Category Archives: Economics

Size doesn’t matter; age does

John Haltiwanger, Ron S. Jarmin, and Javier Miranda, “Who Creates Jobs? Small versus Large versus Young”, The Review of Economics and Statistics, May 2013, Vol. 95, No. 2, Pages 347-361.


The view that small businesses create the most jobs remains appealing to policymakers and small business advocates. Using data from the Census Bureau’s Business Dynamics Statistics and Longitudinal Business Database, we explore the many issues at the core of this ongoing debate. We find that the relationship between firm size and employment growth is sensitive to these issues. However, our main finding is that once we control for firm age, there is no systematic relationship between firm size and growth. Our findings highlight the important role of business start-ups and young businesses in U.S. job creation.

The entire article is here.

Technology vs. economy in a nutshell

Paul Krugman continues to ponder the impact of technology on income distribution.  The takeaway, in my opinion, is here:

Smart machines may make higher GDP possible, but also reduce the demand for people — including smart people. So we could be looking at a society that grows ever richer, but in which all the gains in wealth accrue to whoever owns the robots.

A troubling prospect indeed…

I was wondering about this for a long time…

…and, apparently, so did Paul Krugman:

Robots mean that labor costs don’t matter much, so you might as well locate in advanced countries with large markets and good infrastructure (which may soon not include us, but that’s another issue). On the other hand, it’s not good news for workers!

This is an old concern in economics; it’s “capital-biased technological change”, which tends to shift the distribution of income away from workers to the owners of capital.

Twenty years ago, when I was writing about globalization and inequality, capital bias didn’t look like a big issue; the major changes in income distribution had been among workers (when you include hedge fund managers and CEOs among the workers), rather than between labor and capital. So the academic literature focused almost exclusively on “skill bias”, supposedly explaining the rising college premium.

But the college premium hasn’t risen for a while. What has happened, on the other hand, is a notable shift in income away from labor:

If this is the wave of the future, it makes nonsense of just about all the conventional wisdom on reducing inequality. Better education won’t do much to reduce inequality if the big rewards simply go to those with the most assets. Creating an “opportunity society”, or whatever it is the likes of Paul Ryan etc. are selling this week, won’t do much if the most important asset you can have in life is, well, lots of assets inherited from your parents. And so on.

I think our eyes have been averted from the capital/labor dimension of inequality, for several reasons. It didn’t seem crucial back in the 1990s, and not enough people (me included!) have looked up to notice that things have changed. It has echoes of old-fashioned Marxism — which shouldn’t be a reason to ignore facts, but too often is. And it has really uncomfortable implications.

But I think we’d better start paying attention to those implications.

Indeed.  And the case for some sort of redistributionist policy is getting stronger…

Growth and income

Paul Krugman writes:

Apologists for rising inequality often argue that since most Americans’ income has risen despite rising inequality, there’s no reason to complain about inequality other than envy. So it’s worth remembering that we used to expect economic growth to deliver large increases in real income, not just a bit of a rise that’s accomplished in large part through longer working hours; and that a major reason so many have seen such small gains is that a large part of growth has been siphoned off to the very high end.

Lane Kenworthy had a nice chart illustrating both points, comparing median family income with real GDP per family (for those worried about the fine points, it was nominal GDP divided by the CPI, avoiding some technical issues):

You see the contrast: a doubling of family incomes in the post war generation compared with maybe 20 percent since, and family incomes growing in line with GDP before, lagging far behind since, with the difference basically being the rising share of the 1 percent.

This is real stuff, not some trivial envy-driven concern. But we must be very, very quiet about it, right?

[Doing my best imitation of Hugh Grant] Riiiiight…

Paul Krugman on British debt history

Paul Krugman writes:

I’ve been playing around with the IMF’s historical public debt database, which has long-term information on ratios of debt to GDP. And you really have to marvel, given that historical record, at the deficit panic now so widespread. Here’s debt as a percentage of GDP in Britain, back to 1830:

UK debt since 1830

That uptick at the end — you’ll see it if you squint — is what’s driving the Cameron government’s insistence on slashing spending in a liquidity trap.

It’s also interesting to note — contrary to what you often hear — that at the time Keynes was writing, and calling for fiscal stimulus, Britain was substantially deeper in debt than Britain or the United States are now.

Brad DeLong on central banking

Link to the original.

The ECB’s Battle against Central Banking

BERKELEY – When the European Central Bank announced its program of government-bond purchases, it let financial markets know that it thoroughly disliked the idea, was not fully committed to it, and would reverse the policy as soon as it could. Indeed, the ECB proclaimed its belief that the stabilization of government-bond prices brought about by such purchases would be only temporary.

It is difficult to think of a more self-defeating way to implement a bond-purchase program. By making it clear from the outset that it did not trust its own policy, the ECB practically guaranteed its failure. If it so evidently lacked confidence in the very bonds that it was buying, why should investors feel any differently?

The ECB continues to believe that financial stability is not part of its core business. As its outgoing president, Jean-Claude Trichet, put it, the ECB has “only one needle on [its] compass, and that is inflation.” The ECB’s refusal to be a lender of last resort forced the creation of a surrogate institution, the European Financial Stability Mechanism. But everyone in the financial markets knows that the EFSF has insufficient firepower to undertake that task – and that it has an unworkable governance structure to boot.

Perhaps the most astonishing thing about the ECB’s monochromatic price-stability mission and utter disregard for financial stability – much less for the welfare of the workers and businesses that make up the economy – is its radical departure from the central-banking tradition. Modern central banking got its start in the collapse of the British canal boom of the early 1820’s. During the financial crisis and recession of 1825-1826, a central bank – the Bank of England – intervened in the interest of financial stability as the irrational exuberance of the boom turned into the remorseful pessimism of the bust.

In his book Lombard Street, Walter Bagehot quoted Jeremiah Harman, the governor of the Bank of England in the 1825-1826 crisis:

“We lent…by every possible means and in modes we had never adopted before; we took in stock on security, we purchased exchequer bills, we made advances on exchequer bills, we not only discounted outright, but we made advances on the deposit of bills of exchange to an immense amount, in short, by every possible means consistent with the safety of the Bank, and we were not on some cases over-nice. Seeing the dreadful state in which the public were, we rendered every assistance in our power…”

The Bank of England’s charter did not give it the legal authority to undertake such lender-of-last-resort financial-stability operations. But the Bank undertook them anyway.

Half a generation later, Britain’s Parliament debated whether the modifications of the Bank’s charter should give it explicit power to conduct lender-of-last-resort operations. The answer was no: granting explicit power would undermine confidence in price stability, for already there was “difficulty restrain[ing] over-issue, depreciation, and fraud.” Indeed, granting explicit lender-of-last-resort powers to the Bank of England would mean that the “millennium of the paper-mongers would be at hand.”

But the leaders of Parliament also believed that the absence of a codified authority to act as lender of last resort would not keep the Bank of England from doing so when necessity commanded. As First Lord of the Treasury Sir Robert Peel wrote: “If it be necessary to assume a grave responsibility, I dare say men will be willing to assume such a responsibility.”

Our current political and economic institutions rest upon the wager that a decentralized market provides a better social-planning, coordination, and capital-allocation mechanism than any other that we have yet been able to devise. But, since the dawn of the Industrial Revolution, part of that system has been a central financial authority that preserves trust that contracts will be fulfilled and promises kept. Time and again, the lender-of-last-resort role has been an indispensable part of that function.

That is what the ECB is now throwing away.

Paul Krugman on the Lucas project

Link to the original.

Lucas In Context (Wonkish)

I thought it might be helpful to think of Lucas now in terms of the history of economic thought. By the way, I basically lived through the story I’m about to tell, so this is more or less first-hand.

So, here’s the history of macro in brief.

1. In the beginning was Keynesian economics, which was ad hoc in the sense that on some important issues it relied on observed stylized facts rather than trying to deduce everything from first principles. Notably, it just assumed that nominal wages are sticky, because they evidently are.

2. In the 1960s a number of economists started trying to provide “microfoundations”, deriving wage and price stickiness from some kind of maximizing behavior. This early work had a big payoff: the Friedman/Phelps prediction that sustained inflation would get “built in”, and that the historical tradeoff between inflation and unemployment would vanish.

3. In the 1970s, Lucas and disciples take it up a notch, arguing that we should assume rational expectations: people make the best predictions possible given the available information. But in that case, how can we explain the observed stickiness of wages and prices? Lucas argued for a “signal processing” approach, in which individuals can’t immediately distinguish between changes in their wage or price relative to others — changes to which they should respond by altering supply — and overall changes in the price level.

4. In the 1980s, the Lucas project failed — pure and simple. It became obvious that recessions last too long, and there are too many sources of information, for rational confusion to explain business cycles. Nice try, with a lot of clever modeling, but it just didn’t work.

5. One response to the failure of the Lucas project was the rise of New Keynesian economics. This basically went back to ad hoc assumptions about wages and prices, with a bit of hand-waving about menu costs and bounded rationality. The difference from old Keynesian economics was the effort to use as much maximizing logic as possible to interpret spending decisions. I find NK economics useful, if only as a way to check my logic, although it’s not really clear if it’s any better than old-fashioned Keynesianism.

6. The other response, by those who had already invested vast effort and their careers in the Lucas project, was to drop the whole original purpose of the project, which was to explain why demand shocks matter. They turned instead to real business cycle models, which asserted that the ups and downs of the economy are caused by technological shocks magnified by rational labor supply responses. Full disclosure: this has always seemed absurd to me; as many have pointed out, the idea that the unemployed during a recession are voluntarily choosing to take time off is something only a professor could believe. But the math was impressive, and RBC became a self-contained, self-replicating intellectual world.

7. The Lesser Depression arrives. It’s clearly not a technological shock; clearly, also, nobody is confused about whether we’re in a slump, as the old Lucas model required.

In fact, it looks a lot like what Keynes described, and old-Keynesian models work very well, thank you, both at explaining it and in making predictions about such things as interest rates and the effects of fiscal austerity. But the descendants of the Lucas project know that Keynes was wrong — it’s what their teachers and their teachers’ teachers have been saying all these years. They cannot accept anything resembling a Keynesian explanation without devaluing everything they’ve done with their intellectual lives.

So it must be Obama’s fault!

So the jobs really didn’t go to China…

On several occasions, I wrote about manufacturing jobs going to machines rather than to China.  Just another piece of evidence on that.

Paul Krugman recently did something interesting; he used industrial production data and capacity utilization data to obtain an estimate of U.S. industrial capacity.  Here’s the result:

Note the rapid capacity build-up during 1990s, as America was supposedly losing its manufacturing base…

Paul Krugman on old and new Keynesianism

Link to the original.

How Much Hoc to Add? (Wonkish and Methodological)

Mark Thoma objects to Tyler Cowen’s attempt to pigeonhole some of us as “Old New Keynesians”, and makes the case for flexibility in use of models. Indeed. But there’s something more systematic to the macro story – something that very much informs my work. Namely, “old Keynesian” and “new Keynesian” models represent two intelligent but imperfect responses to the problem of thinking about an economy in which people must make future-oriented decisions. Neither is fully convincing, but there are no better alternatives at this point. So what I do, and I hope others do as well, is to think about policy issues both ways, and try to “bracket” things in a way that leads to reasonably secure conclusions.

Like a lot of macro, this goes back to John Hicks. In his classic Value and Capital (1939, but he had much of the work done when he invented IS-LM), he laid out the basics of general equilibrium analysis – that is, thinking about how all market interrelate, instead of thinking about each one in isolation – but realized that he had a problem when key decisions in markets depended on expectations about the future. One way out is to assume Arrow-Debreu markets in which contracts can be signed now governing all possible future states of the world; never mind.

What Hicks proposed was an ad hoc solution (“temporary equilibrium”): let’s just assume that people expect future prices to be the same as current prices (“static expectations”). This lets you collapse the dynamic problem into a sort of quasi-static analysis of the short run.

And in particular, Hicks suggested thinking in terms of a three-good economy, in which the three goods were money, bonds, and physical output. When you do that and add temporary price stickiness, you get IS-LM.

Now, you can add a bit more flexibility by making assumptions about expectations more complicated in ways that seem more realistic – adaptive expectations, regressive expectations, etc.. In international macro, for examples, the Mundell-Fleming model – which is just IS-LM with borders – gets more convincing if you assume that investors expect exchange rates to revert to some kind of normal level. But it’s basically about squeezing dynamic issues into something that looks like a static framework.

And that’s not a criticism! IS-LM is in fact a deeply sophisticated framework, as evidenced by the number of economists who dismiss this crude stuff, then stumble ludicrously over even very simple issues.

But can’t we do better? The only workable alternative to temporary equilibrium at this point is rational expectations – assuming that what people expect about the future is what your model says they should expect. When you do that, and again add some realistic temporary price stickiness, you get New Keynesian macro, which is in a way more intellectually satisfying that old Keynesianism.

The trouble with New Keynesian macro is that it goes too far the other way – people aren’t that rational, or if you prefer, in the real world nobody knows what the right model is, so rational expectations breaks down as a concept. Also, NK models are much harder to work with; compare Obstfeld-Rogoff with Mundell-Fleming, and you’re going from simple diagrams to 60-plus-equation derivations.

So what’s an economist to do? Well, what I do is use both. Typically, I work things out first in terms of IS-LM, but then try to write down a stripped-down NK model with similar results; if I can’t make that work, it’s time for some hard thinking about where the difference lies. And sometimes this leads to insights that I don’t think would have come from either approach alone, like the crucial role of monetary credibility in making a liquidity trap possible.

The point is always to realize that the map is not the territory, but also to realize that IS-LM is a pretty good map, and that you can often fill in the gaps with a fancier—but not better, just different – NK model.