Investment and Employment

Reacting to my post on capital-labor substitution, reader points me to this analysis.

This excess rise in the capital-labor ratio highlights the negative effect of Federal Reserve
policy on wages and unemployment. The persistent, extremely low interest rates are
keeping real wages from climbing and retarding the rate of hiring. The Federal Reserve is
making unemployment worse than it has to be.

Putting on my macro hat, I would say that we are talking about too many endogenous variables here, meaning variables that depend on what is happening to other variables. The capital-labor ratio depends on investment and on hiring decisions. The real interest rate depends on supply and demand factors in the capital market. And so on.

In general, when investment is high, you might expect the demand for labor to be high. This could be because capital and labor are complementary. Even more, from a textbook Keynesian perspective, investment is spending, spending is economic activity, and more economic activity means more employment. The late 1990s exemplify this, with strong investment and a high ratio of employment to population.

Again, from a Keynesian perspective, one expects in a slump that hiring will be low, investment will be low, and real interest rates will be low. All of these are endogenous to whatever caused the slump.

Now, let me put on a PSST hat, meaning that I look at the economy entirely from a structural perspective, not from a Keynesian perspective. I would say that for the past fifteen years, we have seen both capital-labor substitution and factor-price equalization. Both of these require a reallocation of labor. This is not taking place very quickly. What are the reasons? Some possibilities:

1. Weak incentives for the unemployed to take jobs that require a loss of status or an adverse relocation. Older unemployed people can collect disability. Younger unemployed people can live with their parents.

2. Unusually few fast-growing firms. Perhaps entrepreneurs are not finding ideas that pan out. Perhaps when things pan out they are finding ways to grow quickly without adding thousands of workers (think of Internet businesses).

3. Perhaps the labor-leisure choice is being driven by attitudes about health insurance. If you really care a lot about health insurance, you take a job, even if you think that the take-home pay is barely worth it. The same deal gets turned down by someone who does not value health insurance. With the health insurance component of compensation so high these days, this can be important.

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3 Responses to Investment and Employment

  1. Ajay says:

    Using PSST, I’d say it’s a double whammy. Manufacturing jobs dropped by half during the last 30 years, with a huge slide in the last decade and service jobs that can be offshored, like call centers or back-office work, are going away. Meanwhile, the successful tech firms pride themselves on their extremely high profit per employee, outsourcing whatever they can to low-wage workers, largely abroad. Between the two trends of globalization and automation, american jobs are caught in a vise, squeezing them out.

    I think there is a lot of scope for new information work in the coming years, but the tech companies that could enable this are simply too dumb to do so. When it inevitably happens, they are as likely to be toppled as everybody else.

  2. George says:

    You REALLY missed the 600 pound gorilla argument: That the broad range of government policies and regulations plus the enormous growth in government control in monetary and financial areas have created an environment where business owners and managers are being incentivized or scared into substituting automation or other capital investments for labor. I personally know many business owners that are not confident about the future, so any business growth is primarily met with productivity improvements, or, at best, with hiring of part time workers. The general feeling is that this recovery is based upon money printing and debt, and is not based upon real organic growth.

  3. Thomas DeMeo says:

    I see us as being slowly bogged down over time by a relentless desire to increasingly manage risk, combined with the fact that our population is living longer. The more social and personal problems we prepare for, the more risks we hedge against, the more it saps the upside to any entrepreneurial efforts. A startup today will spend much more time and money dealing with various risks than a startup did 30 years ago.

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