keynesian economists misjudge the economy

Natural disasters like hurricane Sandy tend to spur the following food fight among economists.

One or more economists — seeking attention and a chance to look clever — say something stupid like well, at least, the rebuilding will be good for the economy.

In response, other economists quote Frederic Bastiat’s Broken Window Fallacyask why we don’t smash everyone’s house to help the economy and lecture us that economic metrics, like GDP, do not take into account the value lost in destruction.

However, I think that both sides of this food fight talk past each other. Silas Barta’s has similar thoughts.

While I agree with the second set of economists, I think they ignore what I think is one key point of the first set of economists argument — ‘slack resources’.

The first set of economists know destruction is bad, but believe that because the economy wasn’t operating at ‘full capacity’, it had slack resources that can now be put to good use in the rebuilding effort. The second set of economists never address this point.

Here’s how I would address the slack resources argument: ‘Slack resources’ is a subjective, incorrect and misleading way to characterize what’s happening in a bad economy. So is the idea of ‘full capacity’.

It looks right-enough that almost nobody questions it, even the second set of economists. Except, maybe, one that I know of (Arnold Kling).

And I can understand why so few people question the ‘slack resources’ hypothesis. When you see a friend who is unemployed and struggling to find work you tend to think of him as a slack resource.

It’s like seeing your kid doing nothing on a Saturday afternoon and you get this strong urge to put him to work. He or she appears to be a slack resource.

It’s natural for us to think — We should be able to put these folks to work! They’re ‘slacking’ off.

But, I believe the ‘slack resources’ characterization is incorrect and misleading. Scratch past the surface you will find more to the story.

Have coffee with that unemployed — slack resource — friend and you find out he has turned down three job offers, because they were for 20% less than what he made at his previous job.

You ask, why not accept the pay cut so you can get back to work? Maybe you’ll get in there, knock their socks off and be back to your old wage in no time.

Well, it turns out he had enough savings and unemployment benefits to allow him to hold out for a job that will pay him his previous wage. Why should I accept less until I absolutely have to (i.e. when I run out of unemployment benefits)?

We find out our friend isn’t a slack resource. Rather, his skills are being re-priced and he doesn’t like it.

I don’t blame him. Nobody likes to have their wages “re-priced” down, but it happens all the time and it happens due to decisions that you and I make.

When one of our favorite Hollywood superstars makes a stinker of a movie that we choose not see, he may have to accept lower pay on the next movie to get studios to hire him. He could say, if only my fans would have supported me and seen that movie. His fans might respond, if only you would have made a movie worth seeing.

The first set of economists in the food fight see a bad economy as having slack resources. But what they truly reveal to me is that they don’t understand what’s really happening — things are being repriced based on the decisions that we make.

This is lack of real understanding of a bad economy is readily apparent when you consider how many barriers to repricing the first set of economists have had a hand in putting in place.

Minimum wage is one such barrier. It’s also the reason why there are so many officially unemployed unskilled workers at the moment. The market clearing price for unskilled labor is below the minimum wage, which is a price floor. Econ 101 teaches us that when the market clearing price is lower than the price floor, we will have a situation where supply (workers) exceeds demand (jobs). That’s exactly what we have.

This is fodder for another post, but it never seems to bother these economists that their favored wage price floor is causing so much unemployment. They’d rather feel sanctimonious about supporting something that seems well-intended than allow the official price of unskilled labor to move below what they have deemed an acceptable level.

Unemployment benefits is another such barrier to repricing. Many people believe that the low amount one receives from unemployment insurance is not enough to prevent them from accepting  work and they may be right if we lived in a simpler world.

But, in this world we have folks who have some savings, working spouses and the ability to take on black and gray market jobs to earn some coin while also receiving unemployment. We also learn in Econ 101 that incentives matter. If I accept an official lower paying job, I lose my unemployment check. Why do that when I can accept an unofficial lower paying job and continue to receive unemployment — or ‘double dip’?

These barriers slow the repricing process and lengthens the ‘bad economy’. They are the reasons why our recessions seem to take longer and longer to recover from.

If our friend didn’t have a free unemployment check that he would lose by accepting an official job, he might accept an official job sooner.

So, the next time you hear an economist talk about slack resources, give some consideration to whether the resource is really slack or whether someone just hasn’t been willing to accept a lower price for that resource and why.

Coming soon…repricing downward is awful, but is it really that awful?