Monday, November 29, 2010

More on Sectoral Reallocation and Labor Markets

DeLong, Krugman, and Thoma, were recently fuming about this op-ed in the LA Times. The relevant quote is this:
The day before his party's shellacking in this month's elections, President Obama sat down with his economic team to examine the single most important issue for voters across the country: jobs.

But the question on the agenda was not how to accelerate the recovery or target job creation to the depressed Rust Belt. It wasn't even the challenge of how to persuade corporations to spend their cash piles on investments and jobs — although both have been extensively debated for many months. The president had called the meeting to grapple with what he and his propeller-head economists have been debating for some time: the wonkish question of whether today's high unemployment rate is structural or cyclical.

Such questions are no doubt vital to shaping economic and trade policies as well as the general worldview of the West Wing. But on the eve of an electoral disaster, the esoteric discussion in the Oval Office points to a larger challenge facing the Obama White House as it tries to stage its own revival.
If you thought that DeLong/Krugman/Thoma are upset about the abuse of propeller-headed wonks, you would be wrong. Apparently, the problem has to do with the fact that Obama and his economists would deign to mull over "structural" unemployment.

According to Thoma:
The administration is still allowing the other side to take control of policy debates.

DeLong stays in character by going nuclear:
Let me point out that I think that the senior Obama advisor quoted is a liar.

Krugman comments here and here. Here's a quote:
More generally, I can’t think of any Democratic-leaning economists who think the problem is largely structural.

Yet someone who has Obama’s ear must think otherwise.

No wonder we’re in such trouble. Obama must gravitate instinctively to people who give him bad economic advice, and who almost surely don’t share the values he was elected to promote. That’s what I’d call a structural problem.

This is all very interesting. DeLong/Krugman/Thoma are confused, and on several dimensions. I've discussed sectoral reallocation before here, and in other posts, and I think it is important for our current predicament. Here are the key issues:

1. Unemployment is unemployment. Attempts at organizing our thinking using such concepts as "structural unemployment," "cyclical unemployment," "the natural rate of unemployment," etc., is unproductive. These terms have no precise meaning, and therefore cannot be measured. We do, however, know what unemployment is, i.e. the number of people who answer "no" to a particular question put to them by the BLS surveyor (roughly: are you employed?) and answer "yes" to another question (roughly: are you actively searching for work?). Unemployment is a particular activity - search - which involves choices. How much effort should I allocate to searching for work? When should I stop searching and exit the labor force? If I receive a job offer, should I accept it, or continue searching? Economists who put themselves in the shoes of the unemployed came up with models that helped us understand unemployment and its determinants. Those models are search models, and economists think so much of search models that we gave Nobel prizes to three smart guys who worked on them. The Mortensen-Pissarides search model has become a workhorse in dynamic macroeconomics for studying problems in labor/macro.

2. Labor market behavior in the US during the recession and up to the current time has been anomalous. Lee Ohanian does a nice job of describing some of the key anomalies here (though I am not much into his views on financial factors and on the effects of recent policies). In particular, relative to the average post-WWII recession in the US, and relative to what occurred in other developed countries during this recession, the fall in employment has been very large relative to GDP, and very persistent. Ohanian does not discuss this, but as I point out here, the drop in residential construction is also extremely large and persistent. The housing sector, which was at the center of the financial crisis and the recession, can also be the center of a sectoral reallocation story about the recession. The housing slump was certainly not uniform across regions in the country, and residential construction is notably low-skill-intensive. Both of these features make the frictions associated with sectoral reallocation particularly important currently.

3. Buying the idea that sectoral reallocation is important does not mean that I throw out the idea that government intervention can be productive, nor does it mean that I must be a Republican. Here's what Krugman says:
As far as I can tell, the only economists who believe that we’re suffering largely from a rise in structural unemployment are those who are ideologically committed to the view that the demand side of the economy doesn’t matter — and so by definition, in their universe, any large rise in unemployment must be structural.

But you have to ask, why do these people have a voice in the Obama administration?
Well, baloney. I take it as encouraging that people in the Obama administration are actually struggling to understand what is going on in the US labor market. I know people in the Federal Reserve System who are doing the same thing, and they should be commended for it.

Now, it's clear we need some better models. The Mortensen-Pissarides (MP) model I mentioned above is useful on certain dimensions, but it has little to say about sectoral reallocation and its role in this or any other business cycle episode. The idea behind search theory is that heterogeneity on both sides of the labor market creates a friction that makes finding the right job (or finding the right worker) time consuming. MP embeds that friction in the matching function. Taking the matching-function approach avoids what is most interesting, and key to the problem. What we need is a multi-sectoral model with heterogeneous labor and firms, but of course building such a model would be difficult (otherwise someone would have already done it).

However, suppose we had such a model. What might it tell us? There may be a particular role or roles for the government that we have never contemplated. Maybe, if applied to our current predicament, such a model would tell us that we need a much more generous unemployment insurance program, or that we should have government subsidies for relocation. Who knows? In any event, the proper reaction to the current state of the world is not to shut off the parts of our brains that might want to think about sectoral reallocation.


  1. You argue that the spike in unemployment has been particularly great with respect to the fall in GDP due to the recession.

    However, that does not mean that the main cause for unemployment has been sectoral reallocation. Is there any evidence out there that sectoral reallocation may be a significant factor in current unemployment levels?

  2. Yes, that's what I discuss here:

  3. in the shoes of the unemployed came up with models that helped us understand unemployment and its determinants. Those models are search models, and economists think so much of search models that we gave Nobel prizes to three smart guys who worked on them. The Mortensen-Pissarides search model has become a workhorse in dynamic macroeconomics for studying problems in labor/macro.

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