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June 02, 2005

A Defender of Daniel Okrent on Paul Krugman... Well, Half a Defender

Andrew Samwick of Dartmouth couches his lance and spurs his horse forward. But he's only going to defend Okrent halfway:

Vox Baby: I'm not going to get into the issue of whether Okrent should have provided an example.

This is wise on his part--for Okrent is indefensible. In fact, it's worse than Okrent not providing any examples. It looks like he didn't have any examples that stand up in mind--otherwise he would have provided them by now.

Samwick attempts a much more limited exercise:

The discussion that followed Okrent's piece might lead one to believe that there are no examples. I'll remind my readers of one that occupied our time back in October. It started with the post, 'Paul Krugman, Meet Irony.' The key quote (with the offending statement highlighted) from Krugman's op-ed, 'Checking the Facts in Advance' is:

Mr. Bush will boast about the decline in the unemployment rate from its June 2003 peak. But the employed fraction of the population didn't rise at all; unemployment declined only because some of those without jobs stopped actively looking for work, and therefore dropped out of the unemployment statistics. The labor force participation rate - the fraction of the population either working or actively looking for work - has fallen sharply under Mr. Bush; if it had stayed at its January 2001 level, the official unemployment rate would be 7.4 percent.

As I noted in my original post and the considerable discussion that followed (here, here, here, here, and here), there are two channels that allow the unemployment rate and the labor force participation rate to fall while leaving the employment-population ratio unchanged. The first is that people who want to work give up looking for work. (This takes the same person out of both unemployment and the labor force, with no one entering or leaving employment.) The second is that people who have jobs decide they don't want them anymore (perhaps to take care of their kids or go back to school), and they get replaced by someone who was previously looking for work. (This takes one person out of employment and the labor force and another person out of unemployment and into employment. Same net effect.) The two channels have opposite implications for whether we think the statistics are bad news for the economy. Krugman asserts--via the word 'only'--that the second channel doesn't exist...

I will concede that Paul Krugman should have written "primarily" rather than "only."

Andrew's two channels have the same effect on the unemployment rate and the labor force participation rate, but they have very different effects on wages. It's just supply and demand. In the Samwick channel--unemployment falling because some of the employed decide they don't want jobs anymore, and the unemployed fill their place--the driving force is a reduction in the supply of workers--a leftward shift in the labor supply curve. Such a leftward shift is associated with a higher price of labor: higher real wages relative to trend. In the Krugman channel--unemployment falling because some of the unemployed update their views of the state of the labor market and conclude it's no longer worth it to look for work (rather than doing something else)--the exit of people from the labor market is a response to lousy labor market conditions. It is a move downward and to the left along the supply curve rather than a leftward shift of the supply curve. It is associated not with higher but with lower real wages relative to trend.

So we can figure out which channel predominates--which is the primary cause--by looking at what has happened to real wages relative to some measure of trend. And the natural trend to use is that of labor productivity. If we plot total compensation per manhour deflated by labor productivity for the nonfarm business sector, all from Economic Indicators, we find:

Since the end of 2000, employee compensation--wages and salaries plus benefits--has been falling way behind productivity. This isn't what we would expect to find if changes in preferences had led to a leftward shift of the labor supply curve, making labor scarce and expensive. This is what we would expect to find if weak labor demand had pushed the economy down the labor supply curve.

I cannot come up with a story according to which the Samwick channel is the dominant one that is consistent with the growing gap between wages and productivity.

Posted by DeLong at June 2, 2005 11:20 AM