Saturday, June 28, 2014

What a little reading light can do for you


Unless you're determined to ignore it--and you've already ignored the textbooks. It, being what João Paulo Pessoa and John Van Reenen of the LSE have found in the UK;
Based on the experience from past recessions, we would have expected unemployment to have soared into double digit territory. In fact, the labour market has held up surprisingly well. Unemployment peaked at 8.3%, which – although unacceptably high – is lower than the unemployment during the 1980s and 1990s recessions, even though these took less of a toll on output.
The flip-side of the unemployment picture is the so-called ‘productivity puzzle’. Labour productivity as measured by output per hour worked has collapsed: It is about 4% lower than it was pre-recession and according to the Bank of England, 16% below what would have been expected if past trends had continued ....
But it's not really a puzzle, it's just our old friends Supply and Demand;
Between the second quarter of 2008 and the third quarter of 2013, average hourly wages in the UK fell 8.5% in real terms....
Which neatly explains why, 'the labour market has held up surprisingly well.' At lower prices, all else equal, more quantity sold--or, at lower wages, more quantity of labour bought. That's what an economist--supposedly including Seattle's Kshama Sawant--would expect to happen. Back to the two LSE guys;
Lower real wages seem to have helped reduce lay-offs because they have made it cheaper for firms to hang on to their workers even in the face of falling demand. But low wages also made it relatively cheaper for firms to take on more workers rather than invest in new capital or technologies.
Wonder what enforcing a $15 per hour minimum wage for unskilled labor would do to this formula.
This trend is reinforced because the cost of investment has also increased for many firms.
That's an opportunity cost argument from the textbook.
Although the Bank of England has kept the base interest rate near zero, and has tried to get this passed on by printing money (quantitative easing), the actual cost of capital seems to have increased.
The Bank estimates that the cost of capital has increased by two percentage points (from 8%) for large firms, with the challenges even greater for smaller firms. This is at least partly a result of the tougher standards introduced to ensure that banks hold sufficient levels of capital to cover risky lending, which helps to explain why investment in the UK has fallen by about 25% from 2008 levels and remained low until the beginning of 2013....
Again, no surprises here for the Grunts in economics. Summing it up;
The upshot of this is that the price of labour (wages) has fallen and the price of capital has increased, so firms have had incentives to substitute cheaper workers for more expensive machinery and buildings. And while this means employment is much higher than we would have otherwise have expected, it means that productivity has been depressed as a result of less investment per worker.
No need for I Love Lucy Economics, but Milton Friedman knew all this.

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