First,
Suppose that for some reason, the marginal value of many former employees in sector A has gone down nearly to zero. My contention is that whenever this happens, the marginal cost of sector A’s products should be plummeting…The spiffy new technology can only dislocate traditional production if it is so productive that it can outbid firms with access to this cheap labor. Maybe this will happen, but either way we should be seeing a huge decline in marginal cost.
I have a somewhat different perspective on zero marginal product. Remember that nowadays very few workers produce widgets. As Garrett Jones pointed out, they produce organizational capital. In the sense of the neoclassical production function, they are always ZMP. The decision to retain them or unload them depends on management’s assessment of the future value of organizational capital.
Suppose we take the example from Ben Stiller’s mediocre remake of the Walter Mitty story, in which Walter’s job is threatened because the print magazine he works for is looking obsolete. It’s not the case that if you could just bring down the marginal cost of producing copies of the print magazine, everything would be fine. The magazine has a dim future, regardless. To make matters worse for Walter, his skill set involves working with negatives from old-fashioned film cameras.
Second,
we don’t see huge relative price declines in the sectors that are losing workers due to some structural change. The auto industry, one of the very most cyclical industries in terms of output and employment, shows virtually no cyclical pattern in relative prices
The pre-1990 business cycles generally involved accumulation of excess inventories of autos and other durable goods. In hindsight, these seem like timing errors on the part of businesses. An inventory recession is not a permanent disturbance to patterns of sustainable specialization and trade. When the excess inventory has been worked off, you can recall the men on the production line.
The secular change to the auto industry in Detroit and elsewhere in the Midwest, due to more automation and stiff competition from overseas as well as from the South, is quite different from an inventory correction. In theory, the effect could be gradual, with Detroit shedding a few workers each year. In practice, the adjustment tends to be “lumpy,” with an entire plan shutting its doors forever, then a few years of little change, then another plant shutting down forever, etc.
the postwar experience is even more problematic for PSST. Including the prewar arms buildup, at the end of the war in 1945 the economy had just spent 4 to 5 years on an extreme military-oriented path, a vastly distorted pattern of production and consumption. Before that, there was the Great Depression, not exactly a normal time either. The transition to a relatively normal postwar economy following 1945, therefore, was an extraordinary adjustment
I agree, except that I want to be clear that I do not think of it as a transition back to a normal economy by pre-war standards. 1949 was very different from 1929. The agricultural work force has plummeted. The proportion of the work force with only an 8th-grade education has shrunk. The urban factory worker is giving way to the suburban sales clerk.
In my view, the key to the transition was the uprooting that took place during the War. After you have been shipped all over the country (or all over the world) and met all sorts of people from other backgrounds, you are not as committed to returning to that obsolete farm or declining small town or stagnating city. You are much more willing and able to move to where the opportunities are. My guess is that we had a particularly mobile society in the late 1940s, and this contributed to the surprisingly rapid establishment of patterns of sustainable specialization and trade.
But I agree that one of the more interesting questions of economic history is how the U.S. economy managed to undertake the transition to peace time so quickly and smoothly.
Another thought on low-marginal-value workers.
(No one of these things would change employment on the whole. But lots and lots of them, in a world of ever more global markets for ever more niche fields, perhaps does.)
It might be that workers are losing value (and employment) in sectors where automation is of low direct value, but the winner-take-all aspects of the web have changed the market. (Huge parts of the population listen to Lady Gaga all the time and never bother with the live band at the local bar, hence employment for non-elite live bands that used to make their living in local bars goes away.)
It has nothing to do with automation of production, and everything to do with automation and globalization of automation of distribution.
In addition to the war ending, a certain influential politician also died in 1945.
I also wouldn’t be surprised if companies use savings in large investment projects that require a large down payment.
If automation makes the marginal cost of distribution go down, then the most profitable way to give yourself an economic moat is to invest in advanced methods of production that allow you to create things that your competitors can’t.
I think observation bears out this prediction. Pharmaceutical and software companies epitomize high $$ investment/ low $$ distribution business models, and they’re always throwing money at large projects, not lowering prices.
I like the magazine example. In 2008, many construction workers were ZMP, simply because demand for new homes plummeted, but the marginal cost of building a new home did not fall toward zero. So there can be demand reasons for ZMP as well as method of production reasons.
As for post-WW2, it seems to me that there must have been a lot of low hanging fruit back home after the country had been at war so long and that could have allowed for the strong growth, even as new patterns of trade were being discovered.
The hardest part of PSST is figuring out what the consumer wants. Today it’s difficult to guess whether people want more twits or spacebooks or electric cars. But in 1945, after 15 years of consumers not getting what they wanted, it was very easy to figure out what they wanted.
So the huge quantities of capital and labor disinvested from the war could readily be set to producing things that people knew needed producing. The PSST patterns were written largely from scratch with a great deal of accurate knowledge.
One could also predict from this explanation a mild recession a few years later as the economy discovers that in the capital rush too many resources were set to producing the same items and not enough to produce other items. What did the US get in 1948? A mild recession.
yes, having a simpler economic structure makes it easier to find PSST
Of of the things that happened after WWII that doesn’t get much press is the relaxation of rationing and the gradual (nearly two years) abolition of the controls of the Office of Price Administration (OPA) (later reestablished as the OPS in the Korean War).
Because of the rationing, people were earning a huge amount of nominal money that they could not really spend on anything (especially if they were single and fighting in the war itself). A huge proportion of the population put almost all their savings into Liberty Bonds.
After the war, the government stopped borrowing so furiously, people had lots of disposable income, and the rationing was over. Also a lot of couples were getting married and women were getting pregnant (not always in that order).
The surge in consumer demand cause an abrupt and massive expansion the consumer sector, and it actually wasn’t that hard to retool a lot of that era’s production into consumer items – industrial technology being quite primitive and regulation being light meant very quick and easy paths from idea to product.
There was also a lot of ‘pent-up’ productivity enhancement innovations that had been building up during the Great Depression and The War. (See, e.g. Alexander Field’s, A Great Leap Forward)
Finally, because of domestic wage-controls (to avoid competition for labor that would undermine recruiting for the armed forces), companies tried to outbid their rivals through perquisites and in-kind benefits like tax-free health care. This benefit became almost ubiquitous and the tax cuts didn’t go away after the war, and this is what led to America’s unique employer-provided healthcare model.
But after everyone already had comparable health benefits (1940’s medical care was neither very expensive not had a lot of variance in value), then the only way to go back to business-as-usual and continue to compete via bidging up wages again.
What all this, and the fact that the government was so incredibly indebted (+100% GDP), would suggest to your economic intuitions is that there must have massive inflation to help this transition along.
Indeed there was! Consider the cumulative historical inflation rates for the following two 30-month periods.
Jan-1944 to June-1946: 5.5%
July-1946 to Dec-1948: 34.0%
That’s huge, and part of the reason the transition was so rapid. But it’s almost a sui generis situation and our more economy is simply too different to compare. PSST explains Newtonian Physics or Euclidean Geometry, but the post-WWII economy was Relativistic – outside the bounds of typical analysis.
Is psst a recent problem?
One remarkable thing about the economy back then was the simplicity of the economy. Allocating capital is harder today. This is a big signal in the rising wages of Wall Street.
Seventy years ago central planning sort of worked: figure out how much food, cloth, and steel and go from there.
One factor which may have guided the transition back into PSSTs after the Second World War was that there was the expectation among Americans that specializations had to change after the war. People might have therefore been more alert to changing their specialization than after errors in specializations during peacetime, when people don’t have the expectation that their specialization won’t go away at the end of the war.
My question is what effect did the Bretton Woods system have on post-war growth. More specifcally what does PSST have to say about money supply/credit supply?
Thanks so much for taking the time to respond. Some comments follow…
“I have a somewhat different perspective on zero marginal product. Remember that nowadays very few workers produce widgets. As Garrett Jones pointed out, they produce organizational capital. In the sense of the neoclassical production function, they are always ZMP. The decision to retain them or unload them depends on management’s assessment of the future value of organizational capital.”
This is a good observation, but I’m not sure that it addresses my concern. Suppose that output is a combination of two factor inputs, production labor and organizational capital (the latter of which is built up by organizational labor). Suppose further that neither of these factors is very mobile, at least in the short run – organizational capital is usually organization-specific, while the idea underlying PSST is that it takes a while to reallocate labor.
If an industry experiences sudden decline in output due to a competing product or technology, then effectively the industry-specific factor market has an excess of both factors, labor and organizational capital. The marginal cost of these factors should then fall dramatically. So unless there’s some reason that firms aren’t passing marginal cost through to prices, why don’t we see a large decline in prices?
I would understand if your contention was “when an industry goes into decline, almost all the job losses are of workers producing organizational capital – which will be less valuable going forward – and not of production workers; additionally, output does not decline immediately”. But this doesn’t seem true, since both output and employment of production workers fall dramatically and quickly during industry downturns. And as long as that’s true, prices should be falling.
Essentially, I’m saying that since industry-specific factor supply is inelastic in the short run, the induced supply curve is relatively close to vertical, and any quantity change should be matched by a large price change. And I don’t see how organizational capital really resolves that puzzle; in fact, arguably it accentuates it (because the stock of accumulated organizational capital is effectively inelastic in the short run).
By the way, although I do think organizational capital is wildly underrated, I am skeptical of the claim that “very few” workers directly produce goods and services, and that most produce organizational capital. I suspect that the enthusiasm of you and Garrett Jones for this view is partly colored by your own experiences – you are both high-level, high-intellect people that naturally gravitate toward roles and organizations where you mainly produce organizational capital, rather than being “directly” involved in production. But looking at the Occupational Employment Statistics data on jobs, for instance, it seems like a large fraction of jobs still involve nearly direct involvement in the provision of goods and services: http://www.bls.gov/oes/current/oes_nat.htm.
(Going down the list, this is true of most occupations in healthcare; protective service; food services; building and grounds cleaning and maintenance; personal care; sales; farming; construction and extraction; installation, maintenance and repair; production; and transportation. It is less true of things like business and financial occupations; computer and mathematical occupations; and architectural occupations. Of course, many jobs on the former list have some delay between labor effort and final production, so taken literally there is some accumulation of capital. But if this delay is measured in weeks or months more than years, it can be appropriate to abstract away from it and think of effort and final production as happening simultaneously.)
The gap between the (properly measured) book value and market value of corporations also places a bound on the size of the organizational capital stock, at least to the extent that book value does not reflect organizational capital. By some accounts, this gap is surprisingly small, and possibly even negligible. See, for instance, the flow of funds balance sheet data for nonfinancial corporations, which puts their “book” net worth at $19.6 trillion, virtually identical to the $19.3 trillion market value of equities outstanding. http://www.federalreserve.gov/releases/z1/Current/z1r-5.pdf
I am a little skeptical of these numbers because the assets category contains a huge contribution from “miscellaneous assets”, but still the upper bound on the total value of organizational capital does not seem to be that high. (Especially since there are other contributions to the equity valuation, like the capitalized stream of future monopoly rents.)
“The pre-1990 business cycles generally involved accumulation of excess inventories of autos and other durable goods. In hindsight, these seem like timing errors on the part of businesses. An inventory recession is not a permanent disturbance to patterns of sustainable specialization and trade. When the excess inventory has been worked off, you can recall the men on the production line.”
Inventories were an important part of the story, but even pre-1990 there were prolonged periods (from a couple quarters to a couple years) during which motor vehicle output was well below trend. See http://www.bea.gov/iTable/iTableHtml.cfm?reqid=9&step=3&isuri=1&910=x&911=0&903=268&904=1967&905=2013&906=q
What I don’t understand (without sticky prices/wages) is why during those times, prices did not fall substantially. After all, there was often plenty of excess capacity, suggesting that the marginal cost of capital was low. And with unemployed workers who couldn’t easily move to other sectors, the marginal cost of labor was low too. Why wasn’t this passed through into prices?
The only alternative I see is to claim that marginal cost didn’t really fall that much. Maybe workers on temporary layoff are fairly happy with their situation, due to the combination of unemployment benefits and extra leisure time; and maybe idle capacity offers an excellent chance for maintenance, etc. If so, then the marginal cost of using more labor or capacity during the bust might not be as low as I claim, in which case it’s not as much of a mystery why prices don’t fall. But I am skeptical that this is true to the extent that’s necessary.
The sticky price and wage hypothesis, on the other hand, accounts for the lack of cyclical movement in auto prices quite nicely, especially when you consider how the industry’s relatively lengthier production chains delays the transmission of prices.
“My guess is that we had a particularly mobile society in the late 1940s, and this contributed to the surprisingly rapid establishment of patterns of sustainable specialization and trade.
But I agree that one of the more interesting questions of economic history is how the U.S. economy managed to undertake the transition to peace time so quickly and smoothly.”
It’s possible that greater mobility contributed, but I become nervous when I see ad hoc explanations like this. (You could just as easily come up with facts pointing in the other direction. For instance, today modern communication and the internet disseminates information about opportunities much more rapidly than it did in the 1940s.)
I am happier when I see empirical regularities. One empirical regularity seems to be “if a shock creates higher demand for investment, then it produces an aggregate boom; while if a shock creates lower demand for investment, then it produces a bust”.
This (partly) accounts for (not claiming there weren’t other factors at work, which there definitely were):
(1) The Great Depression, which followed a massive capital accumulation boom in the late 1920s. Once people became aware that they had overestimated the demand for capital, there was a bust.
(2) The prewar boom (which restored the nation to full employment even before December 1941), in which anticipation of the war and impending scarcity and inflation produced an increase in investment demand for both military and civilian capital.
(3) The good postwar economy, in which the massive shortfall in civilian capital accumulated during the war led to an investment boom.
(4) The internet boom, as bubbly expectations led to high investment demand.
(5) The post-internet bust, as diminished expectations and an inherited capital overhang led to low investment demand.
(6) The post-housing bubble bust, as the inherited overhang of structures led to a huge fall in investment demand.
… and so on.
It is easy for me to see how this works in the Keynesian view – investment demand affects consumption too through multipliers, nominal rigidities limit the offsetting effects of general equilibrium price changes, etc.
It is very difficult for me to see how this works in the neoclassical view – since there, an investment boom in one sector will generally imply a decline in consumption and investment in other sectors, through general equilibrium effects. It’s tough to get comovement.
I’m not sure what to think about the PSST view. What worries me there, most of all, it’s that it’s not clear why we should expect an asymmetry – where the investment booms always result in overall economic booms, while the investment busts always result in recessions. It seems like the forces leading to *both* investment booms and busts should disturb established patterns of trade enough to result in some dislocation in your model. Perhaps you can argue that busts are bad because they tend to arrive more abruptly than booms, which results in a more sudden and difficult-to-absorb disruption, but I’m not sure that this is always really true – at least not true enough to account for the strong empirical regularity I’ve mentioned.