The role of the introduction of a five day working week in Japan’s Lost Decade
13 Jan 2015 2 Comments
in business cycles, economic growth, economic history, labour economics, labour supply, macroeconomics, monetarism Tags: Japan, Japanese banking system, Lost Decade
When I lived in Japan between 1995 and 1997, they are undergoing the transition from a six-day week to a five day week. At the time, workers at my University had to show up on Saturday morning. They then went home at lunchtime. Saturday morning at the office was phased out a few years later.
In explanations of the Lost Decade of growth in Japan dating from the early 1990s, with the exception of Ed Prescott, the explanation that the Japanese simply chose to produce less per worker over the course of the 1990s does not figure highly.
The Japanese working week was reduced by law from 48 to 44 hours per week in 1988 and further reduced by the same labour standards law to 40 hours per week from 1993 (Prescott 1999; Hayashi and Prescott 2002). The Japanese stopped routinely working on Saturdays over the 1990s. The number of national holidays was increased by three and an extra day of annual leave was also prescribed by law.
Figure 1 shows this regulatory change about the length of the standard working week that started in 1987 was followed by a sharp drop in hours worked per working per working age Japanese over the period 1988 to 1993. The Japanese working age population is defined as those aged 20 to 69 (Hayashi and Prescott 2002).
Figure 1: Weekly hours worked per Japanese aged 20 to 69, 1970-2000
Source: Hayashi and Prescott 2002.
The regulatory process to end the standard six day working week in Japan straddled the start of the Lost Decade. This major change in the regulation of the supply of labour per week in the number of hours worked and the stagnation of GDP growth soon after could be more than a coincidence (Prescott 1999; Hayashi and Prescott 2002).
Americans work more hours a year than workers in Japan. But both work less than before. Data: buff.ly/1LhU5gH http://t.co/7oaGYKLRmk—
HumanProgress.org (@humanprogress) August 18, 2015
More employment did not fill the short-fall in weekly labour supply per worker after the introduction of the 44 hour week and then the 40 hour week in Japan. Many offices and factories closed on Saturday rather than employ more to make up the hours. The regulatory change was a clear cut constraint on the length of the working week that was hard to get around because of the need to recruit a separate set of workers to come in on Saturday afternoon and then all day Saturday.
During the transition to a five day working week, Japanese real GDP growth should slow down because output levels must taper during a transitional period because one day per week less in labour is supplied in production and capital is being worked for one day a week less than before (Prescott 1999; Hayashi and Prescott 2002).
Output per working age person depends on capital-labour ratios, on hours worked per week and on changes in total factor productivity due to factors such as technological progress and changes in institutions and economic policies.
The effects of the change in the length of the working week on output per working age Japanese will persist for a significant time because investment plans and the capital stock must also adjust to a shorter working week. This is another example of a highly persistent shock that can partly account for the Lost Decade. As Prescott (1999) observed:
Given the change in Japanese law and the resulting drop in normal market hours, growth theory predicts the almost stagnant output of the Japanese economy in the 1990s. This reduction in market hours lowered the marginal product of capital, making investment unprofitable.
Given the lack of profitable domestic investment opportunities, the Japanese began saving by investing abroad. This explains Japan’s large trade surpluses
…The Japanese economy in the 1990s is not as depressed as the U.S. economy was in the 1930s. Market hours in Japan in the 1990s have fallen only half as much as market hours fell in the United States during the Great Depression.
More importantly, the reduction in market hours in Japan in the 1990s was the stated objective of policy.
The reduction in weekly hours worked will also reduce the working week of capital because labour and capital are usually complementary inputs. The reduced length of the working week will see some existing capital producing less, some capital will go spare, and the rate of wear and depreciation will fall.
The drop in weekly hours worked will lower the marginal productivity of existing and new capital which will make new capital investments in Japan less profitable than before. Net investment will be less while the Japanese capital stock is adjusting down to the reduced working week for capital and labour.
Measured total factor productivity will fall because of an under-utilisation of a capital stock that is now larger than required for the available labour force. Net investment will decline by a large amount because investment demand is a small yearly addition to the capital stock.
For example, if annual investment demand is 5 per cent of the capital stock, and the desired capital stock becomes 1 per cent smaller than previous, annual net investment will fall 20 per cent. GDP growth will resume at the trend rate once the lower level of output per working age person is reached.
For those that still doubt, consider the contrary, what would you expect to happen in your country moved from five day week before day working week? Do you expect workers to produce as much as before? Britain was on a three day working week during the coal miners’ strike. As expected, output fell because the working week was shorter.
The main gap in the English language literature about the reduction in the working week in Japan is a lack of publications I can find by Japanese economists discussing what predictions of a made about the likely consequences for output, investment and productivity before the reduction in the length of working week was legislated. Did the reduction in the length of the working week in Japan turn out as planned and predicted before it was implemented?
France introduced a 35 hour week some years ago. Although there were various options for over time, albeit strictly regulated, a uniform prediction was that the 35 hour week would reduce productivity. The new workweek was phased in slowly, with large firms adopting it in February 2000 and smaller firms doing so only in January 2002.
French employees were expected to bear only a small part of the cost of the working-time reduction, continuing to earn roughly the same monthly income – in line with the unions’ slogan ’35 hours pays. To ease that transition, the law reduced the overtime premium for small firms and increased their annual limit on overtime work compared with large firms.
The reduction in the length of the French working week failed as work sharing strategy and reduced productivity. This was a fair summary by the IMF:
The 35-hour workweek appears to have had a mainly negative impact. It failed to create more jobs and generated a significant—and mostly negative—reaction both from companies and workers as they tried to neutralize the law’s effect on hours of work and monthly wages.
While it cannot be ruled out that individuals who did not change their behaviour because of the law became more satisfied with their work hours, simple survey measures do not show increased satisfaction.
Between 1997 and 2000, Quebec reduced its standard workweek from 44 to 40 hours to stimulate jobs growth – the old work sharing ideal. The Quebec policy contained no suggestion or requirement that employers provide wage increases to compensate workers for lost hours.
Despite a 20% reduction among full-time workers in weekly hours worked beyond 40, the policy failed to raise employment at the provincial level or within industries. If anything, there were job losses.
Japan was the only case where a reduction in the length of the working week met with wide approval by the public and people simply stopped working on Saturdays. The law succeeded simply because it did but it was designed to do: reduce the number of days existing workers worked. Japan was undergoing mild deflation at the time, so the need to reduce wages was minimal.
Annual hours worked per employed Japanese has continued to slowly taper down since the late 1990s, which may be a further explanation of its continual slow growth.
David Andolfatto wrote a nice paper explaining the consequences for the financial and monetary sectors of this reduction in the length of the Japanese working week:
- a steady decline in bank lending;
- the money multiplier declines;
- nominal interest rates that are close to zero; and
- massive infusions of liquidity by the Bank of Japan that seem to have no effect at all.
In his analysis, David Andolfatto referred generally to a productivity slowdown as discussed by Prescott rather than to the specifically to the reduction in the length of the Japanese working week. Nothing detracts in his analysis, as Andolfatto said, that Japan has a problem: lagging productivity growth and as Andolfatto concluded:
…monetary and fiscal policies, or reforms directed exclusively at the banking sector, are unlikely to re-establish productivity growth. What is likely needed are economy-wide reforms that enhance the willingness and ability of individuals to adopt potentially disruptive technological advancements and work practices.
Real business cycles, the declining clarity of information and learning by waiting
22 Dec 2014 Leave a comment
in business cycles, entrepreneurship, job search and matching, macroeconomics Tags: real business cycles
Willems and van Wijnbergen (2013) identified reduced clarity in information about business cycle fluctuations as a factor that is the lengthening the lag in the response of employment to output changes in recent US recessions.
Willems and van Wijnbergen (2013) – ungated – found that the trough in employment in the 1991 and 2001 recessions was much later than the troughs for earlier US recessions.
- There was a stronger immediate reduction in employment in pre-1990 US recessions and a faster recovery, so the 1991 and 2001 recessions were initially job-preserving – the rate at which workers were laid off was less than in prior recessions.
- Employment in the 1991 and 2001 recessions continued to fall for another year after the trough in output.
- The job-preserving recessions in 1991 and 2001 were then followed by this delayed recovery in employment growth.
- There is a lengthening labour adjustment lag that slows the loss of jobs at the start of recessions and delays the renewal of recruitment at the end of recessions.
Willems and van Wijnbergen (2013) attributed this combination of job-preserving recessions and delayed employment recoveries in 1991 and 2001 to the interaction of rising labour adjustment costs and a reduction in the clarity of entrepreneurial information about the business cycle.
The rising labour adjustment costs arose from the capital losses to employers of laying off employees who are increasingly rich in firm-specific human capital. The risks of laying off and investing precipitously have increased in recent decades because output growth subsequent to the great moderation in real output growth volatility is less predictable.
The US economy experienced a 50% reduction in volatility for many leading macroeconomic variables as well as low inflation since the early to mid-1980s. Similar declines in the real volatility and inflation rates occurred at about the same time in other industrial countries.
Prior to the mid-1980s, US real output growth was more variable, but this variation was more predictable. Frequent recessions were soon followed by recoveries. Since the early to mid-1980s in the US, major variations in real GDP growth have come increasingly as genuine surprises – 1983–2007 was one long boom punctuated by two mild recessions in 1991 and 2001.
The delay in the official dating of the peaks and troughs in business cycles in the US has increased from an average of 7½ months before 1990 to about 15 months in the post-1990 period (Willems and van Wijnbergen 2013).
With recessions more of a surprise – and the scope and depth of the panic of 2008 is an example of such a surprise in New Zealand and abroad – the value of waiting for better market information has increased.
Less certain information makes it more profitable than before for entrepreneurs to invest in waiting before laying off increasingly human capital-rich employees, making new investments and undertaking fresh recruitment. The impact of the business cycle on employment will be more muted.
Modern recessions can be initially job-preserving – layoffs are postponed for longer because the rising cost of laying off experienced labour is higher and because of the increased value of waiting to see. Recoveries in employment can be more sluggish as investors wait to be sure about the latest trends. These employers can use the employees they hoarded in larger numbers in the downswing to fill orders in the early days of the upswing in business:
We have presented evidence that the lag with which labour input reacts to structural economic shocks went up in the 1980s, thereby bringing jobless recoveries and recessions that were relatively job preserving to the US economy.
Using a real option model, this lagged response is shown to be optimal in a setting where labour input is costly to adjust and where employers are uncertain about the persistence of shocks that drive the business cycle
The role of news in real business cycles
18 Dec 2014 Leave a comment
in business cycles, economic growth, entrepreneurship, job search and matching, macroeconomics Tags: real business cycles
Revisions in investor beliefs about productivity prospects can partly account for business expansions and contractions. If favourable news about future technological opportunities can seed a boom today in consumption and investment before the actual technological improvement arrives and is realised, news that future productivity growth may not be as good as was previously expected can induce a recession without any actual change in productivity ever occurring.
Investors build in anticipation, starting new projects and recruiting more staff. Their forecasts can turn out to be too optimistic. When entrepreneurial expectations of future productivity are revised, investment demand can fall because of an excess in capital accumulation – recent investments were made under more optimistic beliefs about productivity (Beaudry and Portier 2004).
Investment demand must be muted for a time until the excess capital accumulation is brought into use, refitted or scraped. There also will be layoffs and a lull in recruitment. Job search strategies must also change as job seekers redirect their careers in light of the news about their revised prospects in different firms, industries and competing occupations.
The optimism and pessimism of investors are rational profit-seeking responses to new entrepreneurial knowledge. Profit expectations reflect consumer preferences, resource constraints and technological factors as they exist and are forecast to change and actual and forecasted opportunities and constraints in the investment sector. Entrepreneurs are dynamic risk takers who profit from anticipating shifts in consumer demand, input costs and technology.
Recessions and booms can arise due to the challenges facing entrepreneurs in forecasting the uncertain and ever-changing future demand for new capital that is implied by their forecasts of consumer demand and technological opportunities as Beaudry and Portier (2004) explain:
The view that recession and booms may arise as the result of investment swings generated by agents’ difficulties to properly forecast the economy’s need in terms of capital has a long tradition in economics.
For example, this difficulty was seen by Pigou as being an inherent feature of any economy with technological progress.
As emphasized in Pigou (1926), when agents are optimistic about the future and decide to build up capital in expectation of future demand then, in the case where their expectations are not met, there will be a period of retrenched investment which is likely to cause a recession.
Revisions in entrepreneurial beliefs and investment plans can be required when new information is uncovered (Beaudry and Portier 2004; Sill 2009). There can be lulls in investment demand following these revisions to entrepreneurial forecasts leading to recessions. As Pigou noted in 1927:
The varying expectations of business men … constitute the immediate cause and direct causes or antecedents of industrial fluctuations
Interview with Robert Lucas on the global financial crisis and the great recession
17 Dec 2014 Leave a comment
in budget deficits, business cycles, economic growth, fiscal policy, global financial crisis (GFC), great depression, great recession, macroeconomics, monetarism, monetary economics Tags: bank runs, GFC, great depression, great recession, Robert E. Lucas
Real business cycles and learning the value of major technological changes
17 Dec 2014 Leave a comment
in business cycles, entrepreneurship, macroeconomics, technological progress Tags: boom and bust, general purpose technologies, real business cycles
The true value of any technological improvement is uncertain. Investors adopt a new technology after forecasting the likely productivity of the new technology. Investor learning in the face of imperfect information about the true value of major new technologies can also lead to business cycle fluctuations (Li 2007).
As a new technology slowly diffuses, entrepreneurs learn more about the true potential of the new technology and re-evaluate in hindsight whether they have invested beyond the optimal amount. If entrepreneurs have not over-invested, they revise their beliefs about the magnitude of the innovation and invest more.
Because the agents have to learn the magnitude of the technology shock, they are cautious in making investment decisions before they have learned much about the underlying technology. Consequently, GDP growth is gradual, which stretches out the length of booms.
When entrepreneurs later find that investment has over-shot the optimal amount, they reduce investment demand perhaps sharply and start a recession (Li 2007). This eventuality may seed a recession within many major technology advances such as the IT boom in the 1990s and the computer revolution in the 1970s.
The true value of the major technological improvement is often discovered only after investment over-shoots the optimal level (Li 2007). A general technological innovation affecting many industries is required for the cluster of entrepreneurial errors about the true magnitude of the productivity increase to seed a recession (Li 2007).
The 2001 US recession followed a long boom involving major new information and communication technologies that raised the productivity of many existing technologies. The information, communications and software boom lasted over a decade in the US (Li 2007).
Entrepreneurs invested gradually in new information and communication capital to learn more about the underlying technologies that they embodied. These new information and communication technologies were productivity improvements of a major but uncertain scope (Li 2007).
The eventual productivity gains come from two complex sources – both from adopting the new technology itself and from its interface with existing capital and expertise. Because both productivity gains must be forecasted and because both are discovered only by experimentation and learning by doing, it is entirely possible that entrepreneurs can invest ahead of consumer demand.
This surplus capacity will emerge despite the best efforts of investors to mitigate this risk by staggering investments to learn more about the true value of the new technology. This investor caution and staggering to allow for more learning is an important factor that stretches out the length of investment booms in major new technologies (Li 2007).
There was a sharp decline in US investment in 2001, with large accumulations of unused capital in some sectors. For example, 90% of the optical fibre laid in the US in the 1990s was unused in the years that followed. Entrepreneurs discovered the optimum investment level in, for example, optical cable fibre by investing past it and revised plans for further investments in light of this over-shooting (Li 2007).
Real business cycles of a significant magnitude can emerge simply from technological learning.
Li (2007) argued that many investment booms start with the advent of a revolutionary technology and ended with overinvestment. For example, canal building boomed after the invention of the steamboat, and by the year 1860 more than 4,000 miles of canal had been completed. However, many of these canals did not live up to the expectations of their promoters. Many of these projects eventually turned out to be financial failures.
Later in the same century, the railroad expansion shared a similar fate. Thousands of miles of railroad were built and left unused or under used, a phenomenon described by Schumpeter (1949) as construction “ahead of demand.”
That real business cycle theory required technological regress for there to be recessions is one of its oldest criticisms. That criticism that standard equilibrium business cycle models have difficulties in predicting the investment boom and overshooting grows weaker by the day.
Li presents a strong internal propagation mechanism with respect to technology shocks and endogenous recessions without invoking technological regress:
…firms invest in new capital to take advantage of the IT revolution, without knowing the limit to which this new technology can increase productivity.
The belief of this limit becomes increasingly optimistic over time as investors repeatedly realize that they have not invested enough to exhaust the potential of the new technology. Such belief revisions lead to increasingly aggressive investment and a capital overhang, followed by a recession.
What is labour hoarding?
16 Dec 2014 Leave a comment
in business cycles, labour economics, macroeconomics, unemployment Tags: business cycles, labour hoarding
The fall and rebound in employment growth usually lags a few quarters behind the fall and later recovery in output growth in any recession because of labour hoarding. Hamermesh (1993) defined labour hoarding as
a less than proportionate decrease in worker hours in response to a negative demand shock
Firms may hoard or retain under-utilised employees despite falls in demand because of demand uncertainty.
Becker (1975) and Oi (1962) both refer to the fixed costs of employment as an incentive to retain experienced workers with firm-specific human capital during lulls in demand.
The fixed costs of employment are the costs of recruiting and training workers. These fixed costs meant that the demand for labour does not adjust instantly to changes in demand for the firm’s product:
The cyclical behaviour of labour markets reveals a number of puzzling features for which there are no truly satisfying explanations . . .
I believe that the major impediment to rational explanations for these findings lies in the classical treatment of labour as a purely variable factor (Oi 1962).
Hirings and layoffs are costly. Hiring costs include advertising vacancies, the time spent finding and screening applicants and training. Layoff costs include redundancy payments, legal procedures and, importantly, the capital loss of losing access to experienced employees with firm-specific training and then later having to train their replacements.
To reduce these current and capital costs early in recessions, employers will first adjust hours worked and rely on natural attrition of staff to defer laying off their more experienced employees. Only once these options have been exhausted, and demand for the firm’s product is still slack, the capital loss of laying off a worker may become necessary.
Labour hoarding is a speculative investment based on forecasts of demand. The decline in product demand must be seen as short. There will be more layoffs if the recession is expected to be deep or long.
If there is a quick recovery, unnecessary layoffs and the cost of training replacements are both avoided.
Entrepreneurship and sectoral mismatches in labour supply and labour demand
15 Dec 2014 1 Comment
in business cycles, entrepreneurship, job search and matching, macroeconomics Tags: business cycles, Fischer black, mismatch unemployment, sectoral unemployment
An important factor behind business fluctuations arises not from the balance between aggregate output and aggregate consumption, but from the accuracy of entrepreneurial matching of the individual patterns of output with the pattern of actual consumer demand in individual sectors (Black 1987, 1995).
Fluctuations in the match between resource deployment to different sectors and product demand across sectors can create major fluctuations in output and employment because moving resources from one sector into another is costly and time consuming.
What consumers will want and what can be produced in the future is uncertain. A plethora of sectors produce highly differentiated products with increasingly specialised inputs to serve consumers. Modern economic growth is built on ever greater product differentiation, ever greater product variety and ever increasing product quality produced by ever more specialised workers, firms and sectors. This explosion in specialisation is increasing the vulnerability of the business cycle to technology and taste shocks (Black 1987, 1995; Mehrling 2005).
Mismatches in the sectoral pattern of installed production capacity with actual consumer demand will arise because investments are driven by entrepreneurial forecasts of what will be wanted by consumers in the future. The capacity to produce output requires prior investments based on speculations about future consumer tastes, resource availabilities and technology progress. Part of the volatility in output and employment growth is from these investments depending on the uncertain details of the future.
Entrepreneurial errors in forecasting consumer wants will lead to inevitable mismatches of the production capacity with unfolding consumer demand. If future consumer tastes and upcoming technologies were better known now, employment would grow and be reallocated more smoothly to new uses than otherwise (Black 1987, 1995; Mehrling 2005).
When the match between forecasted and realised demand is good, there is a boom. Resources are where consumers want them. When the match is poorer, there is a recession. If events unfold in a markedly unanticipated direction, existing plans, investments and contracts require revision (Black 1987, 1995).
The existing matches between consumer desires, resource allocations by sector and production technologies can deteriorate. While a reallocation occurs, resources are diverted from production and are scrapped or are unemployed while searching for new uses (Black 1987, 1995).
Fixing a deteriorating match requires the structure of production to shift more into line with the structure of consumer demand. This takes time and consumes resources because human and other capital is highly specialised. It takes time for the new investments consistent with the latest entrepreneurial forecasts of consumer demand to be planned, built and start producing (Black 1987, 1995).
What can appear to be cyclical unemployment comes from alternations between periods of above and below average accuracy on entrepreneurial forecasting and better and worse matches in actual consumer demand and actual capacity to supply at the sector level (Black 1987, 1995; Mehrling 2005).
This type of cyclical unemployment is not a product of monetary, fiscal or other policy shocks. Resources need to be reallocated into a better alignment with consumer tastes and technological and resource possibilities. Preventing these sectoral reallocations will keep resources from moving from lower to higher value uses.
After longer booms, more human capital is more specialised to specific sectors, firms and jobs. This increased specialisation that helped underpin the prior economic boom can slow the recovery of employment at the end of the recession.
Job seekers will take longer to find good new job matches if they have more distinct backgrounds and specialised human capital. Job seekers have an incentive to search for longer to find these higher-paid job matches.
Employers will take longer to fill vacancies. The applicant pool is more diverse because of the high degree of specialisation of labour that is a legacy of the long prior boom. This accumulation of specific human capital over the course of longer booms will mean the length of the burden will affect the depth of the subsequent recession.More highly specialised workers have to be re-matched with new occupations and new sectors. More workers than usual will be putting off the day of having to face up to scrapping a significant part of their old human capital.
Was the 1990s in the USA a boom period or business as usual?
15 Dec 2014 Leave a comment
Source: Edward Prescott
Sector specific technology and demand shocks and the business cycle
14 Dec 2014 Leave a comment
in business cycles, job search and matching, macroeconomics Tags: natural rate of unemployment, real business cycle, sectoral shocks
New technologies unfold daily, and consumer tastes change with rising incomes and the arrival of new products. Jobs will open in the expanding industries and disappear in the shrinking sectors.
A quarter or more of unemployment rate fluctuations over the business cycle could be due to variations in the rate that labour demand shifts across sectors. These sectoral reallocations in labour demand do not arise from mismatches between entrepreneurial forecasts and actual consumer demand.
The higher unemployment rate is not due to a bunching of technological upgrades in a recession. The above average number of sectoral shifts in labour demand is an independent cause of a temporarily higher natural rate of unemployment.
Lilien (1982) suggested that the amount of labour reallocation can change over time. Some periods may be marked by relatively homogeneous growth in labour demand across sectors, whereas others may be characterized by shifts in the composition of labour demand.
Lilien (1982) provided empirical estimates of the variation in the equilibrium unemployment rate from sectoral reallocation. He concluded that the wide unemployment fluctuations in the 1970s were largely induced by unusual structural shifts in the U.S. economy, which caused the equilibrium unemployment rate to fluctuate by about 3 percentage points over the decade!
An important factor behind business fluctuations arises not from the balance between aggregate output and aggregate consumption, but from the accuracy of entrepreneurial matching of the individual patterns of output with the pattern of actual consumer demand in individual sectors (Black 1987, 1995).
Fluctuations in the match between resource deployment to different sectors and product demand across sectors can create major fluctuations in output and employment because moving resources from one sector into another is costly and time consuming.
To a significant extent, observed fluctuations in the unemployment rate can be fluctuations in the natural rate of unemployment rather than deviations from that natural rate due, for example, to aggregate demand shocks. There will always be some unemployment. There will be new labour force entrants looking for jobs and workers who are between jobs.
The natural rate of unemployment is a long-run level of unemployment that cannot be altered by monetary policy. The natural rate of unemployment depends on the flexibility of wage contracts and labour market institutions, variations in labour demand and supply in individual markets, demographic change, the mobility of workers, unemployment benefits, the cost of gathering information about vacancies and available labour, labour market regulation and random variations in the rate of reallocation of jobs across industries and regions as technology advances and consumer tastes change.
Sectoral shifts in labour demand has a randomness about them because the size, pace and diffusion of technological advances across firms and industries is uneven (Andolfatto and MacDonald 1998, 2004).
The implications of technological progress for jobs has a further randomness because new technologies can displace existing jobs and create new jobs or renovate and update current equipment and employee skills (Mortensen and Pissarides 1998).
As a new technology diffuses, productivity will grow faster in the sectors that are adopting the new technology. During this implementation phase, which is slow, costly and may require considerable learning, there will be reorganisations to capitalise on the impending productivity gains. New technologies differ in the size of the improvement over existing methods and designs and in the difficulty of adopting the new methods. There will be lower growth in years where new technologies offer comparatively minor or less broadly applicable improvements on existing methods. Learning consumes resources, and attempts to learn a new technology through innovation or imitation diverts the resources of firms and workers away from production (Andolfatto and MacDonald 1998, 2004).
This unevenness in the pace and sectoral diffusion of technological progress will introduce unevenness in the rate of labour reallocation across sectors.
With both growing and shrinking sectors, employment may stagnate or fall for a time because the unemployed are searching for new jobs in different industries and perhaps in new occupations or are retraining.
A revival in growth in output and productivity in conjunction with initially poor employment growth is possible and has the attributes of a delayed recovery in employment (Andolfatto and MacDonald 2004).
Cross-sector job searches and the redirection of careers is a longer process than job search in the same industries and occupations. Job migration is more time consuming than the more traditional process of layoffs and rehiring by the same employer or in the same industry and occupation.
During periods of more intensive or above-average sectoral reallocation of labour demand, a mismatch can arise between the skills and experience of the workers who have exited the shrinking sectors and the immediate requirements of the expanding sectors. More workers than average can be moving into new sectors. Some of these job seekers may not be immediately viable candidates for the available jobs and may exert little downward pressure on wages.
There can be mismatch unemployment because the skills and locations of job seekers can be poorly matched with the locations of vacancies. Some local labour markets will have more workers than jobs. Others will have shortages. Job finding can depend on the rate at which the unemployed can retrain or move to locations with unfilled jobs, the rate at which jobs open in different locations and the rate at which workers vacate jobs in places with ready replacements (Shimer 2007).
Cyclical unemployment is a reversible response to lulls in aggregate demand. At the start of a recession, there is a general decline in demand, with few industries creating jobs to replace those that are lost.
As a recession ends, the unemployed are recalled by old employers or find new jobs in those industries as demand renews. Monetary and fiscal policy can aim to smooth these temporary job losses.
Job losses from structural changes in employment and technology are permanent. The sectoral location of jobs has changed. Workers must switch to new industries, sectors and locations or learn new skills.
A role for public policy is to facilitate this process of reallocation to new jobs and retraining.
Critics of the sectoral shifts approach point to the inherent difficulties of distinguishing between sectoral and cyclical movements in unemployment, due to cross-industry differences in sensitivity to aggregate fluctuations.
Does inequality lead to a financial crisis? | VOX, CEPR’s Policy Portal
13 Dec 2014 Leave a comment
in business cycles, economic growth, global financial crisis (GFC), great recession, macroeconomics Tags: GFC, top 1%
Figure 1. Change in loans versus changes in top 1% income shares, 14 countries, 1972–2008
via Does inequality lead to a financial crisis? | VOX, CEPR’s Policy Portal.
Recessions as reorganisations
12 Dec 2014 Leave a comment
in business cycles, F.A. Hayek, history of economic thought, job search and matching, macroeconomics, Robert E. Lucas, unemployment Tags: FA Hayek, recessions, recoveries, Robert Lucas
Most models of the shape of recoveries draw on a learning process. A long tradition in business cycle theory holds that limited knowledge of relative price changes can temporarily disrupt labour demand and supply because of errors in wage and price perceptions (Alchian 1969; Sargent 2007; Hellwig 2008).
Pricing, investment and production plans are made on the basis of incomplete and conflicting knowledge of constantly changing aggregate, industry and local conditions. Firms and workers will over- or under-supply when they misperceive wages and prices.
With imprecise information, it takes time for employers and workers to sort out temporary from permanent shifts in demand and supply, inflation-driven changes from real changes in prices and input costs, and general changes from the local changes that may be more important to particular firms. As Hayek explained in his Nobel prize lecture:
The true, though untestable, explanation of extensive unemployment ascribes it to a discrepancy between the distribution of labour (and the other factors of production) between industries (and localities) and the distribution of demand among their products.
This discrepancy is caused by a distortion of the system of relative prices and wages. And it can be corrected only by a change in these relations, that is, by the establishment in each sector of the economy of those prices and wages at which supply will equal demand.
Recoveries are shaped by the speed of entrepreneurial learning about the new labour and product market conditions, the relative cost of adjusting capital and labour rapidly or slowly and the costs and benefits of labour market search. This new learning is necessary because the old constellation of prices and wages is no longer valid.
It was a misdirection of resources brought about by the initial inflationary firm, as Hayek explained in a visit to Australia in 1950:
During a process of expansion the direction of demand is to some extent necessarily different from what it will be after expansion has stopped.
Labour will be attracted to the particular occupations on which the extra expenditure is made in the first instance.
So long as expansion lasts, demand there will always run a step ahead of the consequential rises in demand elsewhere.
And in so far as this temporary stimulus to demand in particular sectors leads to a movement of labour, it may well become the cause of unemployment as soon as the expansion comes to an end…
If the real cause of unemployment is that the distribution of labour does not correspond with the distribution of demand, the only way to create stable conditions of high employment which is not dependent on continued inflation (or physical controls), is to bring about a distribution of labour which matches the manner in which a stable money income will be spent.
This depends of course not only on whether during the process of adaptation the distribution of demand is approximately what it will remain, but ‘also on whether conditions in general are conducive to easy and rapid movements of labour.
In a recession, employers and workers do not immediately know that demand has fallen elsewhere as well as in their own local markets and recognise the need to adjust to their poorer prospects everywhere, and it is not known how long the drop in demand will last (Alchian and Allen 1973).
The cost of learning about available opportunities restricts the speed of a recovery. Workers and entrepreneurs must gather information on the new state of demand and the location and nature of new opportunities. This information is costly and is quickly made obsolete by further changes, and the cost of acquiring information is more costly the faster the information is sought to be acquired (Alchian 1969; Alchian and Allen 1967).
The process of recovering from a recession would be a faster process if the new constellation of wages and prices that are the best alternative uses of resources was known immediately and was credible to firms and workers (Alchian and Allen 1973).
Workers and employers must first have sufficient time to discover what new knowledge they now need to know to serve their interests well, leave enough room for the unforeseeable and keep their knowledge fresh in ever-changing markets.
New wage levels must be created by workers and employers testing and retesting in the labour market the new relative scarcities of labour. Imbalances between the allocation of labour supply and demand to different firms and sectors and the new level and pattern of consumer demand are gradually remedied by changes in relative prices and wages, layoffs, business closures and job search.
Prices are a signal wrapped in an incentive. Growing demand induces higher employment and rising wages. Wages stagnate, and there are layoffs where there is an excess supply.
These changes give the unemployed an incentive to move to new uses and entrepreneurs to profitably hire the unemployed. The ensuing reorganisations are time-consuming and information-intensive because a job seeker and an employer with an apt vacancy take time to find each other.
Prices and wages must change sufficiently for firms to profitably create new jobs. New jobs require time to plan and build new job capital. This is the human, physical and organisational capital underlying a new job. There are also job creation costs when reopening existing positions that were mothballed during the downturn.
How is this to be done? Hayek explained again in 1950 in his speech in Australia:
Full employment policies as at present practised attempt the quick and easy way of giving men employment where they happen to be, while the real problem is to bring about a distribution of labour which makes continuous high employment without artificial stimulus possible.
What this distribution is we can never know beforehand. The only way to find out is to let the unhampered market act under conditions which will bring about a stable equilibrium between demand and supply.
Utopia, you are standing in it! 
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