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Source link: http://archive.mises.org/13616/13616/

Affording the Unemployed

August 18, 2010 by

Keynesians fear that a weak fiscal and monetary response will cause the presently cyclically unemployed to become so permanently. But is long-term, involuntary structural unemployment even possible? FULL ARTICLE by Jonathan M. Finegold Catalan

{ 26 comments }

The_Orlonater August 18, 2010 at 8:52 am

Unemployment benefits also prevent mobility of the labor force. The reservation wage might higher in other parts of the country, but if unemployed benefits incentivize the unemployed to stay in their geographic area looking for the absolute best offer, then it stalls recalculation.

Nick Bradley August 18, 2010 at 10:12 am

Excellent point! If it weren’t for unemployment bennies, food stamps (SNAP), and section 8 housing, the unemployed would migrate to metro areas with lower unemployment rates to take advantage of the unemployment rate arbitrage. See the link below for unemployment rates by City.

Most of the cities at the top of the list are smaller, but greater Omaha-Lincoln has an unemployment rate of 5 – 5.5% and has over 1.25 million people (combined). Quality of life in Omaha is pretty high as well (used to live there). But the government has people SNAP-ing it up in subsidized housing in Las Vegas instead

http://www.bls.gov/web/metro/laummtrk.htm

saltmanSPIFF August 18, 2010 at 9:08 am

Your analysis is clear and cogent, but I believe you underestimate the psychological effects of unemployment. As you noted, this prolongs an unemployed worker’s search period due to the worker’s reluctance to take a job with a nominal wage rate below that which he or she previously received. This, combined with the insider-outsider problem which Bryan Caplan has recently emphasized (frictions between old workers who survived downsizing and new workers who accepted a lower wage rate, which leads to loss of morale and productivity for the firm) can lead to a sufficiently high degree of wage stickiness, which lends weight to the orthodox New Keynesian business cycle models.

As a fellow free-market thinker, I applaud your effort to highlight the shortcommings of modern economic orthodoxy, but if your goal is not just to explain, but to convert the marginal reader, I believe including an explanation of the effects listed above would go a long way in terms of persuasion.

Nick Bradley August 18, 2010 at 10:15 am

The rift between new and old workers is also a function of savings.

A 30-year old with a family and no real savings has a much lower reservation wage than the 50 year old with a decent rainy day fund.

P.M.Lawrence August 18, 2010 at 11:06 am

Higher, actually. Sure, he is more desperate for work, but he is also more desperate for a higher wage to cover all his needs; the worker with a rainy day fund can afford to take a wage lower than what would enough in the long term while he hung in there waiting for better conditions.

Nick Bradley August 18, 2010 at 11:50 am

I disagree; a rainy day fund has the same impact as extended unemployment benefits — and those raise the reservation wage.

Jonathan M. F. Catalán August 18, 2010 at 12:07 pm

This works both ways. While true to a degree, it’s also quite possible that expecting no greater wage in the future, an individual with a relatively high cost of living (relative to his prospective wage) will decrease the cost of living (finding cheaper rent, eating less expensive food, or what have you). If the individual has no expectations for a higher wage in the future, thus lowering his reservation wage, maintaining a relatively high cost of living is counterproductive (if you can’t survive without a wage past point X, then no matter what your present living costs are, you are going to have to accept a wage).

On the other hand, an individual who can survive on his own for longer has that extra period of time to seek a higher wage without risking his livelihood.

P.M.Lawrence August 18, 2010 at 11:03 am

“Free-market economists adamantly disagree with the notion that mass unemployment is possible in a completely free labor market. Ludwig von Mises went as far as to claim that in a free market such thing as involuntary unemployment is impossible, since if one offers his labor for low enough a price he will always find a buyer… In short, outside of the existence of imperfect information, in a free-market the only limitation to employment is an individual’s reservation wage.”

The first two sentences are false, because they do not allow for that reservation wage, and it may anyway be too high for the labour market to clear even if it is near enough a free market (which it isn’t); people have to hold out for wages they can survive on, and the labour market clearing wage can be lower than that. That is why “Generally speaking, involuntary unemployment must be a product of government interventionism… High long-term unemployment today has to do, not with unsolvable structural unemployment problems, but simply with government intervention in the form of price floors and benefits, which raise the reservation wage” is false in general – though, of course, it has aggravated the problem, and it can be argued that previous government interventionism is at fault for the effect of its past actions stopping people now having enough independent resources to be able to fend for themselves.

“At its basis, involuntary unemployment is a product of disequilibrium between demand for labor and supply of labor, where the aggregate price of labor is too high relative to the aggregate demand for labor. It stands to reason that such disequilibrium is likely to happen in the event of a cyclic fluctuation and from there we can logically deduct [sic] that the most efficient remedy to high unemployment is a fall in wages.”

No; all that that would imply is that the most efficient remedy to high unemployment would be a fall in the marginal cost of labour to employers, which is not the same thing. Actual wage subsidies or virtual ones through tax breaks could achieve that effect without falling real wages (provided things didn’t hit Malthusian limits).

“Such unemployment is actually voluntary in nature, because while the individual may not be able to find a job with similar pay to his last, there are nevertheless employers looking for labor in industries that require less skill, even if these employers therefore offer a lesser wage. Or an employer may offer the individual a lesser wage, but in exchange offer him the relevant training necessary to acquire the demanded skills. The individual rejects this offer because it is under his reservation wage. As such, this type of unemployment is firmly voluntary… Ultimately, all unemployment — except that produced by imperfect information or disequilibrium — is voluntary… Long-term, involuntary structural unemployment is therefore virtually impossible.”

All that is nonsense, because that reservation wage is not a voluntary choice, so that even if any one would be worker could find a job that way, not all could; supposing otherwise is a fallacy of composition.

“Above, we established that structural unemployment is characterized by people who are unemployed with nontransferrable skills”.

While not a complete nonsense, that is a complete mistake. The fact that such people constitute the long term unemployed is in part an effect of that long term unemployment, and in part the fact that the least employable will naturally enough become unemployed preferentially. Training them up, under conditions of structural unemployment, will only move them ahead of others in the hiring priorities – others will be unemployed instead. There may be a small reduction in the total number of unemployed, but this is not the main driver. That is just precisely what the post-war recovery should tell us, what with improvements then not coming from people having acquired new and relevant skills.

“Assuming an economy beset by general government intervention, wage-related price floors, and extended unemployment benefits, the only sensible method by which to approach full employment is fostering wealth creation… Discarding the possibility of a change in public labor policy, the only means of restoring equilibrium in the labor market is through a sustainable increase in aggregate demand for labor — an increase in private investment.”

This is also wrong, in two respects. First, it is a necessary but not sufficient condition for more employment (that is, without infrastructure there would not be enough to work on). Second, even when there is enough infrastructure, and even without continuing government intervention, there is still the issue of a natural minimum reservation wage stopping all of them getting good enough work (if people can’t get that, they will either need adequate unemployment benefits, die or turn to crimes of necessity – all of which create external costs, a market imperfection).

Jonathan M. F. Catalán August 18, 2010 at 12:03 pm

PM Lawrence,

The first two sentences are false, because they do not allow for that reservation wage, and it may anyway be too high for the labour market to clear even if it is near enough a free market (which it isn’t); people have to hold out for wages they can survive on, and the labour market clearing wage can be lower than that.

This has nothing to do with the two sentences you are criticizing, and in fact this exact point is argued in the article. But, not accepting a job because the wage doesn’t meat your reservation wage is voluntary, not involuntary, and it’s not fair to claim that high reservation wages would cause mass unemployment.

So, rather than categorizing something you disagree with as “false” (when it’s not), why not think a little harder about the criticism you are presenting against it? Otherwise, it just makes you look bad.

High long-term unemployment today has to do, not with unsolvable structural unemployment problems, but simply with government intervention in the form of price floors and benefits, which raise the reservation wage” is false in general – though, of course, it has aggravated the problem, and it can be argued that previous government interventionism is at fault for the effect of its past actions stopping people now having enough independent resources to be able to fend for themselves.

This is, more or less, what this article sets out to argue. I have a feeling that you’re trying to prove the article wrong to tout your own intelligence, when in fact most of what you say is agreed upon in this same exact article.

I don’t mean to come off as particularly hostile. It just irritates me when someone starts off a wall of text with the words “false”, and then repeats pretty much what the article in fact says.

No; all that that would imply is that the most efficient remedy to high unemployment would be a fall in the marginal cost of labour to employers, which is not the same thing. Actual wage subsidies or virtual ones through tax breaks could achieve that effect without falling real wages (provided things didn’t hit Malthusian limits).

There are various ways of making labor for affordable. I didn’t discard any. I simply claimed that a fall in wages is the most efficient method. Again, this all stinks of pedantry.

All that is nonsense, because that reservation wage is not a voluntary choice, so that even if any one would be worker could find a job that way, not all could; supposing otherwise is a fallacy of composition.

In what ways is a reservation wage not a voluntary choice? If one worker chooses not to accept a certain job, because the wage is below his reservation wage, then the choice was voluntary. Even if the reservation wage is based on costs of living, those costs of living are also voluntary.

While not a complete nonsense, that is a complete mistake.

The only nonsense is the way you address others, by the way. In any case, this is the classical definition given in a university macroeconomic class.

The fact that such people constitute the long term unemployed is in part an effect of that long term unemployment, and in part the fact that the least employable will naturally enough become unemployed preferentially. Training them up, under conditions of structural unemployment, will only move them ahead of others in the hiring priorities – others will be unemployed instead. There may be a small reduction in the total number of unemployed, but this is not the main driver. That is just precisely what the post-war recovery should tell us, what with improvements then not coming from people having acquired new and relevant skills.

The article doesn’t claim anything that is in direct contradiction to this. The “nonsense” you’re talking about is nonsense you’re pretending the article is claiming.

First, it is a necessary but not sufficient condition for more employment (that is, without infrastructure there would not be enough to work on).

Private investment does not manifest itself only in the development of infrastructure.

Honestly, most of the criticism presented is pedantic and against notions that were never expressed in the article.

Predrag August 18, 2010 at 1:22 pm

I think you are more likely to survive on some wage than on no wage. You can only hold off for a better wage if someone is willing to give you money for waiting. The fallacy of “insufficient” wages becomes clear when the government goes bankrupt (and even printing money cannot help if the people refuse to use that money). Then, the only way to survive is to cooperate with other people in return for a mutually agreeable compensation. To those who say this is impossible, I can only say – I have a story for you, and it is not a sad story.

Matthew Swaringen August 18, 2010 at 2:27 pm

Those who can’t make a “living wage” due to not being able to meet their higher reserve wage can choose to cohabitate in order to make the unlivable wage livable.

It’s not impossible, and it’s been done throughout history.

Ben Ranson August 18, 2010 at 11:09 am

It appears to me that chart labeled, “Relationship between the duration of unemployment… market’s best offer” presents the “best offer” line in a problematic fashion.

I think that there are really several ways that this line could be drawn.

1) From the perspective of the evenly rotating economy. Other things being equal, I would suggest that the “Best Offer” line run straight, parallel with the “Duration of Unemployment” axis. The dollar price chosen would be the marginal value of the worker’s labor, which neither increases nor decreases with time. This, in my opinion, would have been the best option for this essay.

2) If we make the model slightly more complicated, in which the worker and his potential employers are initially ignorant of the marginal value of his labor, then the “Best Offer” line could begin at any positive point on the “$” axis below the line presented above as “1)”. The “Best Offer” line should then run upwards asymptotically towards this line which represents the marginal value of the worker’s labor. The “Best Offer” line should intersect this line “1)” at the exact point that it intersects the worker’s “Reservation Wage” curve. Of course, even this line would represent a simplification of the situation.

What the line should not do is to continue upwards beyond the point at which it intersects the “Reservation Wage” and “1)” lines. This is because, in the evenly rotating economy, as “equilibrium” is achieved by approximation, the employer will slowly become aware of the various investment options available make bids closer and closer to the marginal value of various factors of production.

Jonathan M. F. Catalán August 18, 2010 at 12:05 pm

The graph is redrawn from an almost exact graph provided by Vedder and Gallaway in their book on unemployment. They were not studying the economics of unemployment in an evenly rotating economy.

Walt D. August 18, 2010 at 1:30 pm

Here is my six eggs worth.
1. In most states, for the first six months, unemployment insurance is what is says – insurance – you and your employer pay for it and if you become unemployed you make a claim. I would no characterize this as a government handout, since in principle, it could be replaced by private insurance. (Granted, you would still have the State Insurance Commissioner to deal with).
2. The actual unemployment rate is not 9% or 10% – under the usual definition it is over 20%. The U3 figure has been constructed to “define away” certain categories of unemployed. The U6 figure, still more restrictive than the Great Depression statistic, is 17%.
3. When the Federal Government steps in and pays extended benefits, from the Keynesian perspective, the unemployed just become another category of Federal employee. (You can consider that they are digging and filling in “virtual holes in the ground” – a perfectly reasonable Keynesian economic activity.)
4. When all is said and done, it is the private sector (and overseas investors) that are paying for the public sector. As the private sector shrinks, and money from overseas dries up, the public sector will become unsustainable -it could be argued that it is already past the point of no return.
5. Human Action indicates that people act purposefully. Behavioral Science indicates that if you encourage something you will get more of it; if you discourage something you will get less of it. The current system rewards not working, and discourages working through high taxes and onerous regulation. This is a recipe for bread lines.
6. There is no rule 6! (Monty Python)

Jonathan M. F. Catalán August 18, 2010 at 1:47 pm

Walt D.,

Good points all around. A couple of comments, though. Regarding unemployment insurance, I basically agree, but I feel that for most lower-wage jobs this unemployment insurance is government mandated. From personal experience, I feel that for the most part low-wage earners rather keep the entirety of their wage, rather than pay into some public unemployment insurance scheme. For those with more to lose in case of losing their job, I think your point holds a lot of merit. On the other hand, savings acts as an insurance without having to pay a third party insurer, so that should be considered, as well.

On the actual unemployment figure, Robert Higgs suggests that U3 is the most accurate assessment and that U6 is not closer to the unemployment measuring mechanism of the Great Depression. See: “Will the Real Rate of Unemployment Please Stand Up”.

Walt D. August 18, 2010 at 2:56 pm

Jonathan,
Thanks for the comments and the link to Robert’s article. You can get an alternative opinion at John Williams “ShadowStats”. My own gut feeling is that things are a lot worse than U3, just from talking to people I know – everybody knows somebody who has been out of work and looking for a job for a long time and can’t find anything.
I also agree with your overall assessment. In fact, most people who are unemployed and receiving benefits do not even start to look for work until the month in which the benefits are due to expire. When I lived in Seattle, people laid off from Boeing would use the time to paint their houses, waiting for things to pick up rather than look for another job.
The two things that persuade me that things are not quite so rosy are 1) Tax Receipts 2) Social Security Trust Fund Balance. Tax receipts are way down – these are very difficult to fudge. Payroll tax receipts are down. If people are not working the do not pay FICA and neither do their ex employers. Also, professional people who are 62 and over, and who cannot find what they consider to be suitable work, are opting for early retirement. Thus Social Security if now in the position of paying out more than it is taken in – no surplus anymore for Congress to loot and no phony balanced budget.
BTW the economy is not creating enough jobs to accommodate new entrants into the work force. These people, who opt to stay at home or enroll in college or stay in college do not show up in any unemployment statistics.

Rcder August 18, 2010 at 2:33 pm

So, being relatively new to Austrian economics (and economics in general, for that matter), I have a question about falling wages that I hope someone can help answer.

From my understanding of the Austrian business cycle theory, during the “boom” period, wages, production goods, and land will be bid up to unnaturally high prices because of the artificially low interest rates created by expansionary credit policy. Eventually, prices will be bid up to a point where the average consumer soon finds that his savings have become to erode, panic sets in, businesses realize the malinvestment that has taken place, and the “bust” sets in.

So here’s where my question comes in. During the “bust” phase of the cycle, workers are laid off because their employers can no longer afford to pain them at such a high wage rate, and the price of land and goods decreases so that the market can clear (too high of a supply with too low of a demand). And now we have widespread unemployment. Because, as stated previously, companies will not pay workers at their former reservation wage, there will be unemployment until the reservation wages of the workers decreases to a point where companies find it profitable to employ them again. So my question is this; how, if ever, will wages begin to rise again? Once the market starts to grow naturally (i.e. without the expansionary credit policy), will companies again start to “compete” for workers, increasing the wage rate? What will make this increase in wage rates more sustainable than the increase during the “boom” period of the ABC?

Thanks for taking the time to read and answer what turned out to be a few questions. If my understanding of the Austrian business cycle is flawed, I welcome your corrections. Thanks again.

Jonathan M. F. Catalán August 18, 2010 at 2:46 pm

Rcder,

From my understanding of the Austrian business cycle theory, during the “boom” period, wages, production goods, and land will be bid up to unnaturally high prices because of the artificially low interest rates created by expansionary credit policy. Eventually, prices will be bid up to a point where the average consumer soon finds that his savings have become to erode, panic sets in, businesses realize the malinvestment that has taken place, and the “bust” sets in.

To be more specific, the good which prices will be bid up can depend entirely on entrepreneurial outlook, but yes, generally speaking boom periods are caused when the price of higher-order investments are skewed by decreasing relevant rates of interest. In other words, the price of investment into higher order capital-goods will be the cost of the good, as well as the interest paid on the capital borrowed to procure that capital-good in the first place. So, what we’re really talking about when discussing the effects of low interest rate is the change in the marginal value of capital-goods (the investment will be worth more if it cost the entrepreneur less, in the sense that cost incurred will be lower and so the entrepreneur retains a larger amount of profit).

This boom ends not when savings are eroded, but when these price distortions are not maintained. In other words, a boom period requires an accelerating increase in the supply of money. When the increase in the supply of credit decelerates, or stops altogether, the relationship between prices of capital-goods and consumer-goods (or even higher-order capital goods versus lower-order capital goods) reveals itself not to be as profitable as once assumed.

The underlying problem is that the change in price distorts the true scarcity of the capital-goods in question. When the true nature of the scarcity is revealed, then the entrepreneur will find that his investments are no longer profitable.

Once the market starts to grow naturally (i.e. without the expansionary credit policy), will companies again start to “compete” for workers, increasing the wage rate? What will make this increase in wage rates more sustainable than the increase during the “boom” period of the ABC?

Yes, the idea is that in a growing economy employers will compete for employees (although this doesn’t necessarily mean there will be an increase in money wages; for example, an employer could just as well offer medical benefits, although this is really an increase in real wages [a larger portion of the worker's wage can now be used to purchase something else, or can be saved]). In a healthy, growing economy, with no interest rate manipulation (or very little interest rate manipulation), the price mechanism will reflect the true nature of the scarcity of goods, and as such investment should be sustainable.

Walt D. August 18, 2010 at 4:51 pm

While we are on the topic of unemployment, it is interesting to look at individual states. While FED policy affects all states, state policy can be even more significant. In particular, states that have high taxes,Byzantine regulation and fiscal irresponsibility such as California have much higher unemployment rates than states like Texas. (Interestingly, Nevada seems to be an exception to this rule – probably due to the real estate bubble, and the effect of the recession on the gambling industry.) This also applies internationally. Germany is already in recovery. (Austrian principles apply across state and international boundaries.)

newson August 19, 2010 at 12:51 am

pedant alert: johns hopkins university.☺

J. Murray August 19, 2010 at 5:57 am

I did some rough calculations some time back and figured out that unemployment costs the economy an average of $101,544 per year per person unemployed.

I’m assuming a person, married, two kids, earning $45,000 and having benefits of $10,000 for medical and a 5% 401k match at $2,250. This individual will receive $585/week in unemployment benefits, or $30,420 for the year. Additionally, COBRA will pick up $6,500 of the medical benefits. This is where I give government a strong benefit of the doubt and use a 20% management cost to operate COBRA and the unemployment administration (I used a mid-range charity for this number), adding another $7,384.The total paid by government then comes out to $44,304 which is needed to be picked up by the economy at large through taxes, inflation, and borrowing.

However, we have to remember that the original salary of $45,000, medical of $10,000, and 401k of $2,250 represent a value provided to the economy of, at minimum, $57,250 by that worker who is no longer contributing. This number should be lower as the individual is no longer working, thus representing a lower benefit to the actual economy prompting the termination, but I use this for simplification of calculation and can assume that my generosity of the government waste factor will counterbalance.

When adding that in, a person out of work will cost the economy on the whole $101,554 between value no longer being contributed and benefits received. Take this over the estimated 6 million on the dole and we have an economic loss of $609.3 billion. Add the base $57,250 over those who are out of work but not obtaining any benefits, and the number balloons into the trillions. In pure Dollar terms, this economy can’t suffer this for very long.

Stephen Grossman August 19, 2010 at 2:28 pm

>from the Keynesian perspective, the unemployed just become another category of Federal employee. (You can consider that they are digging and filling in “virtual holes in the ground” – a perfectly reasonable Keynesian economic activity.)

The unemployed or Progressive politicians? Wait! Is there a difference? Wait! Virtual prosperity, a new economic category.

Donald Rowe August 20, 2010 at 7:54 am

J. Murray,

I’m probably not as good with numbers as you are, but I look at the situation a bit differently, overall. The lost job is a loss to society, but there may be another way to perceive the situation than the one you have presented.

One person, who would otherwise have been expending his effort to benefit himself and others (the economy, the community, with his production, you get the picture I’m sure), who is now unemployed is now not doing so. Whatever that loss is, it is not one easily quantified.

The benefit that had been provided by our now idle person at company A may simply be provided by another (or more or fewer) person at company B, where presumably the marginal cost to the employer is less. In this case the loss of the job at company A provides a (likely small) net benefit to the economy.

Or, in a bust phase of the economy such as we are in now, the loss of that job may be because it is simply no longer supported (economically justified, necessary). In this case the lost job itself is *no* benefit to the community, and the money formerly paid to the now unemployed person is no longer *wasted*, along with whatever resources that that particular job required. I see this situation as a rather large net benefit to the community. [This simplification ignores all secondary effects that may serve to eliminate jobs that otherwise would not have been lost, but that does not effect my conclusions.]

I won’t even try to put numbers to any of this because it would only serve to accentuate my ignorance in these matters. But it appears to me that the economy is improved in either case but more improved by the second.

From the viewpoint of the economy, we can simply say “To hell with the actual unemployed person, he doesn’t matter a whit to the economy in the macro.” While true, it is a very narrow perspective, one that is not well tolerated by us pesky real people. In the first case that person may be able to find another job with only minor disruption and setback to his wellbeing. But in the second case, through no fault of his own, he is devastated both financially and psychologically. We (and I mean the royal “We”) do not look upon this situation with favor. Don’t misunderstand, I am not supposing that “We” have any actual moral conviction in this, just that it is easy for “us” to picture “me” in his situation.

Government actions and government sanctioned bank actions created this mess. If there were any real alternative in place to the government program of payments to the unemployed, I would enthusiastically favor it, on the demerit of governments use of force to accomplish the goal of easing the pain of the unemployed. Sadly there is none.

I do have ideas for an alternative, however ideas alone do not provide much comfort to those in need.

Cordially,
Don

Walt D. August 19, 2010 at 11:40 am

J. wrote
“I did some rough calculations some time back and figured out that unemployment costs the economy an average of $101,544 per year per person unemployed.”
What a coincidence – this is about the same as the average salary plus benefits for a Federal Government employee! :-)

Mark August 20, 2010 at 12:11 am

Great article. Check out my blog at http://unemployedundergrad.wordpress.com/ about me pursuing a job before graduation…

gene August 22, 2010 at 8:06 pm

The article completely missed the boat on “price”. As they say, anything can be sold at the right price.

I spose it is these unemployed workers who are holding out for the higher wage that are responsible for “prices” that don’t allow product to be sold?

The price of the product must not be “stickey” to resume full production. Since, actual product labor has become a smaller part of overall cost, as small as ten percent in industries such as some electronics and clothes, etc., the problem lies firmly in the hierarchical overcapitalized structure of the dominate industries. If you want to find inflexible wages, check the still working marketing and bereaucratic levels of the dominant corporations.

The problem lies in the absense of price competition. There is no house on the market right now that wouldn’t be sold for the right price, just as there is no worker that couldn’t be hired for a low enough wage. The price problem is due to over capitalization. dump that, and every unemployed worker and his brother would be working as hard as they desired.

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