What is a Job?

Posted on by

In a recession, we speak of jobs being “hard to find” and “the need to create jobs.” As intuitively reasonable as these phrases seem, they run counter to conventional economics.

The goal of an economy is not to create work. What we want is higher productivity, which means that more goods and services can be obtained with less work.

The traditional view of the economic problem is that we have unlimited wants and limited resources. The folk Keynesian view is the opposite: we have resources that are superfluous because of limited wants (low aggregate demand).

When we focus on trade as the central principle of economics, we can resolve this tension. That is, we can explain a shortage of “jobs” even though the economic problem is to try to produce more with less.

The most striking thing about a modern economy is specialization. Most of us produce goods or services that cannot be directly consumed. And all of us consume goods and services that we could not possibly produce.

As an individual, I earn a living by doing a few tasks that do not produce a single item that I consume. Instead, my few tasks allow me to exchange for goods and services that require many tasks. Think for a moment about all of the tasks required to produce a pencil or a toaster.

How many tasks go into the production of the goods and services that I consume in a single day? My guess is that the number is in the millions. And yet I only have to perform a few tasks myself in order to earn the means to obtain these goods and services. That is the miracle performed by complex patterns of specialization and trade.

So I arrive at this definition of a job:

A job is a context for performing a particular small set of tasks that can be exchanged for the means to obtain goods and services produced by a far larger set of tasks.

This definition of a job is consistent with the ordinary intuition that jobs must be “created.” You cannot just do any random set of small tasks to earn the means to obtain the goods and services of the market. That is why I do not define a job as the set of tasks. Instead, I define it as the context in which those tasks are undertaken. Without a context in which the set of tasks adds value, there is no basis for exchange. In order to have a job, you or an employer must discover a context in which sufficient value is created by a particular set of tasks that you are capable of performing.

This definition avoids the suggestion that jobs are lacking because of a scarcity of wants. It also avoids the suggestion that the labor market should be described as a “matching problem,” with employers and potential employees in search of one another. It is a definition of a job that reflects the importance of patterns of sustainable specialization and trade.

Michael Strong Asks a Question

Posted on by

He asks,

Has Romer “thought seriously” about a large scale government that can put people in jail? Not to mention ubiquitous police abuse and civil rights violations.

Apparently, Paul Romer is skeptical of private police forces.
My thoughts:

1. Suppose I were to fly to Honduras for a vacation, and I encounter individuals in uniforms who have the power to enforce laws, including putting me in jail. Would I prefer that those individuals be employed by elected officials or by a private corporation? It is not obvious to me that I should place more confidence in the former.

Actually, I think that most people are like Romer in that it does appear obvious to them that police accountable to elected officials will be more trustworthy than private police. This could be a self-fulfilling equilibrium. If people believe that their voice gives them status under a state, they may be more inclined to obey the laws of that state. When people confer legitimacy on the police and the state, the police need to employ less violence in doing their jobs. This reinforces the trust that people place in the state.

2. FOOL rules. I think that the issue of the power to put people in jail illustrates the importance of Fear Of Others’ Liberty. When one thinks of it as “the power to put me in jail,” it seems hard to trust anyone with that power. But when one thinks of it as the power to put an incorrigibly destructive person in jail, one wants someone to have that power. For example, I bet that if you took a public opinion poll after the non-stop television coverage of riots in Baltimore, the support for police incarcerating those involved would have been overwhelming.

Because of FOOL, I think that most people are willing to tolerate the existence of police and of punishment, including incarceration. I think that once you accept that those institutions will be present in a society, the best one can hope for is that laws are just and that they are justly enforced. I do not think that we can reach an ideal in practice, but I would like to see competitive forces at work. It seems to me that if we had competitive government with free movement of people and businesses, then perhaps places where laws are unjust or enforced capriciously would tend to lose population. Or perhaps one might see a pattern where different laws are considered just by different cultures.

3. If you think about how people actually choose where to live, they tend to place a high priority on avoiding areas with reputations for a lot of crime. This tends to produce a population distribution in which some areas are safe and affluent, while other areas are relatively dangerous and also poor. Police work in the former is relatively simple, and police work in the latter is relatively difficult.

4. As an aside, note that the three-axes model has predicted the reactions to the events in Baltimore among progressives, conservatives, and libertarians with uncanny accuracy.

Reading David Brooks on Character

Posted on by

After downloading his new book, The Road to Character, I started by skipping to his concluding chapter, where he writes,

The things we call character endure over the long term–courage, honesty, humility. People with character are capable of a long obedience in the same direction, of staying attached to people and causes and callings consistently through thick and thin…They are anchored by permanent attachments to important things. In the realm of intellect, they have a set of permanent convictions about fundamental truths. In the realm of emotion, they are enmeshed in a web of unconditional loves. In the realm of action, they have a permanent commitment to tasks that cannot be completed in a lifetime.

…Wisdom starts with epistemological modesty. The world is immeasurably complex and the private stock of reason is small. We are generally not capable of understanding the complex web of causes that drive events. We are not even capable of grasping the unconscious depths of our own minds. We should be skeptical of abstract reasoning or of trying to apply universal rules across different contexts…The humble person understands that experience is a better teacher than pure reason. He understands that wisdom is not knowledge. Wisdom emerges out of a collection of individual virtues. It is knowing how to behave when perfect knowledge is lacking.

As to whether I will like the entire book, I am worried about two things.

1. The reviews I have read are bland and uninteresting. An interesting book should provoke interesting reviews.

2. My instinct was to skip over the meat of the book, which is his biographical sketches of people whose character he admires. When I get around to reading those, the question is whether I will find them rewarding.

Real Interest Rates and Secular Trends

Posted on by

Commenter Handle writes,

There’s nothing an entrepreneurial employer can buy to augment his workers to increase their labor productivity. They’re no equipment or anything for him to invest in. There’s no point: labor productivity in NCH sectors cannot be increased.

Well, computers can increase productivity in health care and education, but I get the point. It’s not like you can buy equipment that makes humans 10 or 20 times more productive. Barring strong AI, the only way to make humans much more productive in the NCH sectors is to dramatically re-organize the process, and that does not require a big investment in equipment.

Another trend is the drop in labor force participation. If people do not want to work, then you do not have to buy equipment for them to work with.

But suppose that you could tell stories about trends that imply low interest rates. At some point, low interest rates should make capital projects really attractive. That leads me to the suggestion that risky investments still fact high interest rates, and it is only government debt that enjoys low interest rates. And that leads me to the further suggestion (which I think I can find in Rogoff) that government debt is crowding out investment.

Without government debt to work with, financial intermediaries would have to satisfy the demand for safe, liquid assets by undertaking maturity transformation and risk pooling. That is what financial intermediaries do. But with so much government debt awash in the system, the public’s need for safe, liquid assets is satisfied without financial intermediaries having to do any sort of transformation at all.

What’s Wrong with Keynesian Economics?

Posted on by

It looks like I will be contributing to a set of essays on this topic. Here is what I am thinking of in terms of an outline.

1. What is Keynesian economics?

I think that there are two important versions. There is the folk Keynesianism of policy makers and journalists, and there is the academic Keynesianism of graduate school and peer-reviewed papers. When pressed to give a narrative interpretation and discuss policy, economists tend to fall back on folk Keynesianism. When other economist object to some basic flaws in folk Keynesian economics, macroeconomists fall back on academic economics. In Greg Mankiw’s terminology, the policy engineer does not make use of the scientific paper, but he can pull a copy out of his back pocket if somebody asks to see it.

What I call Folk Keynesianism is what is used in narrative interpretation and policy discussions. Spending creates jobs and jobs create spending. The Folk Keynesian economy is one in which the price mechanism for adjustment and clearing markets has disappeared. Instead, quantities determine other quantities.

The other version is what I call academic Keynesianism. Think of it as an attempt to introduce re-introduce prices into an otherwise Keynesian economy. You start with Hicks sneaking the interest rate back in as a determinant of investment. Then you have the Phelps volume sneaking the real wage back in as a determinant of employment. Then you have the Lucas critique, which is answered by bringing in intertemporal optimization. You end up with Blanchard’s “state of macro” paper.

2. What is the alternative?

PSST, of course, which interprets macroeconomic phenomena as the problem of coordinating in a world of very complex trading patterns. Compared with folk Keynesianism, PSST fails to offer as compelling a basis for a narrative interpretation and policy discussions. If you want a satisfying narrative that probably is false, then stick with Keynesianism.

3. What can we learn from the data?

There are at least two problems with macroeconomic data. One is the fact that it is non-experimental. We cannot test important hypotheses against one another. It is easy to impose competing narratives on the same data. I might also mention Leamer’s attempts to document patterns in the data.

The other problem is that the classification and aggregation of data is questionable. According to economic theory, education is an investment. But in the national income accounts, what consumers spend on education is called consumption. What government spends on education is government consumption. And even what businesses spend on training is not typically included in investment. If I buy a cell phone for my household, it is consumption. If my company buys me a cell phone, it counts as investment. Much of what is counted as labor income in the national income accounts is actually a return on investment. The concept of “the real wage rate” is ridiculous. Neither the numerator nor the denominator is the same across individuals. Aggregate productivity statistics are also ridiculous.

4. Where did Keynesian economics go wrong? I think it focused too much on (the lack of) price adjustment, and not enough on trial-and-error adjustment. And, more fundamentally, I think it errs by thinking in crude aggregate terms. The economy is not one giant GDP factory. It is a pattern of specialization and trade.

The Middle Man as Information Processor

Posted on by

Suppose that I am one of three boys at a summer camp. Each of us receives an identical care package, consisting of two bags of pretzels and two boxes of apple juice. I like pretzels and apple juice, but boy A only likes apple juice and boy B likes only pretzels. I trade one bag of pretzels to A for two boxes of apple juice. I trade one box of apple juice to B for two bags of pretzels. [OOPS. This was backwards. I trade the apple juice to A and the pretzels go B] Everyone is happier after the trading, but I wind up with three bags of pretzels and three boxes of apple juice.

How did I end up with so much, without producing any apple juice or pretzels myself? What I did was process information. I used the information about the preferences of the other boys to make them better off while earning a profit for myself. Some further remarks:

1. Because the middle man is an information processor and not a producer, his role is often resented. People talk about eliminating the middle man. But you cannot eliminate the middle man without coming up with an alternative way to process the information.

2. There is a classic article by R.A. Radford, called The Economic Organization of a P.O.W. Camp. See also Michael Munger’s essay.

3. There is often competition, involving multiple middle men. They may use similar methods, or they may use very different methods.

4. Because they are information processors and because there is competition, middle men need to be mentally sharp.

5. Finance is to a large extent a middle-man industry.

The Central Principle of Economics

Posted on by

Trade is almost always good.

I want to propose that as the central principle of economics. More on that in other posts. In this post, I want to talk about how trade might be bad or might be perceived to be bad.

1. If you hold a gun to my head and demand something, that is bad. In fact, I would say that does not even count as trade.

2. If I buy on the basis of fraud or deception, then the trade is bad. Florida swampland. Snake oil.

3. What if I was not deceived, but afterward I regret the trade? In 1964, the Chicago Cubs traded Lou Brock to the St. Louis Cardinals for Ernie Broglio. The Cubs came to regret that trade. I have made some investments that I regret. But in my view there is nothing unfair or morally wrong about trades that someone later regrets making.

4. What if you are in the desert in danger of dying of thirst, and I offer to sell you a bottle of water for $1000. Is that a bad trade? I would argue that what is bad is the circumstance in which you find yourself, but the trade itself is legitimate. I would argue that even more strongly in the case of buying clothing made in a sweatshop. Assuming that the worker chose to work in a sweatshop over other alternatives that were worse, it is not a bad trade. For more on this issue, I recommend this podcast with Russ Roberts and Michael Munger.

5. Is it bad to trade with people whose cultural or political views you dislike? A lot of people feel that way, but the opposite might well be true. Suppose that you choose to trade solely on the basis of profit. Clearly, that makes you better off. Also, by not discriminating against others on the basis of ethnicity or culture or politics, you are probably helping to make the world a better place.

6. In fact, trade is probably best when it is impersonal. The closer you are to a person, the more doubtful trade becomes. I would not recommend to parents that they pay children to help around the house. Instead, I would recommend telling children that you consider it their responsibility to help around the house (and being specific about what that means).

7. Trade involving a person’s body makes people squeamish. We do not want people selling themselves into slavery. Many people, although not all, oppose prostitution. Many people, although not all, oppose the sale of drugs like heroin or cocaine. Many people, although not all, oppose allowing people to pay for organs to be used in transplants. Among economists, there is more support for legalized prostitution, drugs, and a market for organs than there is in the general population.

8. It could be that one of the reasons that we rely heavily on third-party payments in health care is that we are squeamish about trade that pertains to the body. We prefer to think of the doctor as offering the gift of healing rather than as someone making a trade.

Hayek and Business Management

Posted on by

Chris Dillow writes,

If extensive knowledge is possible, then bosses might be able to manage big companies well. If not, then centrally planned companies will be inefficient. Sure, perhaps competition will eventually weed out egregious incompetence, but market forces might not grind so finely as to eliminate all inefficiency

Pointer from Mark Thoma.

I cannot emphasize enough how much I agree with this. Because I spent 15 years in business, I got an opportunity to see large organizations close up. I saw that in a large business, the top management cannot keep track of more than about three major initiatives at a time. I saw that compensation systems have to be frequently overhauled, because employees learn to game any system that stays in place for more than a couple of years. I saw the “suits vs. geeks” divide, as specialists in information technology or financial modeling had difficulty communicating with executives who had only general knowledge.

The notion of large, efficient organization is an oxymoron. If you think that large corporations have overwhelming advantages, then you have explained why IBM still dominates the computer industry, while Microsoft and Apple never really got amounted to much of anything. I like to say that if you are afraid of large corporations then you have never worked for one.

Of course, large corporations do exist. That is because as clumsy as they are, they can still be less clumsy than the alternative, which is to break a corporation into a network of contractually related divisions. Nobel Laureate Oliver Williamson tried to address the issue of when to expect a market and when to expect a hierarchy. His answers do not really speak to me, but I do not claim to have better ones.

I do think that government often tilts the scale in favor of large organizations. The high fixed cost of regulatory compliance is one factor. Government has been a key customer in industries like aerospace, information technology, and finance, and the fixed costs of selling to government are very high, because of all of the hoops that you have to jump through.

Joseph Heath on the Roots of Conservatism

Posted on by

He writes,

There is of course a much-observed tension between the cultural-evolutionary and the free-market versions of conservatism, particularly since the untrammelled free market is the most effective device for destroying traditional institutions that has ever been devised by man. Most of what cultural conservatives and religious fundamentalists hate about the modern world – the rootlessness, hedonism, crass commercialism, loose sexual morality, anti-authoritarianism, and general lack of discipline – is either a direct product of the market, or is a tendency that is dramatically amplified by it. What brings the cultural and the market conservative together is the conviction that these unplanned processes are better than the alternative, which is “social engineering” in the rationalist style.

Read the whole thing. I arrived at it starting from Alex Tabarrok’s link.

Thinking about the quoted paragraph in terms of the three-axes model, I would say that there is a tension about markets in the civilization vs. barbarism axis. A conservative would view productive work as civilized, and markets encourage productive work. However, a conservative would worry that consumer tastes are barbaric, and markets work to satisfy consumer tastes.

Another way in which the market process is civilized from a conservative perspective is that businesses fail. Failure builds character because it reinforces humility. It keeps us from developing too high an opinion of ourselves as individuals or of humanity as a whole. (David Brooks’ latest book, The Road to Character, which I have started reading, seems to stress humility.) In contrast, progressives seem to see government as a tool to eliminate all forms of failure.