Category Archives: Labour market

Whoever won the debate, economics lost

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You lose

I try to avoid politics on this blog and keep it focused on economics but sometimes politics and politicians just won’t leave economics alone. When that happens you have a right and possibly a duty to check what they are saying. After watching last Monday night’s presidential debate between Hillary Clinton and Donald Trump, one thing we can say with depressing near certainty is that the next president of the United States will be almost totally clueless about economics.

Hillary Clinton

Investment vs spending

Hillary Clinton seems to have discovered Gordon Brown’s old trick of referring to every penny piece of government spending as ‘investment’. She would not be spending money on this, that, or the other, rather she would be investing money in this, that, or the other. “I want us to invest in you. I want us to invest in your future.”

But investment isn’t just another, cuddlier term for spending. It actually means something. When you invest you are spending money in such a way as to increase your future income. If a driving licence will enable you to get a high paying job then paying for driving lessons is investment. If you spend money on food and clothes, necessary as that me to keep you going in the here and now, it is consumption spending, it is not investment. There are greyish areas. A suit bought for a job interview is clothing and also an investment.

Government can invest but it often doesn’t do it very well. Look, for example, at the histories of Britain’s coal and steel industries. Both had vast sums of money lavished on them by government with the aid of dragging them into the late twentieth century. Almost all of that money was wasted, going on higher wages – consumption – rather than actual investment. But that’s politics. Miners and steelworkers vote. Modern machine tools don’t.

Simply put, an enterprise which, via the government, has access to taxpayer funding has no bottom line to worry about. They can be as inefficient as they like, they will be bailed out. And, yes, many banks are an example of this these days. Competitive businesses however, with access to no funds other than those which people will give them willingly (either as loans, investment, or payment for goods and services) have to worry about their bottom lines. They have an incentive to invest profitably, not in whichever direction is most expedient over the election cycle. And if they get it wrong, they carry the can, not the taxpayer, ie, you.

As an illustration, Clinton gave the politically popular area of renewable energy as an example of somewhere she’d invest: “Take clean energy. Some country is going to be the clean- energy superpower of the 21st century”. The experience of Solyndra – a politically well connected solar panel producer which took took $535 million of taxpayers money and went bust without producing a single solar panel – doesn’t bode well.

Tax the rich

Clinton claimed that she would be able to pay for all this ‘investment’ by taxing the rich. “Because what I have proposed…would not add a penny to the debt…What I have proposed would be paid for by raising taxes on the wealthy, because they have made all the gains in the economy. And I think it’s time that the wealthy and corporations paid their fair share to support this country.”

I’ve written before about the futility of British governments trying to wring a greater share of the national income out of the public in tax revenue: “Whether the top rate of income tax is 83%, as it was in the 1970s, or 40%, as it was in the years before 2010, the British people seem to have decided in some mysterious way that 35% of their income is all the government is going to get.”

Something similar applies in the United States. As you see in Figure 1, in the ten years 1972 to 1981 inclusive, the top rate of Federal income tax was 70%. Over those years the share of national income taken in by the Federal government in tax averaged 11.67%. Over the ten years from 2003 to 2012 inclusive the top rate of Federal income tax was half that level, 35%. And, over those years the share of national income taken in by the Federal government in tax averaged 9.83%: a difference of 1.84 percentage points.

Figure 1

picture1

Source: World Bank and the Tax Foundation

You can take any message you like out of Figure 1 depending on which bit you choose. The steep rate cut in 1982 was accompanied by a decline in the share of national income taken by the federal government, but the even steeper cuts of 1987 and 1988 were followed by no such decline. Rises in the top rate of federal income tax from 1991 to 1993 might have started the rise in the federal government’s share of national income beginning in 1993, but this rise continued until 2000, seven years after the rate stopped rising. Indeed, since then, if anything, it looks as though it is changes in the federal government’s share of national income which have led changes in tax rates.

Indeed, as Figure 2 shows, the share of the US national income taken by the federal government in tax seem more closely correlated, in recent years at least, with economic growth.

Figure 2

Picture2.jpg

Source: World Bank and the Tax Foundation

The policy lesson would seem to be that if you want the government’s share of national income to rise you’re better off working to get the economy growing rather than tinkering with tax rates.

Clinton also blamed the housing boom and bust of the 2000s on the Bush tax cuts. “Well, let’s stop for a second and remember where we were eight years ago”, she said, “We had the worst financial crisis, the Great Recession, the worst since the 1930s. That was in large part because of tax policies that slashed taxes on the wealthy, failed to invest in the middle class, took their eyes off of Wall Street, and created a perfect storm.”

In am not aware of a serious economist, in their serious work at least, who thinks that tax cuts were even in part behind the housing bubble and its bursting. Indeed, there is a surprising amount of consensus that the causes were monetary, not fiscal.

Joseph Stiglitz has written that following the burst of the dot com boom in 2000

“…Greenspan lowered interest rates, flooding the market with liquidity…[the lower interest rates] worked – but only by replacing the tech bubble with a housing bubble, which supported a consumption and real estate boom”

Nouriel Roubini wrote

“The bubble eventually burst in 2000, and Greenspan’s Fed responded by slashing interest rates by 5.5 percentage points – from 6.5 percent to 1 percent – between 2001 and 2004. The rising tide of easy money helped cushion the bursting of the tech bubble, but it fed another bigger bubble in housing”

Thomas E Woods writes

“That year [June 2003 to June 2004] saw eleven rate cuts. The unsustainable dot-com boom could not, in the end, be reignited…But the Fed’s easy money and refusal to allow the recession of 2000 to take its course led to an even more perilous bubble elsewhere”

The gender wage gap and the minimum wage 

Beyond this, Clinton showed that she is interested in solving problems that aren’t problems and using solutions that aren’t solutions. Paradoxically, she claimed that, while cutting regulations for small businesses, “We also have to make the economy fairer. That starts with raising the national minimum wage and also guarantee, finally, equal pay for women’s work.”

As has been pointed out time and time again, the gender pay gap is a myth. The oft repeated charge that “the typical woman who works full-time earns 79 cents for every dollar that a typical man makes” is completely bogus. It is derived simply by taking a ratio of the difference between women’s median earnings and men’s median earnings: 21 cents. It takes absolutely no account whatsoever of the different types of work men and women do. When factors like that begin to be figured in the gap disappears.

Indeed, Clinton herself might not actually believe it. At one point in the debate she said “(Trump) doesn’t think women deserve equal pay unless they do as good a job as men”, leaving me asking “Well, what’s wrong with that?”

Clinton also said she would raise the federal minimum wage as part of an effort to help the middle class (a policy Trump also supports). It will do no such thing. Put briefly, if an employer estimates that a worker will add $8ph to their revenue, they will hire that worker at any wage up to $8ph as they will be adding more to their income (the revenue) than their costs (the wages) by doing so. If the minimum wage is raised so that that worker cannot now be hired at any wage less than $10ph, the employer will not hire them. Doing so will add more to costs (the wages) than to income (the revenue). No company that increases costs more than income will be around for very long.

All a raise in the minimum wage from the current $7.25ph to $10ph would do is lock out of the labour market workers whose contributions to turnover employers estimated at less than $10ph. These will be the lower skilled workers Clinton presumably seeks to help. As I wrote recently, one way to help these workers is to help them acquire the skills to raise employers expectations of what revenue they might generate. This is somewhere where genuine government investment could play a part.

Donald Trump

Corporate Tax

Indeed, the first bit of economic sense came from Donald Trump. “So what (companies are) doing is they’re leaving our country, and they’re, believe it or not, leaving because taxes are too high and because some of them have lots of money outside of our country.” He went on to argue that one way to bring them back is to lower the tax on corporate profits.

This makes sense. The United States has the third highest rate of corporate tax in the world. You can’t really blame companies which increasingly do business in multiple political jurisdictions for choosing to domicile in one that doesn’t take nearly four in every ten dollars profit they make.

Indeed, the tax should be abolished completely. Just because a tax is called a ‘corporate tax’ does not mean that corporations pay it. The incidence of the tax, ie, who the burden of paying for it actually falls on, is a different thing altogether. In reality, corporation tax is paid by either consumers, shareholders, or workers.

When tax on cigarettes are put up the cost is not paid by the tobacco companies in lower profits but by the addicted smokers in higher prices. The price elasticity of demand for the product is low so the producer can pass the full cost of the tax on to the consumer.

If the price elasticity of demand for a product is high, ie, an increase in its price will see consumers buying less of it, then the tax will be paid by either shareholders or workers. How the burden is split between these two categories depends on how many of each there are relative to the other. If there are lots of workers around, they will accept wages low enough to offset the burden of the corporate tax. By one estimate, the average share of the corporate tax burden borne by workers is 57.6% of the amount raised by the tax.

Monetary policy

Trump was also onto a winner with his comments about Federal Reserve monetary policy.

“Now, look, we have the worst revival of an economy since the Great Depression. And believe me: We’re in a bubble right now. And the only thing that looks good is the stock market, but if you raise interest rates even a little bit, that’s going to come crashing down.”

“We are in a big, fat, ugly bubble. And we better be awfully careful. And we have a Fed that’s doing political things. This Janet Yellen of the Fed. The Fed is doing political — by keeping the interest rates at this level. And believe me: The day Obama goes off, and he leaves, and goes out to the golf course for the rest of his life to play golf, when they raise interest rates, you’re going to see some very bad things happen, because the Fed is not doing their job. The Fed is being more political than Secretary Clinton.”

This echoes something I wrote three years ago

“As interest rates are lowered in response to an adverse shock investment, calculations change, especially when, like Alan Greenspan, those behind the policy publicly promise its continuance. To the extent that this fosters a wealth effect, consumption, as well as investment, may be stimulated. And this, in fact, is exactly the way the policy is supposed to work.

But the rates cannot stay that low indefinitely, nor, despite the jawboning by monetary policymakers, are they intended to. At some point they will rise. Again, this actually is the way the policy is supposed to work.

And when those rates do rise what happens to those marginal investors who made their decision when rates were at their lowest? What happened to the NINJAs who bought condos in Michigan when interest rates were 1 percent when the rates went up in 2006? They were scuppered. And what will happen to all the enterprises which are currently dependent on interest rates remaining at their historic lows when those rates start to rise? It is because more people are now asking that question that markets have turned skittish recently, since Ben Bernanke even began to discuss a possible future ‘tapering’ of Quantitative Easing.

Those rates will have to rise at some point. But, when they do, whichever bubble we have now will burst. Our monetary authorities have printed themselves into a corner.”

Shortly afterwards I wrote

“On Aug. 15, the London Telegraph reported that British retail sales had risen unexpectedly sharply and that American unemployment had fallen to a six-year low. This would usually be promising macroeconomic news, but that day major indexes—the Dow Jones Industrial Index, the S&P 500, the CAC 40, among others—tumbled. Markets, hooked on the Fed’s cheap liquidity cocktail, were terrified that an improving U.S. economy might see the punch bowl removed with a Fed “taper” of quantitative easing.

A day later, when the results of a U.S. consumer confidence survey came in “far worse than expected,” stock markets rallied. Markets are supposed to be driven by the expectations of a stock’s perceived profitability, not the pursuit of speculative gains caused by the manipulations of central bankers. Now the economy appears to be in a position where the interests of financial markets are precisely at odds with the interests of the rest of the economy.”

International trade

And then he went and blew it. “You look at what China is doing to our country in terms of making our product” he said, “They’re devaluing their currency, and there’s nobody in our government to fight them. And we have a very good fight. And we have a winning fight. Because they’re using our country as a piggy bank to rebuild China, and many other countries are doing the same thing.”

I recently wrote

Indeed, it is true that policymakers in Beijing have tried to keep the yuan weaker against the dollar that market forces might allow…But…this has not been a costless exercise for the Chinese.

By holding down the value of the yuan the Chinese government has held down the purchasing power of Chinese producers. This has effectively worked as a subsidy from Chinese producers, with an average GDP per capita of $14,100, to US consumers, with an average GDP per head of $56,000. If anyone should be angry about this arrangement, it should be Chinese producers.

Indeed, the argument that the Chinese have been using the US as a piggy bank to fund investment in China is exactly the wrong way round. Instead, the US has been using China as a piggy bank to fund American consumption.

Trump often talks of international trade as a struggle with winners and losers. But trade is not a zero sum game in which the benefits for one are offset exactly by losses for another. This fallacy, the root of much modern misguided economic rhetoric, is based, essentially, on the ancient misunderstanding that for two things to exchange for each other these things must have an equal value.

But logically that must be wrong. If I hand over £1.10 for a tuna sandwich I do so because I value the tuna sandwich at more than the £1.10. Conversely, the unnamed supermarket where I buy my lunch values the £1.10 more than the tuna sandwich. If I valued the tuna sandwich as much as I valued the £1.10, why would I exchange the latter for the former? I wouldn’t and the supermarket wouldn’t either. In fact, trade can only take place because people value things differently. ‘Value’ is not a property inherent in a product, it is entirely a function of the human mind and these value different things differently at different times and in different places. Value is entirely subjective.

It follows from this that people trade less valued things for more valued things. They accumulate value through trade. Both parties gain. Trade is a positive sum game.

The verdict

The United States has been woefully governed by both parties for a long time. On the strength of this debate, that won’t be changing for at least another four years.

Wages, immigration (again), and economic methodology

econ

A while ago I wrote about a Bank of England paper investigating the effect of immigration on wages in Britain which found that “the immigrant to native ratio has a small negative impact on average British wages”. Then, some time after, I came across a paper by Julie L. Hotchkiss in the Southern Economic Journal which finds that “illegal immigrants actually raise wages for documented/native workers”. How to explain this contradiction in the economic evidence?

The first thing to note is that the Bank’s researchers, Stephen Nickell and Jumana Saleheen, are looking at slightly different question to Hotchkiss. Nickell and Saleheen are looking at immigration in general, Hotchkiss only at that part of it which is illegal.

Second, they are also looking at different data. Nickell and Saleheen are looking at data from Britain, Hotchkiss from the US state of Georgia.

But should this matter? Should not an economic theory which predicts that, ceteris paribus, an increase in immigration will raise/lower wages in Britain also predict the same for Georgia? In his excellent History of Economic Thought, Lewis H. Haney called the belief that the answer to this question is Yes ‘cosmopolitanism’ and the belief that the answer will be Yes at any point in time ‘perpetualism’.

That seems to depend on which theory you mean. As I wrote of Nickell and Saleheen’s paper, “In the short run at least, this is what economic theory would lead you to expect. If you increase the supply of anything relative to the demand for it, ceteris paribus, the price of that thing, whether it is shoes or labour, will fall.” But Hotchkiss applies a different bit of economic theory, that of comparative advantage, and finds the opposite. So which theory to apply?

The theory of comparative advantage is one of the old workhorses of economics. It states that Country A should specialise in the production of the good or service A that it produces most efficiently, even if it also produces good or service B more efficiently than Country B. This will lead to more efficient production and, via trade, make both countries better off. The more countries there are, the more they can specialise, the more productive they become, and the better off everyone is, so the theory goes.

Hotchkiss applies this to illegal immigration. Illegal immigrants “with limited English skills” (I’m quoting Art Carden’s write up here) coming into Georgia and finding jobs   “frees up low-skill American workers who can then specialize in tasks that require better English”.

That makes theoretical sense, but it isn’t happening in Britain, according to Nickell and Saleheen. Perhaps this is because the premium on speaking English particularly well isn’t all that high lower down the value chain in the UK. Consider Mike Ashley’s Sports Direct warehouse where the signs are posted in English and Polish. There would seem to be little advantage accruing to a native English speaking employee over his or her Polish immigrant colleague from their greater language skills.

It is interesting to speculate on the microeconomic differences between the British and Georgian labour market that allow for so much more specialisation in linguistic ability lower down the value chain in Georgia than there would seem to be in Britain. After all, these differences would seem to determine whether we apply standard supply and demand analysis to the question of immigration’s impact on wages, or the theory of comparative advantage.

But how much of this is fitting theory to the facts? When I read Nickell and Saleheen’s paper I thought “Well, that’s what standard supply and demand analysis would predict”. Did Hotchkiss, I wonder, see her results and think “Well, that’s what the theory of comparative advantage would predict”? Imagine if the British results had also shown a positive impact on wages from immigration. Would I then have thought to myself “Well, that’s what the theory of comparative advantage would predict”? If so, whither economic theory?

Prior to conducting the analysis on British and Georgian data, we would not have known which theory to apply and, hence, could have made no predictions. If, for example, you assumed that comparative advantage applied to the British labour market you would have predicted that immigration would cause wages to rise, as in Georgia. When confronted with the result, that immigration actually causes wages to fall in Britain, you would conclude that your prediction was wrong and that your theory had been falsified. But if you had gone through the same process in Georgia, your prediction would have been borne out and your theory would stand.

These are fundamental questions of economic methodology. Economists generate theories which make predictions such as ‘if X then Y‘.Governments spend large sums of money according to these predictions based on these theories. Is it the case, however, that the appropriate economic theory is entirely contingent on the particular circumstance in which it is applied?

I generally consider myself a cosmopolitan perpetualist in economic methodology. This can lead to situations where, when data contradicts theory, I assume that the data is faulty, that it must be failing to take some relevant factor or magnitude into account. But if there is even a question over which theory to apply in the first place, whither economic methodology?

Wages and immigration in the short run

The Bank of England has a new paper out titled The impact of immigration on occupational wages: evidence from Britain. Its key finding is that “the immigrant to native ratio has a small negative impact on average British wages…Our results also reveal that the biggest impact of immigration on wages is within the semi/unskilled services occupational group.”

Why, then, does the Bank of England correctly state that “There seems to be a broad consensus among academics that the share of immigrants in the workforce has little or no effect on native wages”? The reason is that “These studies typically have not refined their analysis by breaking it down into different occupational groups”, which the Bank’s paper does.

To de-jargon this, studies which find no effect of immigration on wages make no distinction between the wages and workers they are examining; they lump the falling wages of nine road sweepers in with the rising wage of one City banker and say that, on averages, the ten workers wages haven’t fallen. A paper from Oxford University which also dug down into the averages found similar results to the Bank of England; immigration disproportionately reduces wages at the bottom end of the labour market.

In the short run at least, this is what economic theory would lead you to expect. If you increase the supply of anything relative to the demand for it, ceteris paribus, the price of that thing, whether it is shoes or labour, will fall.

But that, too, is to fall into the trap of looking at ‘the average’. There is no labour market in which we are all willing sellers of homogeneous labour. I am not offering the same skills on the job market as Sergio Aguero or Stephen Hawking. The market for the labour of economists and the market for the labour of footballers are different markets, they are not part of ‘the’ labour market. Labour, like capital, is heterogeneous.

To simplify, consider an economy with two types of worker, highly skilled and lower skilled. The markets for each are shown below, for highly skilled labour in chart a and lower skilled labour in chart b.

wages

Immigration of  lower skilled workers increases the supply of lower skilled labour – the rightward shift of the supply curve on chart b from S1 to S2. Ceteris paribus, this pushes wages for lower skilled workers down from P1 to P2. But, and this is the point the Bank of England paper makes empirically, this has no effect on the wages of highly skilled workers, as shown on chart a.

If the immigrants were skilled then the opposite would be the case. The wages of highly skilled workers would fall and those of lower skilled workers would be unaffected. It is doubtful, however, that this is currently the case, at least in Britain.

This debate over the effects of immigration on wages, in the short run it should be stressed, is another example of the difficulties economists can find themselves in when thinking of lumpy, homogeneous aggregates. Lumping all labour together for anayltical purposes makes no more sense than, for example, lumping all capital goods together. The Bank of England’s new paper is a welcome step towards greater acknowledgment of the heterogeneity of economic variables.

The ‘epidemic’ of zero hour contracts

Well, I did warn you.

Today Ed Miliband promised that a future Labour government would end the “epidemic of zero-hours contracts” which are “undermining hard work, undermining living standards, undermining family life” in Britain. But the Office of National Statistics, workers on zero hours contracts account for 2.3% of the workforce. Is that really an ‘epidemic’?

I’ll admit, I wouldn’t want to be on a zero hours contract (though it might have been useful when I was studying). You might not want to be on a zero hours contract. But, surely, what matters is whether the people on zero hours contracts want to be on them?

In 2013 the Chartered Institute of Personnel and Development produced a study of zero hours contracted workers. It found that

  • “Almost half of zero-hours contract workers (47%) report they are satisfied with having no minimum contracted hours, with 27% saying they are dissatisfied and almost a quarter (23%) neither satisfied nor dissatisfied.”
  • “Almost two-thirds of employers surveyed that use zero-hours contracts (61%) report that zerohours staff are not contractually obliged to accept work and are free to turn it down. However, 15% of employers say zero-hours staff are contractually required to be available for work, and a further 17% report that in some circumstances zerohours contract staff are expected to be available for work.”
  • “In all, 80% say they are never penalised for not being available for work, a further 17% say they are sometimes penalised and 3% say they are always penalised if they are not available.”
  • “Most zero-hours contract workers (52%) don’t want to work more hours than they typically receive in an average week. However, 38% say they would like to work more hours, with 10% undecided.”
  • “About a third of employers that employ zero-hours workers say they have a contractual provision or policy outlining their approach to arranging work with zero-hours workers or cancelling work that had been offered. However, about four in ten employers say they don’t have such provisions or policies and a quarter say they don’t know.”
  • “In all, 46% of zero-hours contract workers say they either receive no notice at all (40%) or they find out at the start of a shift that work is no longer available (6%).”
  • “Six in ten zero-hours workers report they are allowed to work for another employer when their primary employer has no work available. A further 15% say they are able to sometimes. Just 9% say they are never able to work for another employer and a sizeable 17% don’t know.”
  • “Almost two-thirds (64%) of employers who use zero-hours workers report that hourly rates for these staff are about the same as an employee doing the same role on a permanent contract. Nearly a fifth (18%) report that hourly rates for zero-hours staff are higher than permanent employees. Around one in ten employers report (11%) that they are lower.”

So, a mixed picture. Or maybe that doesn’t matter. Maybe whether people like them or not is immaterial to whether the government permits them or not. That’s a political question and this is an economics blog.

So, take a look at the chart below

Picture1

Source: OECD

Unemployment has been one of the relative British economic success stories in recent years. And, in large part, this is down to its relative labour market flexibility – the ease with which workers can be hired and fired, in other words. Indeed, as the graph below shows, countries with less regulation of temporary employment see more employment.

Picture2

Source: OECD

But maybe those unemployed Greeks and Spaniards are, actually, better off than British workers on zero hour contracts? Actually, the evidence shows that it’s better to have a temporary job than no job.

It’s early days in the campaign so there will be more of this stuff, no doubt, from all parties. But it would be a mistake to let a part of a labour market which has weathered recession remarkably well fall victim to political posturing.