Phillips art

The Wall Street Journal gets a prize for Art in Economics for their Phillips curve article. Abstract expressionist division, not contemporary realism, alas.

Source: Wall Street Journal

(For the uninitiated: There is supposed to be a stable negatively sloped curve here by which higher inflation comes with lower unemployment. Beyond that correlation, most policy economists read it as cause and effect, higher unemployment begets lower inflation and vice versa. The point of the article is how little reality conforms to that bedrock belief.)

Summers and the nature of policy advice

Larry Summers has a fascinating editorial in the Financial Times titled "Corporate long-termism is no panacea — but it is a start" You really should read the whole thing and come back for commentary.

The three paragraphs in the heart of the editorial are a tour de force:

Businesses will raise wages to a point where the cost is just balanced by the reduced bill for recruiting and motivating workers. At that point, a further increase in wages does not appreciably change their total costs but higher wages certainly makes their workers better off. So there is a strong case for robust minimum wages.

Never mind centuries of supply and demand, centuries of experience with minimum wages and other price controls, or even the current controversies. Never mind that who works for what business and how many do so is a little bit endogenous. Larry has a new and very clever theory about monopsonistic wage setting in the presence of recruitment and motivation costs.  (One that apparently only holds at the lower end of the wage scale where minimum wages bite?)

There is also a strong reason for regulating aspects of pay. Usually competition drives desirable economic arrangements. But not always — especially when there is a risk of a race to the bottom. A company that tries to stand out by offering especially attractive family leave benefits, or job security, or egalitarian wage structures faces the prospect of attracting a disproportionately risk-averse work force. So there is an argument for using mandates to level the playing field.

Once again, bravo. Larry has a new and very clever theory about companies attracting a too-risk-averse pool of workers when they offer benefits instead of pay. (Why are they offering benefits instead of pay? How does this paragraph, in which workers move from job to job, fit with the last one, about bilateral bargaining between fixed workers and firms? ) And an optimal pay mandate can just offset this distortion and give firms the proper pool of risk aversion in its workforce. (Why are excessively risk averse employees a problem? Where do the risk neutral go to work? Why does this not just lead to a different profile of pay vs. benefits to clear the market by risk aversion? )

Profit sharing, too, is an area where there are demonstrable benefits in terms of increased productivity — but an individual company that stands out by offering it may encounter difficulties in recruitment because workers are too risk averse. So there is a strong case for tax incentives to spur profit sharing.

Ditto. "may encounter" is a "strong case" for "tax incentives?"

Ignore my whining, though, and admire the prose. One, two, three, policies enshrined as economic fallacies in Econ 101 classes, are stunningly overturned by clever new theories in three short paragraphs.

My thought: is this really a good way for economists to help to advance public policy?

Larry is the Smartest Guy In The Room.  I mean that, and I mean it as a compliment. I've seen him in action at conferences and other meetings, and his performances are breathtaking. You can see that bravura here. If you have a policy in mind, Larry can come up with three theories to justify it in half an hour, all novel, all clever, all plausible.

But is this at all a service? We all know the elephant (or perhaps I should say donkey) in the room: these are all proposals Mrs. Clinton is making on the campaign trail. For totally different reasons, of course.

Does it really do lots of good to reverse-engineer clever new theories to justify old policies that happen to be politically hot at the moment? And to ignore all the old arguments over those old policies?

Larry's column is great advice for Harvard graduate students. Here are three great thesis topics. Work them out, see if the theory actually holds together (my questions need answering), see if there is a hope of support in the data. You'll have a great thesis.

But is this reverse-engineering great advice for the country?  Shouldn't economics act a little more like science, and keep our clever new ideas as clever new ideas until they have at least some certified theoretical coherence and empirical support?

***

I was also a bit annoyed by the classic missing subject and passive voice that pervades economic policy writing. Just who is going to do all these great things and how?

In this case it's more striking because the prose denies the obvious implicit subject -- the Federal Government. No, it's all going to happen

...not through government actions but through mandates or incentives to change business decision-making." 

And later,

So the idea of achieving reform through altered business behaviour, rather than government programmes, is appealing....

That's important, because of the obvious objection: If these clever new market failures exist, do government bureaucrats have any hope of measuring the distortions well enough to craft a policy? If pay mandates are not about giving one group with political access more pay than others, but to carefully offset an incentive to attract too many high-risk-aversion employees, does the current Department of Labor have a hope of getting it just right?

No, obviously. So it would help a lot if this were not a plea for a hopeless dirigisme. And by using the passive voice with no subject, and explicitly denying this is about government, Larry is trying to overcome that obvious hole in these ideas.

But just who other than the government is going to mandate  mandates, incentivize incentives, alter behaviors, impose "robust minimum wages," enact the "tax incentives to spur profit sharing" do the "regulating aspects of pay" and so on? Is Mrs. Clinton no longer running to be head of a government, but some sort of improve-business do-good website?

The last paragraph attempts an answer

The real need is for a cadre of trusted, tough-minded investors in any given company who can credibly commit to support strong management teams and to provide assurances to a broader investment community so that productive investments are made. Accomplishing that, while maintaining market discipline, is the crucial challenge.

Where is this cadre (!) of investors going to come from? How are they going to take over capital markets? How are these Wise People going to impose the long list of things Larry recommends that only governments can do, including minimum wages, tax incentives, and pay regulation? Just who if not the government is this "crucial challenge" for?

Surely this isn't a pean to the wonders of private equity (Bain capital), who can take companies off the short-termist stock market? Neither Harvard's nor Chicago's endowment managers did a great job of being "long-term" investors, both selling madly in 2008, to say nothing of taking little stance on minimum wages, tax incentives, pay regulation, and so forth. This is not a Summers criticism: university presidents do not direct endowment policy. But if university endowments are not the cadre of wise investors, who are? If (explicitly) not a plea for government intervention, is it a plea for alien invasion or divine intervention?

This part is just inconsistent in a very uncharacteristic way. There is a political discourse that wants to pretend there is a "government lite," that will just nudge us here and there. Unwittingly, perhaps, Larry has set forth quite clearly how empty that promise is.  But why he wants to make this obviously weak argument  I do not understand.

Similarly, the first paragraph is

There are not many wholly new areas to open up in economic policy. But in recent months there has been a wave of innovative proposals directed at improving economic performance in general, and middle-class incomes in particular...

Larry himself provides the counterexample to the idea that corporate short-termism is a "wholly new area"

A generation ago, the Japanese keiretsu system of cross ownership of corporate shares — which insulated corporate managements from share price pressure — was seen as a strength.

What's new, of course, is that the Clinton campaign has taken on these very old ideas.

Why go to such lengths to hide the subject of all these policy entreaties -- very much regulation by the Federal Government -- and pretend the final conclusion is to document a need for a new cadre of investors to parachute in from Mars and take over markets? Why ignore the elephant and donkey in the room when analyzing policy proposals by candidates?

Unemployment insurance and unemployment

"The Impact of Unemployment Benefit Extensions on Employment: The 2014 Employment Miracle" by Marcus Hagedorn, Iourii Manovskii and Kurt Mitman is making waves. NBER working paper here. Kurt Mitman's webpage has an ungated version of the paper, and a summary of some of the controversy. It's part of a pair, with "Unemployment Benefits and Unemployment in the Great
Recession: The Role of Macro Effects" also including Fatih Karahan.

A critical review by Mike Konczal at the Roosevelt Institute blog, and a more positive review by Patrick Brennan at National Review Online are both interesting. Both are thoughtful reviews that get at facts and methods. Maybe the tone of the economics blogoshpere is improving too. Bob Hall's comments and response on the earlier paper are also worth reading. This is a bit deja-vu from the observation that North Carolina experienced a large drop in unemployment when it cut benefits. My post here, WSJ coverage, and I think there are some papers which google isn't finding fast enough at the moment.

The basic issue: I think it's widely accepted, if sometimes grudgingly, that unemployment insurance increases unemployment. If you pay for anything, you get more of it. People with unemployment insurance can hold out for better jobs, put off moving or other painful adjustments, and so on. The earlier paper points out that there are important general equilibrium effects as well. We should talk about how UI affects labor markets, not just job search.

Quick disclaimer. Let's not jump to "good" and "bad."  Searching too hard and taking awful jobs in the middle of a depression might not be optimal. Pareto-optimal risk sharing with moral hazard looks a lot like unemployment insurance.  Perhaps that disclaimer can settle down the tone of the debate.

But the question remains. How much?  How much does unemployment insurance increase unemployment? And the related macro question, just why did unemployment in the US suddenly drop coincident with sequester and the end of 99 week unemployment benefits?

Method is important. Too much media coverage starts and stops with "study finds unemployment insurance raises unemployment." And then the next day "study finds unemployment insurance crucial to stopping people from dying in gutters." If we focused on the facts, we'd all get along better.

In macro, we always are faced with the problem that interpreting time series, we never know what else changed. Sure, congress lowered unemployment benefits and the economy took off. But lots of other stuff happened. Maybe it's "despite" not "because."

This paper is part of a new breed trying to get around this problem by looking at cross-sectional evidence. Roughly, the evidence in this paper builds on the fact that Congress' action had different effects in different states.

Bob Hall described the strategy compactly:

They compare labor markets with arguably similar conditions apart from the UI benefits regime. In their work, the markets are defined as counties and the similarity arises because they focus on pairs of adjacent counties. The difference in the UI regimes arises because the two counties are in different states and UI benefits are set at the state level and often differ across state boundaries. The research uses a regression-discontinuity design, where the discontinuity is the state boundary and the window is the area of the two adjacent counties....

Table 3 contains the basic number, which the authors digest as

We find that a 1% drop in benefit duration leads to a statistically significant increase of employment by 0.0161 log points.  In levels, 1.8 million additional jobs were created in 2014 due to the benefit cut.

(Small complaint: economists should not write that jobs "were created," especially economists writing in the search, match and labor-supply tradition, to say nothing of passive voice and strong causal inferences.) I tried to digest the fact a bit more, but stopped here:

Column (1) of Table 3 contains the results of the estimation of the effect of unemployment benefit duration on employment using the baseline specification in Equation (6).

If commenters can vocalize the actual fact in words, fixed effects, controls and all, I'd be grateful.

Bob Hall echoes standard but important complaints.

The issues that arise in evaluating the paper are those for any regression-discontinuity research design: (1) Are there any other sources of discontinuous changes at the designated discontinuity points that might be correlated with the one of interest? (2) Is the window small enough to avoid contamination from differences that do not occur at the discontinuity point but rather elsewhere in the window?

In words, is there something else about state policies that changed at the same time in the "generous" vs. "stingy" states? And are counties really small enough to capture only the border effects?

The deeper issue in evaluating this paper, I think, comes from blowing the county results up to the aggregate, as Bob but it

The authors conclude that, absent the increase in UI benefits, unemployment in 2010 would have been about 3 percentage points lower.

The jump back from micro to macro isn't so easy either.  For example, suppose the expansion came from selling more goods from expanding states to contracting states. Then you'd see a micro effect but no macro effect. I don't think that's the case, but I have been skeptical about other papers jumps from micro to macro. For example, if the Federal government spends a trillion dollars in the desert, and a bunch of businesses move to sell donuts to the construction workers, you get a nice stimulus. That doesn't mean stimulus works for the economy as a whole.

This is a small nitpick. The basic fact is interesting, and I think a lot harder to dismiss.

It's interesting that so much of the pushback, both from Bob and from Mike Konczal's critical review comes down to theory, not the fact.

Update: Wednesday's Wall Street Journal covers the paper. The WSJ spends more time on the macro question, the claim that unemployment insurance actually boosts the economy via stimulus.