Thursday, February 06, 2014

Wait, there are supply curves?

You wouldn't know it from his tone, but it has not been a good week for Paul Krugman's blog or the legions that link to it. First there was a post playing off a widely cited research finding that a substantial part of the failure of US employment to return to its pre-2007 pattern was due to demographic factors as opposed to the cyclical suspects. Part of his refutation is to do his own back of the envelope calculations which conclude --

This would seem to suggest that around 40 percent of the decline is demographics, but the rest is cyclical, and that we’re still far below full employment.

In all the tirades about austerity over the last few years, in all the complaints about Republicans blocking worthy initiatives, in all the sighs about weak monthly jobs reports, did his readers know that all that only applied to little over a half of the employment shortfall during that time? And that nearly half was simply voluntary departures from the labour force associated with ageing?

Then there's that Congressional Budget Office report from yesterday showing that the Affordable Care Act ("Obamacare") will reduce total labor supply by the equivalent of 2 million full time jobs. Of course there's a solid explanation for that -- fewer people are locked to their jobs through need for health insurance. But Krugman actually doubles down on the logic and produces a model where labor supply before Obamacare was too high, so this reduction in employment could actually be efficient.

So again, after years of ridiculing any explanation for slow job growth that didn't involve austerity or insufficiently lax monetary policy, all of a sudden, not only could employment be falling (relative to previous trend) because of incentive effects, but it might even be a good thing that it does so!

One final thing, The other part of his argument against the demographic calculations above is that the researchers are led to an implausible assumption that the economy was operating above potential for a considerable period. Yet as of this week, it appears that government policies can have such strong incentive effects that people might previously have been working too hard.

It might cause whiplash for some in the liberal economics comfort zone, but there actually are reasons to mention the word "supply" outside of ritual denunciations of alleged believers in Say's Law.