Austrians and Lazear & Speltzer on Structural Unemployment

Steven Horwitz

I had reason today to re-read this post of Peter Lewin's from September on the Lazear and Speltzer stuff denying that we have a structural unemployment problem.  Peter seemed somewhat befuddled by their argument and I think he's groping toward an Austrian response.  In re-reading it, I think I perhaps have a better one.  This is off the top of my head, but I share it below for reaction.  This was taken from an email I sent to a non-Austrian, which explains some of the rhetoric.

 

I think the language of “structural” unemployment is often unhelpful when Austrian types are in the conversation.  The idea of skills not matching needs presumes that we know what those needs are and know that workers don’t have the skills to meet them.  For Austrians, the problem is deeper.  We had an artificial boom for the better part of a decade (longer perhaps) that created all kinds of distortions in the capital structure, and those in turn made certain kinds of labor more valuable, and that, in turn, led to a (long run) distorted pattern of investments in human capital. 

The problem now is that we don’t know where that capital and labor should be allocated and only market discovery processes can figure it out.  As we continue, during the recovery, to make it difficult to engage in that reallocation (or “recalculation” as Arnold Kling has termed it), we may or may not be “getting it right.”  The fact that labor is coming back to the very industries that it was engaged in during the boom is, to the Austrians, not a sign of a lack of a “structural” problem, but rather evidence that such a problem is continuing. 

In other words, as Austrians insist, the long-run structural problem is created in the boom itself.  Those are the errors, but they are masked over for a while by the excess of credit, which allows them to persist.  When the boom ends, the errors are clear and it takes time to clean them out and figure out what we should do next.  The only way out of this is to let markets work to sort it all out and discover where labor and capital should be.  It’s highly unlikely that pattern would look like the distorted structure of the boom.

The problem is that we can’t know what the “needs” are and to assume they are the same as during the boom is to take the boom period as “correct,” which is exactly what the Austrians deny.

Comments

[geoffrey lea]

Yes.

[Russ Nelson]

I see your boom and bust and raise you by animal spirits. Since animal spirits trumps everything, I win!

[Xerographica]

I created a Wikipedia entry for heterogeneous activity...

http://en.wikipedia.org/wiki/Heterogeneous_activity

...it's just a stub...but a stub is better than nothing! So have at it!

[Ron Ronson]

I have seen critics of ABCT pointing to the period following the end of WW2 as an example of a time where major changes to the structure of production were needed but there was no recession and the required adjustments were made painlessly.

Is there a good Austrian response to these critics ?

[Allan Walstad]

Ron Ronson: FDR was gone, and with him his disastrous anti-market depredations. It's the Keynesians who have the problem with post-WWII history: federal spending dropped, soldiers came home to look for work, and yet there was no depression.

[Ron Ronson]

I'm sure Keynsians would only have to say that "animal spirits" were high at that time and they would be off the hook.

But serious question: Is there a fundamental difference between the kind of restructuring needed between war and peace and the kind needed after a few years of a low-interest-rate fueled boom that means that the latter always means a recession but the former may not ?

[Daniel Kuehn]

Allan -
I don't get it.

Traditional ABCT models about unemployment as a result of readjustment don't have an FDR boogeyman in them (although people have obviously added that boogeyman). So how is the absence of FDR an answer to the question Ron posed?

I've never heard of a Keynesianism that says that you need government spending for full employment, so I've never been clear on what the problem with the post-WWII economy was supposed to be.

[RPLong]

I agree with the thrust of what I think Horwitz is getting at here, but I think the concept of "structural unemployment" is extremely useful to Austrians in general. I feel that the term does a great job of illustrating Austrian key messages pertaining to general disequilibrium, and for that reason it is a term well worth keeping.

That said, I think Horwitz is probably right that in a discussion about business cycles and widespread unemployment, it is probably best to steer clear of "structural unemployment" as a key explanation, for exactly the reasons Horwitz mentioned.

But, take my uneducated, unacademic perspective for what it is. :)

[Sherry]

This is the same argument that has been made time and time again. I see no reason to believe that this time it will be taken seriously by anyone not already sympathetic to the Austrian perspective.

[Bill Woolsey]

A monetary disequilibrium approach, including Market Monetarism, would start with the notion that if spending on output has fallen relative to trend, it should all increase in proportion.

Spending is too low. All of it should be higher.

Now, it could be that the composition of output resulting from this proportional increase in spending is less than optimal. What that means is that too little of some things are being produced and too much of other things are being produced.

I think we can trust the private sector to reallocate spending. Spend more on the things they want more of and less on the things they want less of. This is consistent with spending remaining on trend.

It is possible that the resources currently used to produce goods that people want less of cannot be immediately used to produce the goods they want more of. This is a "structural" problem. When labor is the resource involved, it is possible (and likely) the result will be structural unemployment. Workers are laid off in industries where there is less demand, and they are not appropriate for industries where there is more demand.

Austrians do a better job than most in pointing out that capital goods are the same. We will have excess capacity in industries with less demand, and only gradually is it possible to construct appropriate capital goods for industries with greater demand.

Kling's new economic theory of "standing around waiting and thinking about what to do," is not traditional Austrian economics. It doesn't apply well to a world of scarcity.

It may be helpful ideologically to those who beleive that the best response to a drop in spending on output is to do nothing. Spending and output will recover when people figure out what to do.

In my view, this view is not only inconsistent with scarcity, it is also inconsistent with basic monetary economics.

If people quit producing because they don't know what to do, the result in shortages of those goods that people like best, which could be all sorts of "second best" choices.

Only if you have a monetary regime where shortages of money constrain production do you end up with less output and people standing about waiting to do things.

Consider what would happen if all wages and prices were perfectly flexible. Then prices and wages fall, the real value of money (fiat currency, gold stocks, or whatever) rises, and real expenditures rise as people spend off part of the growing real balances. Now, it may not be possible to produce the things they want more, so those prices fall less. And the prices of the things people want less fall more. There is no standing around thinking of what to do. Prices and wages fall enough so people are willing to buy (out of growing real money balances) the existing goods that they like best. That there might be some other good that they would like even better doesn't prevent markets from clearing.

Now, because wages fall more (in response to unemployment) and prices of those things whose production cannot be expanded because of bottlenecks fall less (while those things people don't want as much fall more,) real wages drop. If people decide they don't want to work because real wages are lower, then employment falls. That is the waiting around phenomenon.

The notion that the demand for money (or base money) has risen, so therefor we just need to wait around until those holding additional base money balances choose to spend them, because the problem is that they don't know what to do--is contrary to basic monetary theory.

[Allan Walstad]

Daniel--the problem for Keynesians post-WWII is the "demand shortfall" that you referred to on another thread. Government spending drops. Why no depression? This is exactly what mainstream economists are warning about now, that we can't let the government get smaller because we'll have a recession.

What's the difference from an Austrian perspective? When the Fed's Keystone-Cop tinkering with interest rates distorts the information available to market participants, it results in a distortion of the structure of production that is not at all easy to sort out, precisely because of the information problem. When the manipulations stop, it must take time for the price structure to revise itself and translate into the necessary reallocation of labor and resources. When consumer production has been stunted in a major war, the broad outlines of reallocation are much more transparent. You know for example that you wil have to convert factories from making tanks and bombers to making cars and trucks, which takes a lot of labor and can be done right away. You already have a blueprint. To first approximation, you can use all your information from before. Consider that the Soviet economy did in fact grow considerably at first, and was able to struggle along for many years, on the basis of simply copying what was done, and relying on the price structure, in market economies. That's quite a different situation from when you have a market economy up and running and fully integrated through market prices, and then it becomes subject to an insidious distortion of the very information that accomplishes the integration.

[Daniel Kuehn]

Allan -
By the mid-1940s demand had been suppressed during the war despite full employment. Advances in mortgage lending reduced credit constraints and all sorts of capital investments were ready to be made after years of delay for the war effort. Monetary policy had improved considerably and there were no issues with financial markets or the stability of international markets that might raise balance sheet concerns.

Exactly what shortage of demand do you have in mind? Even in the early years of the war it was quite clear from all indicators that government was crowding out private investment and consumption.

Where is this idea that without the government demand would be insufficient coming from, Allan?

[Ron Ronson]

Daniel/Allan,

I'm trying to take an impartial view here.

The problem for the Keynsian view appears to be that a large part of AD was made up G, which fell sharply in 1945 but somehow AD quickly recovered with no additional G needed to help it along. I'm not really sure that poses too much of a threat to the Keynesian model. If one assumes that the propensity to consume and to invest was high after the war (as Daniel claims) then a drop in G would not lead to drop in Y beyond the short-term.

I am still struggling with the Austrian model though. I can see that the artificially low IRs will distort relative prices as described in ABCT and cause the structure of production to become sub-optimal. I struggle however to understand why this leads to a long recession when interest rates return to their natural levels. Market forces , even starting from a position of severe disequilibrium, should surely sort things out quite quickly - at least in terms of returning to full employment. It looks to me like it is secondary factors (such as severely depressed AD) that occur when the boom comes to an end that maintain the recession not the disequilibrium or the bust itself.

I suppose it may be that Austrian would say that market forces would indeed quickly fix things but in the bust (as much as in the boom) govt interventions of various sorts prevents those forces from working. They may then say that the post-WW2 experience demonstrates those market forces at work in an environment where G (and govt activity generally) are suddenly reduced.

BTW: I am not really convinced by Allan's statement

"When consumer production has been stunted in a major war, the broad outlines of reallocation are much more transparent. You know for example that you wil have to convert factories from making tanks and bombers to making cars and trucks, which takes a lot of labor and can be done right away"

Why is direct govt intervention in the allocation of resources less harmful to the structure of production than the same thing done via IR manipulation ?

[Daniel Kuehn]

Ron -
I think Allan has the right response to extended recessions. If the reallocation is not allowed to occur it won't occur. I don't think it's the best model for cases like the Depression or today, but it's definitely a coherent model. And it's been made by a lot of Austrians - most prominently Rothbard. So it's not something that was just thought up for this crisis.

Where I think Allan is less convincing in responding to you is the post-WWII case. FDR wasn't around post-WWII. So? There should still be a recession from the reallocation, right? There was certainly lots of "artificial" demand and credit during the war that produced an unsustainable capital structure. Who cares about FDR? Even in the basic Austrian model without these regime-uncertainty-recession-extenders that should still produce a recession. Why didn't it?

I don't think Allan has adequately answered you on that. I don't have an answer. I think it is a mark against ABCT.

ABCT does much better - IMO - as a theory of "capital over the business cycle". It does not really offer much as a proper business cycle theory. I don't seem to be alone in that last assessment especially.

[Daniel Kuehn]

See Young's recent RAE paper on that last point. ABCT really does quite well predicting the behavior of the capital structure. But we have better theories of economic downturns available (Young would of course agree with my first statement but not my second).

[Ron Ronson]

I agree that the Austrian model of time preference and interest rates shaping the structure of production is very elegant.

I think ABCT is correct in as much as it describes how manipulating the money supply can distort interest rates and hence the structure of production. Its not hard to imagine how this carried on over years or decades is likely to have serious consequences for the economy.

Where, in my view, Austrian theory is weak is that it downplays or ignores the effect of effective demand on output and employment levels and sees everything as structural. This is a concern when , as for example now, much of the empirical evidence seems to show that it is weak effective demand that trumps any structural effects as "causes" of the current recession.

[Allan Walstad]

'"When consumer production has been stunted in a major war, the broad outlines of reallocation are much more transparent. You know for example that you will have to convert factories from making tanks and bombers to making cars and trucks, which takes a lot of labor and can be done right away"'

"Why is direct govt intervention in the allocation of resources less harmful to the structure of production than the same thing done via IR manipulation ? "

Ron, I just gave an answer in the very passage you quoted, not with regard to direct government intervention generally, but with regard to what happened in WWII. If the government has required that factories switch from cars to tanks, then when the war is over it is completely obvious what to do, namely, switch back. You have the blueprint from before, so you can get up and running. When the Fed monkeys with interest rates in an integrated market economy, it distorts the very information that would be needed to restore an effective structure of production. There's a difference between the two cases in terms of information needed and available for allocating labor and resources to start back on track.

Daniel, the purported need for government to "make up" for insufficient demand comes from Keynes. I think you're well aware of that. As Ron pointed out, when government spending dropped sharply at the end of the war, there was no depression, quite the contrary to what Keynesians have to expect. And by the way, for what it's worth, when the structure of production has been distorted as we have now, the necessary allocation of resources to the job of straightening it out requires some abstinence from consumption, i.e., additional SAVING, not the artificial stimulation of still more immediate consumption.

[Ron Ronson]

Ok, I see your point - I had missed that you were saying they could revert back to their old uses.

But wouldn't that be only true in some cases ? Wouldn't their be other situations where whole new lines of production have been created using homogenous types of capital that were dedicated to specific war-uses all of which would have been useless when the war ended ? How would these differ from mal-investments that had to be liquidated ?

[Allan Walstad]

Ron, I think there's generally a clear enough distinction between war "goods" and consumer goods to permit rapid re-conversion in the case of a situation like the end of WWII. It doesn't have to be perfect to be enough to immediately put a lot of people back to work. The malinvestments that are more difficult to work out will have an effect, but it won't be large enough to prevent the rapid upward trend in employment and production of consumer goods. Even in a healthy functioning market economy there are many capital projects that fail. But--they do fail, and the capital is reallocated through the market process. You get lingering economic sluggishness when the government tries to prop up the failures. This is most obvious in the recent case of housing, where the attempt to prop up prices prevents the market from clearing as it must.

[Omar]

Oh, I'm sorry. I mean, you're wrong. What are you, a shill for the big banks? We all know that MONEY IS DEBT. That's how the system is swercs everyone over. Capitalism is going to inevitably collapse because money is debt and debt charges interest, and so there can't possibly be enough money to pay all the interest. It's one big Ponzi scheme. They're going to bring back debtors prison and make us all into debt slaves, and you are one of their enablers! The only way to fight back is to occupy something and live in tents and fight with the police. Viva la Revolucion!More seriously, I'm a nobody from nowhere who knows nothing. It is highly unlikely that I know what I am talking about.