Chris Dillow's Blog, page 120

Lumpy markets & mental models

How lumpy is the labour market? Several recent posts prompt me to ask.

Here's what I mean. Think of two possible extreme mental models of the labour market. At one extreme, the market is flat, and workers are easily substitutable between jobs. At the other extreme, the market is lumpy with each job and each worker being different, and so workers are not substitutable. These markets differ in some important ways.

First, if the market is flat, then John Quiggin is right to say that the internet should have reduced unemployment because it greatly reduces the cost of searching for jobs or workers and so facilitates more matches between them.

However, if the market is lumpy, this isn't necessarily the case. If you're looking for very particular worker (or job) then we're in Nick's world. Where there's lots of heterogeneity, he says, "there might not be any suitable matches on the market right now, and one or other side might choose to wait until a better match appears on the market." His analogy to the car market is good: there are thousands of used cars, but the market for a precise type of Mazda MX6 near Ottawa could be thin.

Secondly, in a lumpy market, we might see shifts in the Beveridge curve as mismatches betweenworkers and vacancies increase and decrease. In a flat market, by contrast, we'd see shifts along the curve in response to changes in aggregate demand. [image error]

Thirdly, in a lumpy market wages and profits depend upon bargaining over how to divide the surplus that results from the match between specific workers and jobs. The division of this surplus will depend upon individual bargaining power. This means there might be many employers who have some monopsony power by virtue of being (near-) sole offerers of some specific jobs. And this justifies minimum wage laws or the exercise of union power - because as Mike says, in the presence of monopsonies, higher wages don't necessarily destry jobs.

Fourthly, in a lumpy market efficiency requires investment in job-specific skills, because each job is different. In such a world, Jackart's advice to workers - if you don't like pay and conditions, leave - becomes inefficient as leaving would break efficient matches.

What's more, workers with an eye on the exit would be deterred from investing in job-specific skills. Take, for example, me at the Investors Chronicle. If I feared for my job, I'd write lots of articles on economics of the sort that would appeal to future employers: pieces of macroeconomic futurology that praised or blamed Osborne. But the IC wants something more specific - pieces that are helpful for individual investors. Job security encourages me to do this, and to develop job-specific skills to the benefit of my employer.

In this context, trades unions and employment protection laws aren't labour market frictions, but are in fact productivity-enhancing, as they encourage job-specific investments.

Finally, in a lumpy market, workers are imperfect substitutes for each other: for example, Aditya Chakrabortty and I are both economics writers, but because of job specificity were are hardly competitors. This means that an excess supply or demand for workers will have little impact on wages. This is one reason why immigration does not depress wages, except at the very bottom end of the market - it's because immigrants aren't substitutes for native workers.  

So, is the labour market flat or lumpy? The answer of course is: a bit of both. On the one hand, the Beveridge curve does slope down, which alone is evidence for John's claim for the superiority of simple aggregate demand models over search models and for flatness over lumpiness. But on the other, the relationship between vacancies and unemployment isn't a 100% fit; unemployment now is higher that the number of vacancies would suggest. That's evidence that, as Noah says, aggregate demand isn't the whole story. And of course, casual empiricism tells us that workers aren't perfectly substitutable; I'm better at writing for the IC than the Guardian, and better at both than heart surgery.

My point here is twofold. First, simple mental models don't map perfectly onto a messy world - which is why simple arguments against immigration, minimum wages or employment protection laws fail.

Secondly, the degree of lumpiness in the labour market can change all the time depending upon the nature of technical change and creative destruction. In this sense, the old warning about economic models - that the map isn't the terrain - actually understates the case: the terrain can change whilst the map doesn't.

Why idiots succeed

Several tweeters, such as Anna and Hopi, have expressed dismay at the fact that Iain Duncan Smith has kept his job in the cabinet (re)shuffle, despite his gross inadequacies. His survival, however, highlights an important fact - that, sometimes, organizations and markets can actually favour incompetence.  There are (at least) eight mechanisms through which this can happen.

1. The wet bed. If a man has pissed the bed, you don't ask someone else to sleep in it. Cameron might well have thought "Universal Credit is an immense clusterfuck which nobody can sort out in a few months. Why waste the reputation and morale of a good man by asking him to try?" I suspect similar thinking led Luiz Filipe Scolari to keep David Luiz on the pitch during Brazil's 7-1 mullering by Germany.

2. A disposition effect. Every bad employee is a bad hire. However, a combination of ego involvement ("this was my decision so it must be a good one") and the endowment effect ("we've got him so he must be good") stops hirers from immediately realizing their error. Just as stock market investors tend to hold onto bad stocks, because of their refusal to admit error, so employers hang onto bad staff.

3. Noise vs signal. In many contexts, feedback about performance is noisy. Ran Spiegler shows (pdf), this can create a market for quacks. For example, if you would have recovered from some ailment anyway but take a homeopathic treatment before the recovery, you can easily convince yourself that the treatment worked. And you'll tell others. A similar mechanism can favour the fund manager who rides a bull market, or the corporate boss who is lucky enough to get a job at a firm with good organizational capital.  

4. The devil you know. In many jobs, a worker's ability can only be assessed after he has done it. As Marko Tervio has shown, this alone can generate adverse selection; the mediocrity who has a track record that is just adequate will be preferred to the unproven man of potentially greater ability. In itself, this is a story about markets favouring mediocrities rather than incompetents, but mechanisms 2 and 3 above suggest that the bar for mediocrity might be set so low as to allow idiots to thrive.

5. Survival of the unfittest. Bjorn-Christopher Witte describes how, sometimes, competition between fund managers can encourage reckless risk-taking with the result that lucky chancers rather than the genuinely skilled will thrive. For example, in the early 00s bankers who danced to the music and took risks got big bonuses whilst those who sat it out got sacked. And during the tech bubble money flowed to those managers who thought boo.com and Baltimire Technologies were good stocks, whilst sceptical fund managers such as Tony Dye were fired.

6. Desperation. If people are desperate for a very high pay-off, they'll be attracted to incompetents and fraudsters, as only these are stupid or criminal enough to offer such rewards. As Laurie has said, "sometimes when you’re dying of thirst, you have to drink the Kool-Aid." This is why con-artists often prey upon the terminally ill or bereaved. But it also lies behind what I've called the Bonnie Tyler syndrome - the urge (often on the left) for a great hero.

7. Product differentiation. In a wonderful paper (pdf) on the persistence of the market for quack medicines in the 19th century, Werner Troesken points out that the manufacturers of such remedies spent fortunes on advertising and product differentiation. In this way, the failure of one medicine did not discredit the industry, but merely shifted demand to other quacks. I suspect the fund management industry operates on a similar principle. So might politics: insiders want us to think that Paterson, Fox, Hammond or whoever are distinguishable when in fact they are fungible.  

8. Like hires like. Senior managers like to hire people like themselves not just because they want yes-men, but because (say) financial people find it easier to assess finance skills and engineers find it easier to assess other engineers. Knowing this, underlings hoping for promotion will cultivate the skills their bosses have, even if their comparative advantage lies elsewhere. The upshot of this, according to Eric Hughson and colleagues, is that organizations can eventually be run by second-rate MBAs whilst technical skills are completely weeded out. Joao Ricardo Faria shows (pdf) that this sort of mechanism can generate the Dilbert principle.

Now, I stress that these mechanisms are not universal, although they are sufficiently widespread to explain the obvious fact that some idiots and charlatans survive and thrive in many organizations. It is, of course, the case that competition does sometimes improve quality. But this Econ 101 view is only a partial truth. The notion that we live in a meritocracy - or even that a meritocracy is possible - is just...

Time

Google boss Larry Page recently called for the end of the conventional 40-hour working week. Some new research suggests this could have more profound cultural effects than generally thought.

Anne-Laure Sellier and Tamar Avnet primed people to choose between organizing some jobs in "clock-time" (scheduling a specific job at a specific time) or in "event-time" (doing a job until you reach a natural break). They found that the choice led to two big pyschological differences.

First, clock-timers were more likely to have an external locus of control; they were more likely to see their lives as determined by fate or powerful others. Event-timers, on the other hand, tended to have an internal locus, regarding themselves as in control of their own fate.

If you regard the clock as your master, you might well come to regard other external things as your boss too.

Secondly, clock-timers were less able to savour positive emotions than event-timers - perhaps because if you have an eye on the clock you are less likely to lose yourself in a job and so enjoy flow.

As one of the lucky few who has been able to escape the office and so move from clock-time to event-time, I can corroborate these effects.  

Here, though, we need some history. One key feature of the emergence of industrial capitalism was that bosses replaced event-time with clock-time. As E.P. Thompson describes (pdf), pre-industrial workers were event-timers; they would milk the cows, plough or weave or observe Saint Monday as required by the competing demands of the job and personal whim:

The work pattern was one of alternate bouts of intense labour and of idleness,  wherever men were in control of their lives.

Over several generations, this pattern was replaced with the discipline of the clock. But as Sellier and Avnet suggest, this replacement had some cultural and psychological effects which its authors did not intend. As Marx said: "The mode of production of material life conditions the general process of social, political and intellectual life."

And herein lies the thing. If Mr Page is right and/or if some combination of robots and a citizens basic income create a post-scarcity economy in which we are no less subject to the tyranny of the clock, this could lead to big cultural changes which we have barely begun to think about.

Unions & productivity

James Bloodworth says we need stronger unions. Unions, he says, give us higher pay and greater equality.

But what do they do to productivity? The standard Tory line for years has been that militant unions are wreckers. The facts, though, tell a different story.

Academic research based upon comparisons of unionized and non-unionized workplaces has found little impact. One meta-analysis (pdf), for example, concludes that the link between unions and productivity is "near zero": it's slightly negative in the UK but positive in the US.

A cross-country comparison, though tells a different story. My chart plots GDP per worker in 2013 against union density for 33 OECD countries. Across all 33, the correlation is positive, at 0.4. Eyeball econometrics should tell you this finding is robust to outliers.

The US - which has high productivity and low union membership - is an exception. More generally, union membership is associated with higher productivity across countries.

You might wonder how the cross-country evidence shows a positive correlation whereas the cross-workplace evidence generally doesn't. Here's a theory. People will always want better pay and conditions. This is simply because they are human. If they can't achieve these through unions they will try to get them through the ballot box, in the form of legislation.

In this sense, as Philippe Aghion and colleagues show, there can be good and bad equilibria; a good equilibrium in which there are strong unions and litte legislation, and a bad one in which there are weak unions and much regulation.

The UK fits their story. Whereas in the 70s businessmen complained about unions, they now whine about minimum wage laws and red tape.

But here's the thing. Regulation is a bad substitute for unions. Regulation is inflexible. Whereas collective bargaining - when done intelligently - can respond to different local conditions.

This might seem like an odd argument, because lefties tend to want both regulation and unions whereas righties want neither. But insofar as there is a trade-off, strong unions are to be preferred.

Which poses the question: if unions are good for productivity, why have bosses traditionally been opposed to them? The answer, I suspect, lies in this paper, which finds that unionization "is significantly associated with lower levels of total CEO compensation."

Trades unions, then, promote the national interest, whereas hostility to them is founded upon narrow sectional interests.

Party politics & social change

Today's strikes have led to complaints about kids' education being disrupted. This, though, poses the question: why fret so much about the loss of one day's schooling and so little about the countless other things that undermine good education, from the bad management that forces thousands of teachers to leave the profession to the anti-intellectual culture that devalues learning?

My point here isn't a partisan one. It's rather that party politics sees some things but not others. And it is often blind to very big socio-techical changes. For example:

 - On those rare occasions when politicians deign to notice the plight of the low-paid, they focus upon the small impact that immigration has, whilst generally ignoring the bigger impacts of globalization, technical change and increasing capitalist power.

 - The share of incomes going to the richest 1% has almost doubled since the 1970s. And yet, until recently, there was little mainstream debate about the desirability of this.

 - There's been little debate about the massive change in the nature of middle-class jobs. The question has been rarely asked: do we want better pay (in some cases) in exchange for more stressful working conditions?   

 - The dominant ideology of our time is managerialism. And yet there's little party political debate about the desirability of top-down hierarchies. Sure, New Labour accelerated managerialism in the public sector, but it did so as piecemeal reform and didn't ask whether we want to be subject to a form of totalitarianism.

- Whilst economists have been debating secular stagnation, politicians have pretty much ignored it, except for George Osborne's weak denial of its existence. The question: what sort of policies would we need in the event of long-term stagnation? isn't asked.

 - The possibility of robotization poses the question: how can we ensure that technical change benefits everyone, not just a few? Again, this isn't being asked.

You might object that these questions aren't being asked because they have no good answers, and politicians set themselves only such tasks as they can solve. I'm not sure. For one thing, lots of mainstream political questions don't have solutions - such as how to increase long-term economic growth. And for another, some of the questions that they don't ask are answerable; I suspect we could reduce the incomes of the 1% if we wanted (though there might be a cost of doing so).

What I'm suggesting here is that party politicians are to some (large?) extent like corks in the sea - they are shifted by tides which they cannot control and of which they are unaware. A lot of big socio-technical change happens without their intervention, whilst they are fretting about smaller matters.

And a damned good thing too, rightist libertarians might say. A bit of me, though, thinks the left might welcome it to. The transition from feudalism to capitalism didn't happen - for the most part - because politicians willed the change. And perhaps the transition to socialism will happen despite politicians too.  

The profits crisis

Everyone knows there is a cost of living crisis; real wages are 8.5% lower than they were in 2008. However, the fact that workers are doing badly does not mean that capitalists are doing well. Today's figures from the ONS show that the return on capital is still well below its pre-crisis level and even further below its late-90s level.

I fear that this might actually overstate how well capitalists are doing. The ONS measures the capital stock at current replacement cost. But what matters for companies is the money they actually spent on capital - that is, its historic cost; if you paid £10m for IT equipment that costs £8m a few years later, your profits haven't thereby increased. And as Andrew Kliman has pointed out for the US, historic cost-based measures of profits have trended downwards by more than current cost measures.

The fact that capital is suffering as well as labour should be no surprise. It's a product of the fact that labour productivity has fallen; a smaller pie means smaller slices for everyone.

But there's something else going on. One feature of this recession has been an absence of large-scale capital scrapping. Even at their peak, company liquidations were much lower in the crisis than they were in the milder recession of the early 90s. This tends to depress the profit rate not only because of simple maths - if the capital stock doesn't fall then ceteris paribus the ratio of profits to capital is lower - but behaviourally. The more capitals there are competing with each other, the more prices will be held down, implying that profit margins don't rise; the share of profits in GDP was lower in Q1 than in 2008. And if businesses aren't liquidated, surviving firms can't buy capital cheaply from their failed rivals.

Now, I don't say all this to suggest we hold a whip-round. Instead, I do so to point out that the cost of living crisis is not due simply to capital exploiting labour by more than usual. It's deeper and more intractable than that.

Worse still, a recovery in the rate of profit might require a painful round of capital scrapping. If, however, Bank of England and OBR forecasts are right (and the fact that profitability is relatively low is a reason to doubt them) we'll see the opposite - an increase in capital. This could spell trouble. This paper finds that:      

Higher aggregate investments...precede greater earnings disappointments, lower short-window earnings announcement returns, and lower macroeconomic growth.

With profits already low, this could mean that the next downturn will prove especially painful. 

The degradation of middle-class work

Back in 1987 my first boss in investment banking used to say that if he got into the office before nine o'clock he had to switch the lights on. This 1964 BBC programme about stockbrokers shows he had a point. "The day begins" says the narrator - with the clock showing 9.20 in the morning. And as Philip Auger says, the mornings weren't long back then either:  

The City was sexist, snobbish and not very hard working. Certain partners disappeared for lunch at 11.45 and reappeared three hours later.

That world has, of course, disappeared. Today, investment bankers work horrendous hours, jeopardizing their health and even their lives.

This is just one example of an under-appreciated change during my lifetime - what we might call, following the great Harry Braverman, the degradation of "good" middle-class jobs. In investment banking and law, this takes the form of deadly hours. In academia, it consists in the stress imposed by the REF. In schools, huge numbers of newly-qualified teachers soon leave the profession disillusioned by targets and bureaucracy. And in journalism, it takes the form of declining relative salaries.

As recently as the 1980s, someone in a professional job could earn good money and have an easy life of long liquid lunches and little supervision. No more. A combination of managerialism, "digital Taylorism" and offshoring have destroyed the easy middle-class life. Sure, some professions can escape supervision, such as authors and musicians - but they do so at the price of incomes so low as to make their careers "monetarily impossible".

It's possible these pressures will intensify if, as David Willetts believes, robots will compete for professionals' jobs.

Now, this change isn't wholly a bad thing. The cushy life allowed drunks, incompetents and pederasts to thrive, and it might be that the decline of the easy middle-class job means that welfare inequality hasn't increased as much as incomes data would imply*. But it has some adverse effects:

 - The managerialism that has degraded the professions has limits itself - it might have driven Peter Higgs from academia - and can be just an ideological cover for exploitation and rent-seeking.

 - As Miles Kimball and Brendan Epstein point out, changes in job utility can have very large impacts upon welfare, which implies that job degradation hurts well-being a lot.

 - If we take job disatisfaction into account, the total return to getting a degree might be lower than the financial return, which is still good (pdf).

 - There's a question here of intergenerational justice. Whereas people slightly older than me who had a degree had an easy passage to a comfortable job, today's graduates don't have that.

I don't say all this to necessarily wholly deplore this change. My point is rather that there's been a huge social transformation with very little debate about its desireability.  

* I'm stressing the degradation of middle-class jobs here. It's possible that the opposite has been true for workers; call centres might be oppressive but I suspect they aren't as bad as coal mines.

Incomes & satisfaction

In her brilliant The People: The Rise and Fall of the Working Class Selina Todd writes:

In 1949 Mass Observation interviewed 2040 people across England about their income and speding patterns. The investigators discovered widespread satisfaction, especially among manual workers and their families: " a third say that they have no particular wants beyond those thay they can afford."

I very much doubt that so high a fraction would say that today, despite the fact that real wages have shot up since then: a male factory worker back then was doing well to get £7 a week, implying that wages have risen by around 80 per cent since then in real terms.

This poses the question. Why was it that in the 1940s there was satisfaction with incomes whereas today we have a cost of living crisis when real wages are far higher? Here are some possibilities.

First, real wages had risen a lot between the 30s and late 40s. This meant that many people felt well off simply because they had not yet become habituated to their higher incomes. By contrast, real wages today are lower than a few years ago. As Adam Smith said:

It is in the progressive state, while the society is advancing to the further acquisition, rather than when it has acquired its full complement of riches, that the condition of the labouring poor, of the great body of the people, seems to be the happiest and the most comfortable. It is hard in the stationary, and miserable in the declining state. The progressive state is in reality the cheerful and the hearty state to all the different orders of the society. The stationary is dull; the declining melancholy.  

Secondly, there are now more potentially adverse comparisons a worker can make between his living standards and his neighbours. In the 40s, almost no worker had a car, TV or took a foreign holiday so workers who didn't have these didn't feel they were missing anything. Today, our neighbours spend more so we feel dissatisfied if we don't keep up; peer effects matter for spending, probably because we feel as if we are missing out if we don't keep up with the Joneses.

This process might be exacerbated by television. There's some evidence that watching TV can make us unhappy in part because adverts and the sight of glamorous lifestyles can increase aspirations and discontent. Back in the 40s, this wasn't a problem.

Thirdly, economic growth doesn't consist merely (or even mainly) of producing more of the same stuff. It consists in an increased proliferation of goods. There are millions of products - from olive oil to iPads - in the UK economy today that didn't exist in the 40s. As Eric Beinhocker pointed out in The Origin of Wealth, the biggest difference between a rich and poor socieity isn't the level of incomes, but the number of different goods.

This profusion, though, has a drawback - it increases our opportunity costs; £10 spent at Nandos is £10 less to spend topping up your phone. Because of this, as Jan Sokolowsky and Katherine Guthrie have shown, more choice can mean less happiness.

In saying all this I don't mean to deny that there is a cost of living crisis. What I am doing though, is challenging sceptics about the Easterlin paradox such as Diane Coyle. She's said that the paradox is based on a statistical misunderstanding; GDP is unbounded whereas happiness ranges on a 1-10 scale, so the two will look unrelated. As a statistical point, this is correct. But even so, there's some historical evidence, and psychological mechanisms, which suggest the paradox is a real one.

Gender, culture & economism

I've seen two different takes on gender inequality this week.

First, Pauline Grosjean and Rose Khattar show that sexist cultural norms can be very persistent.

They studied the effects of convicts arriving in Australia in the 18th and 19th centuries. Because these convicts were mostly men, their arrival led to a big excess of men over women in some areas of the country. In those areas, women were more likely to marry and have children and less likely to work than women in areas with fewer men.

And here's the thing. In those areas today, men are more likely to have sexist attitudes, and women are less likely to work and less likely to occupy good jobs if they do work. In this sense, sexism is path-dependent. It can persist for decades. This fits in with quite a large body of work which shows that history - even quite distant (pdf) history - shapes behaviour today.  

This sounds rather depressing, as it suggests that gender inequality is hard to shift.

However, the ONS has published more optimistic research. It shows that during the last 40 years the gender pay gap has narrowed markedly, especially for younger people. For example in 1975 27-year-old women earned 26% less than men whereas today they earn just 1.5% less.

This seems contradictory. On the one hand, we have evidence for the persistence of sexism, but on the other we have evidence that it has almost disappeared within just a single working lifetime. How can we reconcile this?

Part of the answer, of course, is that the labour market is only one aspect of gender relations, and sexism persists in many others.

But perhaps another part of the answer lies in the relative power of technical versus cultural change. What has contributed to the declining gender pay gap has been technical change - a collapse in relative demand for the sort of hard physical manual work at which (some) men had an advantage over (some) women and rising demand for jobs requiring soft skills at which (some) women are better than (some) men.

Maybe, then, technical change has improved the lot of women whilst culture hasn't changed so much; this is consistent with young women doing well in the labour market but still suffering sexism in other realms.

You might think this theory - it's no more than that - is rather Marxian, as it stresses the importance of changes in "the mode of production of material life" whilst underplaying the possibility of achieving advancement by cultural change alone.

It is, but there's another economistic reading here which rightists might subscribe to. It's that the solution to discrimination lies in market forces more than in the forlorn hope of "changing culture."

Political narratives

Maurice Glasman is among those who thinks Labour needs a narrative:

When it comes to politics, the entertainer Max Bygraves is a better guide than the philosopher René Descartes. “Let me tell you a story” is a better path to political power than rational policy prescriptions...
The problem for Labour is not that it lacks policy but that it lacks a narrative of national renewal.

I'm in two minds here. On the one hand, he's right. Stories are powerful, memorable things. But on the other hand, this is precisely why they are dangerous.

One of Nassim Nicholas Taleb's useful contributions was to popularize the idea of the "narrative fallacy". In constructing stories and seeing patterns we are apt to overlook details. As M.L.J Abercrombie pointed out, people are apt to misread the words in the triangle because they impose a scheme - a narrative - upon them; this is why proof-reading is such a great skill.

A similar thing happens in politics. For example, the narrative of Thatcherism - which was constructed very much ex post - sees Thatcher as, depending on taste, either as a libertarian hero or as a mad axewoman. But in fact, she was neither; public spending in the Thatcher years grew steadily.

I fear, though, that narratives don't just warp our historical perceptions but also our real-time perceptions of politics. Government is not about imposing a grand narrative or vision onto society - or certainly not just about that. It's also about the day-to-day gruntwork of good administration and about responding to "events, dear boy." Just as no battle plan survives contact with the enemy, so political narratives don't survive contact with power. The politician who thinks narrative is enough will end up like Iain Duncan Smith, clinging to a narcissistic self-image whilst his projects collapse.

But it's not just events and detail that undermine narratives. So too do the brute facts of capitalism. In the mid-90s, part of New Labour's narrative was "the creation of a stakeholder economy which involves all our people, not a privileged few*." But in fact, the subsequent two decades have seen an increased concentration of income and power into the hands of a privileged few.

Good politicians will campaign in lies. But they must govern in truth. A narrative might be a useful campaigning tool. But it is not necessarily a guide to govenment.

* Speech at Derby Assembly Rooms, 18 January 1996 in Tony Blair: New Britain: My Vision of a Young Country, p293