Sunday, August 6, 2017

Growth means change, and change is hard.

Today, I would like to draw on a couple of recent posts.  One was on our tendency to interpret events based on what I think Tyler Cowen would call "mood affiliation".  In that post, I note that journalist Matt Taibbi seems to be certain that the GSEs performed terribly because management teams were persistently corrupt and incompetent at both firms (even with a purge of executives at each firm!) and seems to be equally certain that the exceptional performance of the GSEs during the housing bust shows that affordable housing targets didn't lead to any of their problems.  There is an axiom here: redistributional public programs don't fail.  Management fails.  This axiom remains true, even if both factors must define the results of a single institution.

Now, to be fair, it seems to me that much of the damage of the housing bust was the result of the opposite axiom, that public programs fail.  This led to many public policy postures and implementations meant to counter supposed effects of the GSEs that, frankly, to me, seem to either wholly contradict the facts or to use facts that bear little resemblance to reality.  For instance: the frequently repeated complaints that the GSEs represent a subsidy to housing that pumps up the market and fed the bubble.  This has both factual and conceptual problems.  Compared to things like tax subsidies, the GSEs have a miniscule effect on home prices.  And, they were a countercyclical force during the housing boom and bust, if anything - at least until the feds took them over.

What everyone can agree on, it seems, is that management is corrupt and incompetent.  The GSEs had four sets of executives that were each dragged over the coals for allegations that were remarkably correlated with public mania over time.  I've pointed out before that as management at both firms was being accused of hiding their credit risk in late 2007, the previous two CEOs were settling the cases against them from several years earlier for managing earnings, which included the sin of over-reporting their credit losses.  In both cases, though, we could count on a basic national consensus that the executives were greedy and corrupt, so it was easy to form a consensus on some form of liquidationism.  Bastards had it comin', after all.  So, we sort of did the nationwide version of urban rebellions.  We burned our collective Main Street down until we felt confident that Wall Street felt our pain, and we consoled ourselves that it was their fault that we had to do it.


The other recent post was about the Phillips Curve.  We tend to think of the Phillips Curve as a sort of measure of the negotiating power of workers.  When unemployment is low, they can hold out for higher wages.  If one thinks this leads to inflation, then one believes that firms have pricing power, and the higher wages just come out of the pockets of consumers, leading to a sort of zero sum outcome.  If one believes that firms don't have pricing power, then the higher wages come out of profits, leading to a gain for workers at the expense of firms.

I don't think either of these forces are particularly strong.  I think the primary force is about sorting.  At low unemployment, workers can have more confidence about trying out new sources of income.  And, for that matter, so do firms and investors.  Wage growth does tend to be strong when unemployment is low, but this isn't paid for by consumers or by firms.  It's paid for by growth.

So, how do these things fit together?


Well, when unemployment gets low, managers tend to complain about a lack of available workers.  As a reaction, you see a lot of commentary about how those (incompetent or stubborn or dishonest) managers are short sighted and/or ignorant of economics, and if they would just pay the market rate, they wouldn't have any problem finding workers.  The problem is that they are being stingy.

While I have been drawn into that sort of thinking myself, I think there is some justification for the posture of those managers.  Probably a good manager has to be careful about buying into a boom of cyclically overpriced labor.  Certainly, if we are going to demand the heads of, say, homebuilders and bankers, for "dancing while the music plays", we can't really also complain that they aren't outbidding each other for new production in an aging expansion.

We get to play that game because in the realm of "mood affiliation", few are looking for ways to bolster the status of managers.  So, they are always available as "the reason" why things aren't working out.  Ask anyone why the US auto firms lost domestic market share.  I bet most of them will say it was the mistakes management made in the 70s or 80s.  You and Matt Taibbi will never be disinvited from a cocktail party or fired from Rolling Stone for staking out that position.

But, I think if we really think about what is going on in the labor market there is more going on than just managers avoiding commitments that have costs that have been cyclically distorted.  I think we are actually seeing those secular shifts that lead to real growth - those laborers who aren't using negotiating power to demand a marginally higher wage, but are using it to shift to new sectors and new opportunities.

Here I need to walk back some complaints I have made in the past about pundits who claim that employers hope for recessions in order to get the upper hand on labor.  I won't walk it back too much, because, in the aggregate, clearly it is employers who are hurt far worse in downturns than laborers are.  Profits drop by something like 8% to 10% for every 1% drop in wages.  Unemployment and falling wages are really mostly a side effect of how much equity is hurting.

But, I must admit, I see how they can get that impression.  There are employers who will suggest that a little downturn could be useful.  This is horrible.  I can't believe in the 21st century, where we spend more than a decade in full-time education, this sort of nonsense can pass.  But, I can see why they feel that way.  The reason is that Growth means Change!  It's the same reason why all forms of material and spiritual improvement are met with resistance.  If you have some stake in the status of today's moral or physical world, then improvement is a threat.  Creative destruction is destruction, after all.

The reason some employers wonder if a downturn could help - the reason some employers complain that good workers aren't available at reasonable wages - is because in a humming economy, permanent growth - permanent change - is in motion.  For practically any firm that occupied some little corner of yesterday's economy, in this context, that little corner is bound to shrink.  It will comprise a smaller portion of the ever-evolving aggregate basket of goods and services.

So, we shouldn't snark about how those employers are stingy or how they don't know their economics.  We should pity them, because really what is happening is that we are winning - we, as in the emergent collective of a free people in a free economy.  We are winning, and that has to come at their expense.  We're all blind men feeling the elephant, and their part of the elephant, on the margin, is atrophying as the elephant morphs into something new and unimaginably better.  We, the collective, are winning, and they, individually, on the margin, must lose.

Would blacksmiths or film developers or candle makers have saved themselves if during the relentless march to a better material world they had simply raised their wages enough to keep drawing workers in from the auto factories, the digital imaging firms, or the incandescent bulb manufacturers?  Those complaining employers aren't necessarily going the way of film developers tomorrow.  But, on the margin, I think it is this process that they are noticing.  It is painful to them.  And, in spite of that, it is everything right with the world.

Among the countless things I see that seem backwards, one of the big ones is this horrible idea that recessions do some good by squeezing out the "weak hands".  My goodness, that is a toxic idea.  You know what squeezes out the weak hands?  Expansion!  Growth!  You think we don't use many blacksmiths anymore because we wisely imposed recessions on them?!  NO!  The blacksmiths went away because of growth!  Now, I wouldn't be surprised if most of those blacksmiths, individually, actually failed during, and in some immediate sense, because of, economic contractions.  But, can you see how wrong it would be to argue that progress came from the recessions?

The next time you see an employer complaining about tight labor markets, tell them, "My condolences, friend!  What wonderful news!"


  1. I agree with most of this. Not many "want" recessions...I think what that crowd is trying to say is that the obsessive focus on monetary policy is anti-productive. And per-capita growth is always about productivity. We endlessly debate monetary policy and the Fed and yet there is very little serious discussion of how to extend the productivity mindset (apparent in manufacturing) to areas like healthcare, education, and real estate.

    Further, calls for things like a higher inflation target could be massively anti-productive. Basically any owner of existing capital gets a massive wealth boost through zero innovation of their own. There is some natural productivity-seeking behavior that comes from knowing you have to be nimble enough to operate in a variety of macro environments with no central bank or government backstop.

    1. I disagree. I think the distinction between idiosyncratic risk and systematic risk is important here. Idiosyncratic risk - the risk that a competitor will put you out of business - drives productivity. Systematic risk undermines productivity.
      If you have to worry about random economic contractions, you can't optimize for competitive productivity improvements.
      The only way to protect against systematic risk is to demand more profit. This truth is actually implied by much of the rhetoric about the benefits of systematic risk. For instance, the complaint that complacent investors bid yields down because they aren't fearful enough is basically saying income to capital is too low. To fix that supposed problem, investors are supposed to be induced to demand higher yields, to reflect the appropriate amount of fear. How does this improve productivity? All it does is increase producer surplus (profit) that must be hoarded for unpredictable instability. There is nothing redeemable about that.

  2. I like your theory, but in practice I don't think it works so well. "Steady" industries seem to trend towards oligopolies with high returns on capital. There is no desire to push the weak hands out of business as the resulting price war would hurt returns for all involved. It is much more profitable to engage in regulatory-capture, subtle price-signalling, and erecting various other anti-productive barriers than it is to push the weak past the brink.

    In more cyclical industries (mining, energy, manufacturing, semiconductors, etc), I observe ruthless competition and low returns on capital (i.e., high productivity). If you know that periodic price swings will push the weakest hands out of business you have an immense incentive to be cost-competitive.

    Then there is the issue of whether monetary policy can actually smooth the (real) business cycle. I personally doubt that but I understand others disagree.

    1. Maybe you have a point there. There is a lot of seen vs. unseen going on there. And one point I am making here is that what these complaints about labor shortages tell us is that growing pains can induce a lot of economizing just as contractions do. It's a different kind of economizing, and it's not as noticeable in some ways. The costs of a contraction should shift the benefit of the doubt toward a preference for economizing related to expansion, I think.

      Monetary policy can certainly create cyclical volatility. The corollary to that is that some other monetary policy could lead to less volatility.

  3. Great post.

    Possibly in addition to mood affiliation is what I call "framing" which might be tribal, or ideological or class or mere convention that results in framing.

    No one is more aware of property zoning than Kevin Erdmann.

    Yet we read this: "Compared to things like tax subsidies, the GSEs have a miniscule effect on home prices."

    Certainly for many large cities in the US, or many cities globally, property zoning has a lot more to do with house prices than credit availability or interest rates.

    But we see Robert Shiller only now pondering the issue of property zoning.

    I could say this reflects a deep class bias embedded in our law and culture, that property zoning is a necessary given, not a market intrusion. Indeed, the Heritage Foundation pronounces Hong Kong heaven on earth---the city with the least affordable housing on the planet. The Heritage dudes cannot perceive property zoning as a market perversion.

    Given this deep embrace of government regulation and control over private use of property, I see little hope but fore more-expensive housing in key US cities.

    1. Actually, in total dollar amounts nationally, income tax subsidies might have more of an effect on home valuations than zoning does, and their effect is probably more regressive.

  4. Well, I have not thought about which is a bigger perversion, property zoning or the home mortgage interest tax deduction. The quick answer is property zoning.

    House prices have gone nutty in Vancouver, Toronto and Montreal, and there is no home mortgage interest tax deduction in Canada.

    "Average Canadian house worth $504,458 in June, down 10% since April"

    That is an interesting headline in a lot of ways, indicating Canadian house prices are higher than in the US (although that is Canadian dollars, still…) and that prices have started to decelerate. Why?

    I think it China capital controls, but I have only anecdotal evidence…..

    I wonder why average Canadian house prices are so high?

  5. Another way to look at it:

    "The median home value in Los Angeles is $631,600. Los Angeles home values have gone up 8.1% over the past year and Zillow predicts they will rise 2.2% within the next year. The median list price per square foot in Los Angeles is $473…."

    Okay, so LA is at $631,600.

    The national median is $200,400 (and that includes closed access cities!). Both numbers use Zillow as source.

    Seems to me property zoning can boost housing prices a lot more than the home mortgage interest tax deduction.

    There might some ways to cut the data, and there are more home sales outside closed-access cities than inside.

    I suppose you can work back from the national tax loss from the home-mortgage interest tax deduction, and try to estimate what that is worth to homeowners.

    Canada is fascinating. Would you expect their national average house prices to be about double US prices?

    1. The tax effect happens in every city. So, without tax subsidies, a high tier home in LA would sell at a Price/Rent ratio of, say 15x, and in Dallas it would sell at 7x. Because of tax subsidies, the LA home sells for 20x and Dallas for 10x. So, not only to tax subsidies affect prices in everywhere, while supply constraints only create extreme price distortions in about 20% of the country, but where supply constraints create price distortions, the tax effect is increased along with it. Prices, in the aggregate, are probably about 25% higher because of income tax subsidies. At the bubble peak, aggregate price/rent ratios were probably also boosted by about 25% (speaking very broadly) each at the natural level by interest rates and supply constraints.

  6. I think you are right in this answer, in general.

    It does puzzle me that house prices are so high in Canada, even without the mortgage income tax deduction. International comparisons are always vexing, but with a mortgage interest tax deduction house prices would be 25% higher in Canada?

    The word "Anglosphere" seems on the tongue here.

    Great Britain, Canada, Australia, New Zealand, Hong Kong, large swatches of the United States---all are developing housing markets in which prices are escalating far beyond previous norms, and are becoming higher and higher in relation to median household incomes.

    Hong Kong is the most extreme, with houses prices at 18-19 times average household incomes. But entire nations are developing unaffordable housing markets, by past standards such as New Zealand and Canada.

    1. The mortgage deduction is less than 1/3 of the total subsidy. The rest is non-taxable imputed rent and capital gain exemptions. To be honest, I'm not sure what the tax treatment is in the other countries. I know Germany and Switzerland do basically tax imputed rents, and they didn't have a housing bubble, they have trade surpluses, and home ownership tends to be lower. I'm pretty sure the other countries don't tax imputed rent. Depending on each country's general ability to meet demand with new housing supply, it could be that more of the rising price level is simply a product of interest rates. I have a post scheduled to come up on that topic.

  7. I leave it to Kevin Erdmann to untangle the mess.

    BTW, yes, I support an elimination of the mortgage interest tax deduction, and the elimination of property zoning.

    That makes me a party of one in the U.S.!