Home > Uncategorized > Krugman: too pessimistic about Sanders´ ideas about the economy?

Krugman: too pessimistic about Sanders´ ideas about the economy?

Naamloos

Sources:  here (updated)

Will, as Paul Krugman states while trying to debunk the economic ideas of Bernie Sanders, 3,8% unemployment necessarily lead to runaway inflation? I do not mind the debunking (I´m not too interested in USA politics) but I do mind the economics. And the economics 101 answer is ´No, not necessarily´. After 1975 unemployment in Germany was 4% or lower for several years in a stretch. And inflation did not go up. It went down. Notice also that German inflation was quite a bit lower than USA inflation during the entire seventies (graph below), despite lower German unemployment. While inflation in France was higher than in the USA, despite levels of unemployment comparable with German ones. Also, extreme unemployment after 1980 did not lower German inflation that much. Inflation clearly does not just depend on unemployment (or for that matter: money). It is also influenced by the development of productivity and the institutional set up of labour markets. And social-demographic developments, like the very large influx of women into the labour market after 1970 (in South Europe: after 1980 and even later). It´s complicated. The economy is a moving target.

Misunderstanding the nature of the unemployment trade off is not the only mistake Krugman makes in his blogpost.

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He also states that it is bonkers to assume, like Sanders does, that the USA participation rate can return to the 1999 level. But Sanders might in fact be not too optimistic but too pessimistic.  Why should the participation rate not be higher than in 1999? The US of A were about the only country which, after 2008, experienced a large drop in the participation rate. In many other countries this rate is increasing. Take the UK. According to the ONS (the UK statistical institute), in the October-December 2015 period: “The employment rate (the proportion of people aged from 16 to 64 who were in work) was 74.1%, the highest since comparable records began in 1971.” The employment rate is of course not the participation rate (which also includes the unemployed) but about this last rate the ONS states (though it mentions the ´inactivity rate´, 100% minus the participation rate): “The inactivity rate (the proportion of people aged from 16 to 64 who were economically inactive)was 21.8%, lower than for a year earlier (22.3%) and only slightly higher than the record low of 21.7% last recorded for July to September 1990.” I see no reasons why the USA participation rate should not breach the 1999 level. Though the extreme USA incarceration level of course does not help. Neither does its rigid labour market. People with a full time job do not seem to have the right to change it in a part time job, mandatory paid materinity leave is, contrary to the situation in for instance China, non existent. I.e.: people are constrained in making choices, which makes it of course rather unpleasant to work. Rigidities abound! Sanders should porpose to abolish such rigidities and lower the incarceration rate!

Below 4% unemployment might also roll back the increase of inequality (which not coincidentally started when unemployment went through the roof). This might have a mitigating effect on wage claims. Low unemployment might also force employers to make jobs more attractive and to increase productivity while it will lead to people to shift from  low paid unproductive jobs to higher paid productive ones. Such events  will show up as an increase in the GDP price level but considering this ´inflation´ is a fallacy of composition. The increase is not caused by wage increases but by a change in the composition of jobs.

I do not say that a prolonged period of below 4% inflation will not lead to a higher level of inlfation. There are however good reasons to assume that it won´t, at least in the medium term, surely when low unemployment is combined with institutional changes which enable a mitigation of wage claims, like the introduction of paid maternity leave. Krugman can forget about that. But a politician like Sanders shouldn´t and should base his ideas on real life economics. He really has to ask the question if the rise in the female particpation rate led to a change in unemployment/inflation dynamics and how the incarceration rate can be brought down. As I said it´s all pretty complicated.

  1. February 19, 2016 at 3:23 pm

    The textbook relationship between full employment and inflation is based on an industrial model of production where productivity scales worse than linearly with labour. If you employ more people you get diminishing returns in output and purchasing power = goods / wages ratio drops.

    In a modern economy that’s largely not true, or the effect is bimodal. Tech industries steadily reduce employment while raising productivity per worker (and marginal productivity per unit) contrary to conventional wisdom. All while that leaves behind a sea of people who switch to no jobs or unproductive jobs.

    Do we need to rethink the bogeyman of inflation perhaps? There’s certainly strong inflation pressure on non-scalable production such as healthcare, dependent care, quality housing etc. Technology and even consumer goods industries seem much more scalable and resistant to inflation than we thought. If anything we should be talking about build up of imbalances in productivity and the labor mix rather than aggregate real inflation.

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