia, and Finland. This compares to 45% for the OECD unweighted average and 39% for the United States.\” In measures of \”economic freedom\” for the countries of the world, the US tends to rank around 10th, while France tends to rank around 70th.
However, Lemieux also offers some evidence on the other side: \”Not all industries are more regulated in France than in America. The OECD’s Services Trade Restrictiveness index shows France as less regulated than the United States in commercial banking, insurance, broadcasting, and many modes of transport. Even the labor market is less regulated in France with regard to many trades and professions. In the United States, nearly 30% of jobs require a license.\” Moreover, France (like many other economies) has gradually been moving in the direction of less regulation.
\”[A]ny firm of more than 49 employees must create a “work council” (comité d’entreprise) chaired by a representative of the owners but composed of trade union representatives and representatives elected directly by the employees. Consultation of the work council is compulsory on many business decisions. Even businesses of 11–49 employees are forced to allow the election of employee representatives. To appreciate the spirit of the 2,880-page labor Code, consider that the French government is currently pushing businesses to negotiate with their workers’ representatives a “right to disconnect,” referring to after-hours work-related electronic communications. The Department of labor, Employment, Occupational Training, and Social Dialogue (why they didn’t add “General Happiness” to the name is a mystery) explains that “the employees of a large firm are not obliged to answer emails outside of office hours.”
As another example, here\’s a figure about \”employment protection\” from 2015 OECD Economic Survey of France–basically, how hard it is for a firm to fire or lay off workers. The figure shows the US and Canada off on the far left, with little employment protection, while France is off near the far right.
Lemieux notes: \”Because of the cost of firing employees, firms are incited to resort to short-term labor contracts, a loophole that further regulations have tried to limit. In France, a short-term contract may not extend beyond 24 months. The employed work force has thus acquired a dual structure: on one side, the “insiders”—regular workers protected against dismissal; on the other side, the “outsiders,” who survive on short-term contracts and hop fromjob to job. Outsiders make up about 15% of the employed, a proportion that climbs over 50% in the 15–24 age category.\”
The minimum wage in France is also comparatively high compared to other countries. Here\’s a figure from a a 2015 OECD report on minimum wages, which shows minimum wages as a percentage of the median wage in the country. Again, the US is off on the left, with a minimum wage about 35% of the US median wage, while France is off near the right, with a minimum wage at about 60% of the median wage.
Here\’s the unemployment rate in France during the last couple of decades, from the Trading Economics.com website. It seemed for a time in the early 2000s as if France was making some progress on its unemployment rate issues, even if the unemployment rate had only fallen to a still-unsatisfactory 7.5%. But now the unemployment rate is back up around 10% again, and has been there for three years. For comparison, remember that in the aftermath of the Great Recession, the US unemployment rate peaked at 10% in October 2009, before starting a long glide down to the current rate of 5%. Try to imagine the political turmoil in the US if the unemployment rate was higher now, seven years after 2009. That\’s the situation in France.
If you focus only on the youth unemployment rate in France, it\’s been roughly at 24-26% since 2009. Of course, France\’s labor market regulations aren\’t the only cause of unemployment and lower labor force participation in France, the generally torpid European economy bears a large share of the blame. But the many labor market regulations aren\’t helping, either.
The result of these labor market regulations is that France is running a high-powered modern economy for many of those who have jobs, but with high unemployment or temporary work for many others. Blanchard offered an interesting summary of the situation in his 2004 JEP essay. The table shows that when looking at GDP per capita, France went a little backward compared to the US from 1970 to 2000. However, if one looks at GDP per hour worked during this time, France caught up to the US level, while if one looks at hours worked per capita, France started at above the US level in 1970 but then declined to 71% of the US level by 2000.
In short, the French are very productive during their working hours. But the French now work many fewer hours per capita, in part because the labor force participation rate (the share of adults either employed or looking for work) is lower in France, in part because of continuing high unemployment rates, and in part because a number of jobs have more vacation per year than is common in the US.
A couple of warnings about those high rates of productivity in France should be noted. One is that in the US, lower-wage and lower-productivity worker are more likely to have jobs than in France. As a result, France\’s higher productivity is in part because a substantial share of those who would tend be the lower-productivity workers (like young workers, for example) just aren\’t working at all.
The other concern is that productivity in France has in fact started to lag, starting in the mid-1990s, especially if one looks at \”multifactor\” productivity, which doesn\’t just divide output by hours worked, but also adjusts for other inputs like capital investment. Blanchard had raised this possibility in his 2004 essay, noting that while the evidence at the time of his writing was not yet decisive, \”most observers now believe that we have indeed seen a change in relative trends [of productivity growth in the US and continental Europe], starting around 1995.\” Lemieux cites other evidence and writes:
\”Since the mid-1990s, France and many other European countries (but not the UK) have suffered a widening gap with the U.S. standard of living. During that period, the culprit was the slowdown of multifactor productivity growth, especially noticeable in France. According to another paper by Cette and Lopez, the underlying causes were a slower diffusion of the new information technologies, structural rigidities in labor and product markets, and a less educated working population. From 1995 to 2012, French GDP per capita grew at a meager 1% per year.\”
None of this discussion should be read as a prediction of doom for the French economy, which seems certain to remain a high-income economy. But it does suggest that French dirigisme is not cost-free: specifically, the costs in the last couple of decades are measured in elevated unemployment, lower labor force participation rates, a larger number of temporary jobs, and sluggish growth in productivity and the standard of living.
Global debt is at an all-time high: specifically, \”nonfinancial debt,\” which is the combined debt of governments, households, and nonfinancial firms in the 113 countries that make up 94% of world GDP. The IMF discusses the situation in its \”Fiscal Monitor\” for October 2016, which is subtitled \”Debt: Use it Wisely.\” The report starts (footnotes and citations omitted):
\”The global gross debt of the nonfinancial sector has more than doubled in nominal terms since the turn of the century, reaching $152 trillion in 2015. About two-thirds of this debt consists of liabilities of the private sector. Although there is no consensus about how much is too much, current debt levels, at 225 percent of world GDP (Figure 1.1), are at an all-time high. The negative implications of excessive private debt (or what is often termed a “debt overhang”) for growth and financial stability are well documented in the literature, underscoring the need for private sector deleveraging in some countries. The current low-nominal-growth environment, however, is making the adjustment very difficult, setting the stage for a vicious feedback loop in which lower growth hampers deleveraging and the debt overhang exacerbates the slowdown. The dynamics at play resemble that of a debt deflation episode in which falling prices increase the real burden of debt, leading to further deflation.\”
A few thoughts about this situation:
1) As the figure makes clear, the real debt issue here involves the US and China. The red dashed line, which shows global debt/GDP for the world not counting the US and China, shows only a modest rise over this period, from about 205% of GDP in 2002 to less than 215% of GDP in 2015. As economies grow and develop, one of the standard changes is that a financial sector develops, too. But if one includes the US and China, the global debt/GDP ratio rises from about 200% in 2002 to 225% in 2015, which is a quite substantial bump (remember, we\’re talking relative to global GDP here!) in 13 years.
2) Of course, global averages will conceal a number of individual countries which are above-average or below-average in substantial ways. Compared with historical experience, the private sector in the US and other high-income countries has not been deleveraging as quickly as usual since the end of the recession, but for advanced economies the rise in private debt (as a share of GDP) at least leveled off back around 2010 and has even declined a bit.
At present, the bigger worry should be about rising private sector debt in some large emerging market economies. China\’s debt buildup poses some real concerns: from 2008-2015, its private nonfinancial debt increased by about 70% of China\’s GDP; in Brazil, the increase over that time is about 30% of GDP; in Russia, 25% of GDP. As the report notes: \”In a few systemically important emerging market economies, private credit has expanded briskly in recent years. The speed of the increase dangerously resembles that in advanced economies in the run-up to the global financial crisis.\”
3) The sector that is accumulating debt is shifting. Before the Great Recession, it was primarily households; since then, it\’s been primarily government. However, this is a shift that has some economic justification. When a society has built up a lot of private sector debt, and then the economy slows dramatically, one of the ways to help a share of that debt get paid off is to get the economy growing again–and public debt can be a way to do that, at least for a time.
4) There\’s no simple way out of a situation where private debt has gotten excessive, as the world economy learned during the Great Recession and its aftermath. Getting the economy growing again is a huge help, because it means fewer borrowers will end up in default. When cutting a deal to address problems of debt overhand and bad loans, there can sometimes be a role for government loan guarantees when private-sector actors agree to take losses, but the government puts some limit on how large those losses will be. Restructuring banks and financial institutions so that they are required to address problems of bad loans in the past and hold more capital against the risks of future bad loans is a help. Once a debt overhang situation has occurred, then helping get the bulk of the debt problem into the rear-view mirror is a legitimate goal of public policy.
\”[C]onsider two indistinguishable workers, you and your clone. By definition, you/clone have the same gender, ethnicity, years of schooling, family background, skills, etc. In 2006 you/clone graduated with identical academic records from the same university and obtained identical job offers from Facebook and MySpace. Not knowing any more about the future than the analysts who valued Facebook and MySpace roughly equally in the mid-2000s, you/clone flipped coins to decide which offer to accept: heads – Facebook; tails – MySpace. Clone’s coin came up heads. Yours came up tails. Ten years later, Clone is in the catbird’s seat in the job market — high pay, stock options, a secure future. You struggle. Back to university? Send job search letters to close friends? Ask distant acquaintances to help? The you/clone thought experiment may seem extreme, but recent research that I have conducted with colleagues finds that the earnings of workers with near-clone similarity in attributes diverged so much by the place they worked that rising inequality in pay among employers has become the major factor in the trend rise in inequality. … The labor market has been dominated by economic forces that pull the wages of firms further apart from each other, motivating our analysis of the role of employers in increasing inequality.\”
In other words, a lot of inequality is about where you work. The rise in equality is linked to differences across what firms are paying employees who appear to be similarly qualified. As Freeman acknowledges, this argument that this is a quantitatively important cause of rising inequality isn\’t ironclad at this point, but it\’s highly suggested in several ways of looking at the data: Freeman writes:
\”This implies that 86% … of the trend increase in inequality [from 1977-2009] occurs among people with measurably the same skills, whereas just 14% of the trend increase comes from changes in earnings among workers with different skills. The big surprise in the exhibit is that the inequality of average earnings among establishments increased by the same 0.147 points [measuring variance of natural log of earnings, a standard measure of inequality of earnings] as did inequality among workers with the same characteristics. This suggests that all of the increase in inequality among similar workers comes from the increase in earnings at their workplaces.\”
Or here is a figure suggesting a linkage from firm earnings to individual inequality of earnings. The blue line shows the change in individual earnings along the income distribution from 1992-2007. As one would expect, given the rise in inequality, those in the bottom percentiles of the income distribution do worse, while those in the top percentiles of the income distribution do better. But now, notice that the blue line for individual earnings almost matches the orange line for firm earnings. That is, there has also been widening inequality in firm earnings, with those at the bottom of the earnings distribution also seeing a decline from 1992-2007 and those at the top seeing an increase. Freeman also offers evidence that those who stayed at firms have seen their earnings change with the fortunes of the firm–thus contributing to overall inequality. As he writes; \”In sum, changes in the distribution of earnings among establishments affect the change in earnings along the entire earnings distribution and the increased advantage of top earners compared to other workers.\”
What makes it possible for successful firms to pay workers more? The answer must be rooted in higher productivity for those firms. Indeed, productivity seems to be diverging across firms, too.
Indeed, as Freeman emphasizes, this figure shows that the equality of revenue per worker–a rough measure of productivity at the firm level–is diverging faster than inequality of wages across firms. Moreover, Freeman argues that a similar pattern of productivity divergence across firms is happening within each sector of the economy.
Thinking about inequality between similar workers may alter how one thinks about public policies related to underlying determinants of inequality. For example, it may be important to think about how productivity gains diffuse across industries and how that process may have changed. I suspect there is also some element of geographical separation here, where firms in certain areas are seeing faster productivity and wage increases, and so thinking about mobility of people and firms across geographic areas may be important, too.
For economists, a \”cartel\” refers to a group of firms jacking up prices to exploit consumers. Thus, I infer that this Arizona-based chain of coffee shops is not seeking the business of economists.
The company\’s website features comments like \”WE ARE CARTEL\” and \”JOIN THE CARTEL.\” I know nothing about the company\’s thinking in using the term. I suppose the use of \”cartel\” may be an ironic comment on the really big coffee-store chains; or perhaps it just sounded cool; or perhaps the company is trying to emphasize the cooperative nature of what happens inside a cartel, while deemphasizing the costs imposed on everyone outside a cartel. But for an economist, telling a consumer to do business with a cartel is like telling the sheep that it\’s time for shearing.
Hat tip: Victor Claar spotted this store at the Phoenix Airport and posted this picture on Facebook.
When most people think about the goals of education, their minds turn to cognitive skills involved in reading, writing, \’rithmetic, and reasoning. We think about test scores on the well-known US-based tests of cognitive ability like the SAT, ACT, National Assessment of Educational Progress, or international tests like the TIMSS (Trends in International Mathematics and Science Study), PIRLS (Progress in International Reading Literacy Study), and PISA (Programme for International Student Assessment). But maybe we should instead be putting more focus on how students score on some lesser-known tests like the Rotter Locus of Control scale and the Rosenberg Self-Esteem scale. These and other tests that seek to measure noncognitive skills. which are \”social, emotional, and behavioral skills\” that \”include qualities like perseverance, conscientiousness, and self-control, as well as social skills and leadership ability.\”
For a lot of jobs in the US economy, the problem isn\’t a lack of measurable cognitive skills: that is, it\’s not that employers are seeing a wave of job applicants who are truly illiterate or innumerate, or who are unable to complete a particular course or certification. Quite often, the problem as perceived by employers is that job applicants and young workers lack the necessary noncognitive skills. For example, an article in the Wall Street Journal in late August noted:
\”The job market’s most sought-after skills can be tough to spot on a résumé. Companies across the U.S. say it is becoming increasingly difficult to find applicants who can communicate clearly, take initiative, problem-solve and get along with co-workers. Those traits, often called soft skills, can make the difference between a standout employee and one who just gets by.\”
Diane Whitmore Schanzenbach, Ryan Nunn, Lauren Bauer, Megan Mumford, and Audrey Breitwieser offer an overview of some economics on these issues in \”Seven Facts on Noncognitive Skills from Education to the Labor Market\” (Hamilton Project at the Brookings Institution, October 2016).
The US Department of Labor looks at the variety of tasks that are required by different occupations. Over time, their analysis has shown a trend away from routine tasks (which of course are more prone to being replaced by software programs and robots), with a shift toward service tasks and social tasks. By comparison, the use of math/analytical tasks has risen only a bit. Of course, jobs are usually mixture of these skills, so this information should be understood as showing that the social and service part of a lot of jobs is rising, while the routine component of a lot of jobs is falling.
While it\’s true that on average, those with greater cognitive skills also tend to have greater noncognitive skills, the relationship is definitely not one-to-one. Schanzenbach and her co-authors note:
Individuals with high levels of cognitive skills tend also to possess high levels of noncognitive skills … However, measures of cognitive and noncognitive skills are capturing distinct concepts. While positively associated with each other, an individual’s score on the noncognitive index explains only 13 percent of the variation in AFQT scores. Those in the top 10 percent of cognitive skills will, on average, only be at the 67th percentile of noncognitive skills, whereas those in the bottom 10 percent of cognitive skills will rank at the 32nd percentile of noncognitive skills …\”
More detailed studies show that both cognitive and noncognitive skills are rewarded in the workplace with higher wages, and having both sets of skills is rewarded even more. But the importance of noncognitive skills as a predictor of earnings seems to be rising over time, as job tasks evolve.
It seems clear that noncognitive skills can be taught. There are now hundreds of studies of such programs. The report offers this overview of types of programs and findings (citations omitted here for readability):
Although effects differed in magnitude across the types of intervention, impacts on students’ noncognitive skills were considerable: each noncognitive skill intervention resulted in improved academic achievement and positive social behaviors as well as reductions in conduct problems and emotional distress. These studies show that many different facets of noncognitive skills are malleable and teachable. Social and emotional learning programs were the most broadly studied; they also had somewhat smaller effects than did other interventions. Service-learning interventions integrated community service into a school’s academic program and were found to improve student achievement and social skills. Mindfulness interventions helped students’ present awareness, causing improvements in student achievement and reductions in emotional distress. Self-regulated learning programs cause growth in student achievement, and social skill development programs led to growth in social skills and reductions in conduct problems …
However, in much the same way that people may differ in their cognitive and noncognitive skills, there is some evidence that, as the report notes, \”teachers who are adept at raising test scores and teachers who excel at instilling noncognitive skills are often not the same people. … Because the correlation between the two abilities is quite low, there are relatively few teachers who are adept at both cognitive and noncognitive skills development. Under some accountability policies, teachers are judged based on their impacts on test scores. These results suggest that there are many teachers who are adept at developing students’ noncognitive skills who are not also skilled at raising student achievement; these teachers will be identified as “low-impact teachers” under such policies, despite the value they provide to students.\”
It seems to me that the US educational culture has often emphasized cognitive skills, with a sort of implicit assumption that noncognitive skills would be developed while doing cognitive work, or would be developed outside the school setting by family, peers, and nonschool institutions. I suspect that I\’m part of the problem here, in the sense that I\’m sometimes suspicious of programs that seek to build noncognitive skills, because they sometimes seem like time sinks and distractions from the \”real\” tasks of education. But noncognitive skills are measurable and they matter. They should be part of the nation\’s agenda for building its human capital.
Global poverty, measured by the number of people living on $1.90 or less per day, has fallen dramatically in the last couple of decades. The blue line (right axis) shows the decline in the total number of the world\’s poor. The red line (left axis) shows the percentage of the world\’s population below the poverty line. The fall from 35% just 25 years ago in 1990 to about 10% at present is a dramatic improvement.
There are basically two ways that broad swaths of a population can be lifted out of poverty: broad economic growth and redistribution. It\’s worth remembering that the overwhelming majority of poverty reduction is due to economic growth–especially in China and India, but in other low-income countries around the world as well. About half of the world\’s poor live in countries of sub-Saharan Africa, while the nations of South Asia have another third of the world\’s poor, and not coincidentally, those are countries that have not experienced sustained economic growth.
We also consider the reallocation of two illustrative public “bads.” Specifically, regressive fossil-fuel subsidies which are an aspect of fiscal policy that is unequivocally pro-rich and what we have termed “surplus” military spending which we define as more guns than your neighbours meaning military spending above the regional lowest per capita spent. We appreciate that reducing military spending to this level may seem radical to some as no doubt would the reallocation of fossil fuel subsidies away from cheap petrol. However, our estimates of the impact of such changes in fiscal policy show what is at stake — the end of three quarters of global poverty — and our estimates are deliberately conservative for a number of reasons we outline. Our intention is not to annoy those who enjoy cheap petrol for example but to illustrate the resources now available nationally to governments and the implied opportunity costs in terms of poverty.
The report devoted a couple of chapters to policies for reducing poverty and inequality: \”[S]pecific interventions discussed are ECD [early childhood development], including breastfeeding; universal health care coverage; good-quality education; cash transfers, mostly conditional transfers; investments in rural infrastructure, specifically, rural roads and electrification; and income and consumption taxes. The selection means that other policy interventions with potential effects on inequality are not included in the assessment. This is not intended to deny the potential equalizing effects of these other interventions; the evidence of the equalizing effects is merely less compelling, is currently being collected, or a general consensus is absent on how to frame the policies to reduce inequality while reaching other objectives.\”
It\’s interesting to me that the highlighted policy choices mostly are about unconditional cash transfers, and little of the focus is on high marginal tax rates for those with high incomes. Instead, the policies here both offer near-term support to the poor and also can work as longer-term investments in productivity and economic growth.
The chapters of the report focused on inequality point out a theme that I\’ve mentioned before on this blog: inequality across the world as whole is falling, perhaps for the first time since the start of the industrial revolution in the early 19th century. But inequality within specific countries is rising. For example, economic growth in urban areas of China will tend to increase inequality within China, but reduce inequality from a global perspective. Thus, here\’s a picture of global inequality using the Gini coefficient. The break in the line occurs because there was a change how to compare the size of incomes across countries
But even as global inequality is falling, inequality is rising not only in the US, but also in a number of developing economies like China, Indonesia, and to a lesser extent India.
If you combine these sorts of estimates, you can divide up total global economic inequality into within-country inequality and between-country inequaltiy, and see that the first is rising while the second is falling.
I think greater inequality in high-income countries like the US is a legitimate cause for concern. But I worry less about greater inequality in low-income countries. Tumultuous economic growth tends to affect some areas more than others. The challenge is for governments in countries that have experienced strong but region-specific or industry-specific growth to make the investments in health, education, and infrastructure that can help the poor who have not benefited from that growth.
Douglas Clement has an \”Interview with David Autor\” in The Region, published by the Federal Reserve Bank of Minneapolis (September 7, 2016). The subheading give a sense of the scope of the conversation: \”MIT economist on tech, trade & job markets, how Chinese imports affect U.S. politics & family structure, and the Janus-faced gig economy.\” The interview is a lively and interesting read throughout, but here is a sampling of the comments that caught my eye.
On using Commuting Zones (CZs) to look at local employment effects of rising Chinese exports:
\”The U.S. Department of Agriculture developed the CZ [commuting zone] concept. Basically, they are contiguous counties where most of the people live and work within the same county cluster and where the centroid of the county is commutable from the edges of the CZs. It was [David] Dorn who discovered them in his doctoral thesis work, in the sense that they were out there, but no one outside the Department of Agriculture had used them for economic research. Following Dorn’s lead, we started using them because we thought they had a lot of attractive properties—they’re a sort of “revealed preference” measure of local labor markets. They cover the entire mainland United States, and their boundaries can be drawn consistently over time (unlike metropolitan statistical areas, which are regularly redefined as populations shift). Now a lot of scholars are using them, which is great. …
The basic idea is simple: We see China’s share of U.S. manufacturing goods consumption rising rapidly in the 1990s and even more so in the 2000s. Is this due to changes in China’s competitive position—lower prices, higher quality—or is it due to shifts in U.S. consumer tastes or even due to declines in U.S. production capacity … To make progress, we studied China’s exports to eight other high-income countries simultaneously in each of 392 goods categories (covering all of manufacturing). Our idea was that if Chinese exports to the United States are driven in part by falling costs and rising quality, then Chinese import penetration in other rich countries in precisely these same goods categories should rise in parallel. And this hypothesis is strongly confirmed by the data. The bivariate correlation between the rise in China’s market penetration at the product level in the United States and these eight other countries ranges from 0.55 to 0.96.
For our analysis of the impact of the China shock on U.S. labor markets, we use only the component of rising China—U.S. import penetration that is shared with these other countries—that is, we use the component that we can confidently attribute to China’s improved competitive position.
We take these predicted changes in import penetration into the United States by goods category, and then we project that down to these commuting zones, looking at the geographic structure of U.S. manufacturing employment. Manufacturing is always very geographically concentrated. When you’re talking about furniture, for example, you’re talking about Tennessee or the Carolinas; you’re not talking about 50 states making furniture. The same is true if you’re talking about toys or leather goods or textiles—they’re very localized.
So that was the strategy; we thought it was a good idea, and we didn’t have a strong prior about what we would find. We thought we would find contraction of import-competing manufacturing employment, and we did. That was not surprising, but what happens after that was an unknown.
We were quite startled by how slow and incomplete the adjustment process was and the fact that you didn’t see offsetting gains in employment in other sectors. You see people entering unemployment or exiting the labor force, and wages falling modestly, but much adjustment was on the employment margin, not the earnings margin.
That is another thing that differentiated what we were doing. Historically, trade economists have relied upon full employment models, where people may lose jobs but they don’t lose work per se because they are quickly reallocated across sectors. According to such models, you should expect markets to clear by wages falling. But, in fact, what tends to happen is that people lose employment, and wages don’t really change for those who stay in employment.
Similarly, if we were in full general equilibrium all the time, the commuting zone would be irrelevant as an outcome measure because markets would clear nationally. The local shock is geographically dissipated because there’s effectively a law of one price of skill. And if that law did not hold in the very short run, workers would move to areas with higher wages until wages were again equalized. But it turns out that not only are the trade shocks locally concentrated—due to the concentrated geography of manufacturing—they also primarily play out locally. Much of the pain of adjustment is borne at the point of impact. … At the level of commuting zones, looking at workers initially in the impacted industry, you just don’t see the kind of diffusion or reallocation that general equilibrium models suggest. It’s not that it doesn’t happen eventually, but it happens slowly and painfully.
How the polarization of Congress spread to polarization of the public
\”What’s really fascinating—something we were not aware of—is that while the polarization of Congress has been going on for 30 years, basically since Ronald Reagan took office, the polarization of the U.S. electorate is much more recent. It’s really just been in the last 10 years.
By “polarization,” I mean the clustering of beliefs along party lines. So, for example, it’s increasingly the case that your view on global warming is highly predictive of your view on Mexicans, is highly predictive of your view on how high or low taxes should be and whether people should have a right to open-carry weapons.
Those beliefs didn’t used to be as correlated. So people have more strongly held, more divergent views. They have much more negative views of the other party as well. There is rising disapproval of cross-party marriage: The idea that you would be upset if your kid married someone of the other party has risen. Pew has documented this phenomenon. This has coincided with the rise of the Tea Party, and it’s most pronounced after 2006.
We’re seeing this same phenomenon in the data that we’re using to look at the trade exposure. We don’t want to say that all political polarization is due to trade exposure; I’m sure it’s not. But the localized adverse economic impact of the China shock in the 2000s does appear to be a kind of unnoticed contributor. In fact, you can see the antecedents of the current divisive presidential race playing out in the House in the 2000s—and specifically, in the locations where manufacturing was most hard hit.
On the longer-term relationship between technology and jobs
\”It’s a very natural thing to think that if computers do more work, people do less work. But I think the answer is much more nuanced—and, of course, economists have recognized these nuances for centuries.
Computerization changes what type of work people do—that’s very clear; we see the occupational change going on. But the part that people miss is that displacement of a set of tasks or even entire job categories does not augur the end of work. In the last 200 years, technology has totally changed the work that we do. Most of the jobs we have didn’t really exist in any significant number 200 years ago. As a result, work is much better. It’s more interesting, it’s more productive, it’s safer and more rewarding.
My optimism on this topic comes in part from the fact that we’ve already gone through incredibly dramatic adjustments and have been largely made enormously better off for it. It’s not just because we’ve increased aggregate wealth, but more of us work in paid jobs now than 100 years ago. At the turn of the 20th century, most women worked in grueling unpaid employment in the household. Now the majority work in better jobs, for pay, in the formal labor market.
We’ve adjusted to the displacement of human labor by automation along at least three margins. One is that we’ve just created many new and interesting things to do. Think about software development or tourism or all kinds of travel and food and restaurants. We do all kinds of creative and interesting things we didn’t do before.
Two, more of us work, but we work fewer hours. People don’t work until the day they die. They work 40- and 50-hour weeks instead of 80-hour weeks. They work five days a week instead of seven. They take vacations. So they’ve spread the work in a way that’s constructive and leads to a better quality of life.
And the other thing, of course, is that as we get wealthier, our consumption demands rise, so we create a lot of work because we choose to consume rather than just taking it all in leisure. If a worker in 2015 wanted to have a 1915 level of income, he or she could work about 17 weeks a year. But most of us choose not to. We’d rather have a bigger house and a couple of cars and whatever else.
Full disclosure: Autor was the Editor of the Journal of Economic Perspectives from 2009-2014, and thus was my boss for six years.
In the most basic model of supply and demand, the buying and selling takes place at a moment in time. But in the real world, what is bought and sold often takes place in the context of an ongoing relationship. A company signs a long-term contract with a supplier. A bank makes a loan that will be repaid over some years. Workers at some firms and executives at many firms do their jobs expecting that if the firm makes higher profits, they will receive a bonus. Sales people at many firms expect to be paid according to how much revenue they generate. Some organizations operate on an up-or-out principle, where a time comes when you are either promoted or asked to leave. When a market exchange takes place over an extended period of time, a contractual relationship is at work. Sometimes the contract is mostly explicit, and sometimes large parts of it are implicit (or are part of a broader legal framework). But understanding contracts–both what goals they seek to achieve and how they can go wrong–is fundamental to understanding markets.
Just to be clear, the economic analysis of contracts are not an arithmetic problem with a clear cut answer. Amidst the complexities of the real world, there is no all-purpose perfect contract. But researchers like Hart and Holmström can still make considerable progress by spelling out the issues and identifying the key tradeoffs. For example, here is the Nobel committee on some of Holmström\’s insights about pay-for-performance contracts. As you read it, you may wish to consider how it differs from that is actually observed in contracts for top executives at many firms.
\”A central result, published separately and independently by Bengt Holmström and Steven Shavell in 1979, is that an optimal contract should link payment to all outcomes that can potentially provide information about actions that have been taken. This informativeness principle does not merely say that payments should depend on outcomes that can be affected by agents. For example, suppose the agent is a manager whose actions influence her own firm’s share price, but not share prices of other firms. Does that mean that the manager’s pay should depend only on her firm’s share price? The answer is no. Since share prices reflect other factors in the economy – outside the manager’s control – simply linking compensation to the firm’s share price will reward the manager for good luck and punish her for bad luck. It is better to link the manager’s pay to her firm’s share price relative to those of other, similar firms (such as those in the same industry).
\”A related result is that the harder it is to observe the manager’s effort – perhaps due to many distorting factors blurring the relationship between her effort and the company’s performance – the less the manager’s pay should be based on performance. In industries with high risk, payment should thus be relatively more biased towards a fixed salary, while in more stable environments it should be more biased towards a performance measure.\”
Related problems arise in jobs that involve a high degree of multi-tasking. With many interlocking tasks, trying to create an explicit pay-for-performance is very difficult, and it may be better to have an overall performance evaluation which leads to promotions or raises over time. Another issue arises with jobs that involve a high degree of teamwork. As the Nobel committee writes: \”Team work also modifies the original pay-for-performance framework. If performance reflects the joint efforts of a group of individuals, some members may be tempted to shirk, free-riding on the efforts of their workmates. Holmström addressed this issue in an article from 1982, showing that when the firm’s entire income is divided among team members (as in a worker-owned firm), effort will generally be too low.\”
The award to Hart focused on a different set of contracting issues, in the area of what are called \”imcomplete contracts.\” The issue here is that in a number of settings, it is impossible to anticipate all of the possible issues that might arise. For example, imagine a city that hires a contractor to build a bridge. The contractor submits a bid. But what if there are dramatic changes in the price of materials, or bad weather, or a quality problem with a subcontractor, or a flu epidemic that knocks out half the workforce, or an unexpected environmental review that leads to delays, or any number of other issues? When it is essentially impossible to write a contract covering all eventualities, the other option is to write a contract that specifies who will get to make the decisions when an unseen eventuality arises. Here is discussion from the Nobel committee with a sampling of some implications:
\”The main idea is that a contract that cannot explicitly specify what the parties should do in future eventualities, must instead specify who has the right to decide what to do when the parties cannot agree. The party with this decision right will have more bargaining power, and will be able to get a better deal once output has materialised. In turn, this will strengthen incentives for the party with more decision rights to take certain decisions, such as investing, while weakening incentives for the party with fewer decision rights. In complex contracting situations, allocating decision rights therefore becomes an alternative to paying for performance.
\”In several studies, Hart – along with different co-authors, such as Sanford Grossman and John Moore – analysed how to allocate the ownership of physical assets, for example whether they should be owned by a single firm, or separately by different firms. Suppose a new invention requires the use of a particular machine and a distribution channel. Who should own the machine and who should own the distribution channel – the inventor, the machine operator, or the distributor? If innovation is the activity for which it is most difficult to design a contract, which seems realistic, the answer could be that the innovator should own all the assets in one company, even though she may lack production and distribution expertise. As the innovator is the party that has to make greater non-contractible investments, she also has greater need of the future bargaining chip that property rights bring to the assets. …
\”Another application of Hart’s theory of incomplete contracts concerns the division between the private and public sectors. Should providers of public services, such as schools, hospitals, and prisons, be privately-owned or not? According to the theory, this depends on the nature of non-contractible investments. Suppose a manager who runs a welfare-service facility can make two types of investment: some improve quality, while others reduce cost at the expense of quality. Additionally, suppose that such investments are difficult to specify in a contract. If the government owns the facility and employs a manager to run it, the manager will have little incentive to provide either type of investment, since the government cannot credibly promise to reward these efforts. If a private contractor provides the service, incentives for investing in both quality and cost reduction are stronger. A 1997 article by Hart, together with Andrei Shleifer and Robert Vishny, showed that incentives for cost reduction are typically too strong. The desirability of privatisation therefore depends on the trade-off between cost reduction and quality. In their article, Hart and his co-authors were particularly concerned about private prisons. Federal authorities in the United States are in fact ending the use of private prisons, partly because – according to a recently released U.S. Department of Justice report – conditions in privately-run prisons are worse than those in publicly-run prisons.\”
\”Contract theory\” is one of those terms that may sound irredeemably theoretical and academic. But when thinking about the benefits and tradeoffs of contracts in a wide array of different situations–workers, innovation, production, finance, even government constitutional arrangements–you soon notice that this is a branch of economic theory which is applying analytical precision and rigor to gain insights into the messy real-world issues of day-to-day economic and political life.
As the pedants among us never tire of pointing out, the so-called \”Nobel Prize in economics\” is not literally a \”Nobel prize.\” It was not established by the original bequest from Alfred Nobel, but instead was first given in 1969, with the prize money provided by a grant from Sweden\’s central bank as part of the 300th anniversary of the founding of the bank. Thus, the award is officially \”The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel.\” (Justin Fox gives a nice brief overview of the history here.) Although I am pedantic in many matters, this doesn\’t happen to be one of them, so I will continue following the conventional usage in calling it the \”Nobel prize in economics.\”
Your Majesty, Your Royal Highnesses, Ladies and Gentlemen,
Now that the Nobel Memorial Prize for economic science has been created, one can only be profoundly grateful for having been selected as one of its joint recipients, and the economists certainly have every reason for being grateful to the Swedish Riksbank for regarding their subject as worthy of this high honour.
Yet I must confess that if I had been consulted whether to establish a Nobel Prize in economics, I should have decidedly advised against it.
One reason was that I feared that such a prize, as I believe is true of the activities of some of the great scientific foundations, would tend to accentuate the swings of scientific fashion. This apprehension the selection committee has brilliantly refuted by awarding the prize to one whose views are as unfashionable as mine are.
I do not yet feel equally reassured concerning my second cause of apprehension. It is that the Nobel Prize confers on an individual an authority which in economics no man ought to possess.
This does not matter in the natural sciences. Here the influence exercised by an individual is chiefly an influence on his fellow experts; and they will soon cut him down to size if he exceeds his competence.
But the influence of the economist that mainly matters is an influence over laymen: politicians, journalists, civil servants and the public generally. There is no reason why a man who has made a distinctive contribution to economic science should be omnicompetent on all problems of society – as the press tends to treat him till in the end he may himself be persuaded to believe. One is even made to feel it a public duty to pronounce on problems to which one may not have devoted special attention.
I am not sure that it is desirable to strengthen the influence of a few individual economists by such a ceremonial and eye-catching recognition of achievements, perhaps of the distant past.
I am therefore almost inclined to suggest that you require from your laureates an oath of humility, a sort of hippocratic oath, never to exceed in public pronouncements the limits of their competence.
Or you ought at least, on confering the prize, remind the recipient of the sage counsel of one of the great men in our subject, Alfred Marshall, who wrote: \”Students of social science, must fear popular approval: Evil is with them when all men speak well of them\”.
Hayek is quoting from an comment from Marshall which appears in \”In Memoriam: Alfred Marshall,\” a speech given by A.C. Pigou in 1924 and published as part of a Memorials of Alfred Marshall volume in 1925 (pp. 81-90). The fuller quotation attributed to Marshall (on p. 89) is:
Students of social science, must fear popular approval: Evil is with them when all men speak well of them. If there is any set of opinions by the advocacy of which a newspaper can increase its sales, then the student who wishes to leave the world in general and his country in particular better than it would have been if he had not been born, is bound to dwell on the limitations and defects and errors, if any, in that set of opinions: and never to advocate them unconditionally even in ad hoc discussion. It is almost impossible for a student to be a true patriot and to have the reputation of being one in his own time.
