Wednesday, December 21, 2011

I shall now debunk the "Great Vacation" in one sentence.


"I refute it thus!"
- Bishop Berkeley

Chad Stone explains the "Great Vacation" hypothesis:
The “Great Vacation” narrative holds that unemployment insurance (UI) benefits...have dissuaded millions of unemployed workers from taking a job.  If...jobless workers would get off their duff (or if we would give them a good swift kick there), unemployment would plummet.
Some "neoclassical" economists (e.g. Casey Mulligan) have adopted the "Great Vacation" as their favored explanation for the recession we are in. The story has also made its way into the political discourse, where it is now a regular Republican talking point.

I shall now debunk the "Great Vacation" in a single sentence:

If the labor demand curve slopes down, then a fall in labor supply should be accompanied by an increase in wages; since wages fell or stagnated in the Great Recession and have grown only slowly ever since, unemployment is not being caused by a decrease in labor supply.

OK, OK, I used a semicolon. Sue me.

Really, this is incredibly simple. Our intuition says that when a commodity becomes more scarce, the price goes up. Duh, right? Labor is a commodity. If people suddenly decide to take a vacation - whether because of a spike in laziness or an increase in unemployment insurance - employers will raise wages in order to keep some (though not all) of those workers at their desks.

This is just a way of saying that the demand curve for labor slopes down. If the demand curve slopes up, then a negative shock to labor supply (a Great Vacation) will make wages fall (as we observe in reality). That would make labor a Giffen good. It would mean that a rise in wages makes companies want to hire more workers. It would mean, among other things, that union power, by increasing wages, also increases employment. If Casey Mulligan and other Great Vacation proponents want to argue that labor demand curves slope up, well, be my guest, but the burden of proof is on them, and I doubt they will like the implications of the result.

Look, if price goes down and quantity goes down, chances are that there has been a leftward shift in the demand curve, not the supply curve. That is Econ 101 common sense. It's also a specific instance of a general principle of science: when an external influence acts on a stable system, the system will react so as to partially counteract the external influence. In physics this manifests as Lenz's Law, in psychology as opponent-process theory. If you want to see what kind of shock happened to a system, look at how the system reacted.

We are not on a Great Vacation.

29 comments:

  1. foosion3:34 PM

    I'd been partial to pointing out that there are four job seekers for every job opening (per BLS JOLT numbers), but your sentence does a great job of explaining what we're seeing.

    Casey Mulligan is an obvious partisan hack.

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  2. So are you implying that unemployment insurance has no meaningful effect on labor supply? If so that is certainly not the case. Who's to say that both demand and supply aren't falling at the same time? All that is required for wages to fall is that demand falls by a greater magnitude than by supply. Hence there is no reason to believe, through your argument at least, that decreasing unemployment benefits will have no effect on labor supply.

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    1. Anonymous2:10 PM

      Decreasing unemployment benefits?? Is that what the question is? The more obvious solution (from the standpoint of economics) would be to make the benefits unconditional on employment.

      In other words, why stop receiving unemployment checks just because you get a job? That loss is real disincentive to work.

      Taking a job while receiving unemployment benefits is *dangerous*, because if you lose the job within 1.5 years, you don't get the benefits back; and if the job pays less, you may not get the same benefits even that time. If you are making $400/wk in benefits, or $21k/yr, then any time you accept a job, you are *betting* up to $36k that you will keep your new job for up to 1.5 years (the actual amount of time, and value wagered, varying according to whether the wages are greater than the benefits and by how much). Of course, you are also wagering all of the time/energy/expenses/opportunity cost of actually performing the job.

      Most unemployed workers would hesitate a long while to make a $300 bet, let alone a $36,000 bet!

      On the other hand, a good friend of mine voluntarily accepted a part-time job while receiving unemployment benefits, even though it did not increase his total pay, since he lost as much in benefits as he gained in wages. Why? Because he thought the benefits would run out before he could find another job.

      So the incentive structure workers are actually dealing with is rather complex.

      Unemployment benefits certainly out-compete most open jobs in terms of long-term income security, even though the benefits are strictly limited in time. This shows how perilous contemporary USA lack of job security is.

      If the typical job on offer guaranteed even 2 years of income, few people would ever consider unemployment benefits safer than accepting a low-paying job.

      Anyway, phrasing it in terms of a "vacation" rather than workers trying their best to forestall eviction as long as possible is pure ideological evil.

      Delete
    2. Anonymous2:13 PM

      Sigh, obviously $21 * 1.5 = $31.5 (not $36), but I can't edit the post, apparently because it's Anonymous.

      Delete
  3. @Nick:

    You're right.

    The question of what policies we can do to increase employment is a different question than they question of what caused the recession.

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  4. "when an external influence acts on a stable system, the system will react so as to partially counteract the external influence" Le Chatelier's principle

    "Really, this is incredibly simple. Our intuition says . . ."

    Yet I see you drifting into opaque econospeak.

    High unemployment benefits will certainly reduce the incentive to look for a job (I know that from personal experience) and will also make one less likely to accept a job that pays considerably less than your last one, or that you might hope to find before your unemployment (and savings) run out. That is intuitive.

    Clearly if unemployed people were forced into the labor market sooner by economic necessity this would increase the supply of labor, which, all things equal, would push wages downward. But there are other factors pushing wages downward, both in the short-run (a recession) and in the long-run (automation, trade, immigration) so it is hard to either affirm or deny the vacation hypothesis.

    You can always argue that if wages fell further faster employment would rise further faster, which is probably true, intuitively speaking. And when wages go down people are willing to work harder and longer.

    Personally I'd like to see more work-sharing (a shorter standard workweek), an immigration time-out, and tariffs on low-wage imports from East Asia; I'd also prefer more inflation to increase "money-wages" in relation to the price of "wage goods" (in Keynsian speak) in order to reduce involuntary unemployment. All of these things are compatible with each other -- and they all require policy changes in Washington D.C..

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  5. Correction: Keynes advocated (tacitly) inflation in order to increase "money wages" but by a lesser amount than the increase in "wage goods" -- ie, a reduction in real wages brought about by monetary policy. But that was only half his prescription, the other half being fiscal stimulus.

    I don't say this is obvious. Nothing in economics is obvious except to the speaker.

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  6. Anonymous7:13 PM

    Two independent clauses. One sentence. (Carry on)

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  7. I think its possible that the point being made by "great vacation" advocates is not that the supply of labor curve moved to the left but that when the demand for labor curve moved to the left there was a relatively large fall in the amount of labor supplied at the new equilibrium point.

    In other words UI has made the supply of labor curve much more wage-inelastic that it would otherwise be and that explains the high levels of unemployment.

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  8. Malatesta4:00 AM

    Philosopher's nit-pick. The 'I refute it thus' line is actually Samuel Johnson's in response to Berkeley.

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  9. Anonymous5:09 AM

    Based on a comment my mother made, I see unemployment as an investment in the labor force. Unemployment allows workers to take more time looking for a good job, one that fits their required salary and skill set.

    The problem as I see it is confusing labor with commodities. A reduction in the price of toasters, leave money available to spend on other things. If the price reduction is due to process improvements it's a win-win. If it because you cut the pay of the guy making a toaster it's a win-lose.

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  10. Noah. Maybe off topic, but what if the system is unstable to begin with? Does that change anything?

    UI is simply an anti bread lines policy. It's main goal isn't putting people back to work.

    Putting people back to work should be someone's main goal, of course. That's why the government should be hiring directly instead of waiting around for an over indebted private sector to put people back to work.

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  11. "High unemployment benefits will certainly reduce the incentive to look for a job (I know that from personal experience) and will also make one less likely to accept a job that pays considerably less than your last one, or that you might hope to find before your unemployment (and savings) run out. That is intuitive."

    I think that there are two angles here. One, until the number of active job seekers and jobs becomes more comparable, it is unlikely that reducing benefits will change the unemployment rate except in small ways. Right now, when we hire we can pick from really amazing candidates.

    Two, it is actually a bad thing if the median worker needs to accept a decrease in wages. We've built a culture around debt (education, houses, cars, and -- admittedly -- credit cards). If wages drop and debt is stable that increases the relative levels of personal debt. That can be problematic. It'd be less problematic if we had not just finished making bankruptcy more challenging.

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  12. Given how much wages have stagnated and fallen over the past several years, if it is indeed now true that unemployment insurance payments for certain classes of unemployed individuals are too close to the wage rates for the kinds of positions those individuals are most likely to find in the labor market, then the problem is that we have allowed wage levels for those classes of individuals to fall too far. We should take policy steps to raise the wages, and at the same time increase the number of such positions available.

    Impossible, you say, in a recession? Think again. Profit levels for corporations are high. I read recently that the share of corporate revenues that now go into profits is at it's highest level since 1950. These corporations appear to have struck on a formula for increased profit taking that doesn't actually involve expanding the production of the things they produce or hiring more people. If anyone has taken a vacation from the labor market, it is corporations.

    We should adopt tax and regulatory policies that turn whatever it is these corporations are doing into an ill bargain for them, and force them to plow a higher proportion of their revenues back into the employing additional labor. We should adopt similar policies to apply the same incentives to the massive idle stocks of surplus savings that are available in the private sector for hiring.

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  13. Skyman1238:16 AM

    One of my students brought up this canard last week so I showed the class this from the MA website: "If you are eligible for unemployment benefits, you will get about half of your average weekly wage, up to the state maximum weekly benefit in effect when you filed your claim. The state maximum benefit in Massachusetts, effective October 2, 2011, is $653 per week. The maximum weekly benefit is recalculated each year, effective the first Sunday in October."

    What a great vacation! Anyone care to know what the cost of living is here in MA? I refute it thus: if you think that this amount of money is a "vacation" then you are seriously deranged. It not even subsistence living here. The entire class got quiet as this guy then tried to justify his position. He failed. He honestly did not know how UI was calculated or how much it was, he just listened to talking points. Then people like him forget about health insurance and how much that costs, and I asked him what he would do in this case with a family. He uncomfortably shuffled in his seat as we all stared at him. Facts just aren't important to people who hold these views. It's like arguing with a fundamentalist about evolution.

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    1. Anonymous2:20 PM

      That man was an idiot. But the truth is that unemployment benefits do create a disincentive to work, because the benefits end as soon as you accept work. Indeed, technically, the benefits end if you start doing volunteer work!

      Although this depends on the state. $410 is the max in NY! $653/wk sounds like a lot! Maybe not enough for a whole family to pay for health insurance, but a whole family on that income level qualifies for some free healthcare in MA yes?

      This is no argument to eliminate the benefits, though. They should merely be continued even after employment resumes. Problem solved.

      Delete
  14. I think it was Johnson, not Berkeley, who kicked the stone and said "I refute it thus."

    But thanks for the refutation. I'd like to kick Mulligan, myself...

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  15. Good luck. You can't refute a theology.

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  16. @ Joseph - "until the number of active job seekers and jobs becomes more comparable, it is unlikely that reducing benefits will change the unemployment rate except in small ways."

    That sounds plausible. If the recession was triggered by the housing bust, layoffs in the construction industry reduced demand for all the things employed construction workers usually buy. From a businessman's p.o.v., you lay off employees when demand for your product falls no matter the wages, at least in the short run. In the long run you might re-arrange your production to employ more workers and less capital when wages go down, but that is not what recessions are all about. I guess that's an argument for fiscal stimulus more than quantitative easing. Except that if Americans have been living beyond their means there needs to be a permanent rearrangement in their purchasing habits; stimulating present consumption patterns might delay long-term adjustments.

    There are no easy answers I guess, but still I prefer discussing these problems (and their various feedback and qualifications) in ordinary language, not supply and demand schedules, let alone algebraic equations.

    The latter approach, favored by academics, tends towards a kind of scientistic decadence, at least in my opinion. Feynman's commencement address to Cal-Tech seniors captures what I am trying to say: http://www.lhup.edu/~DSIMANEK/cargocul.htm

    I wish it were required reading -- annually. Oh well. Merry Christmas.

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  17. Let me add that I liked Noah better before he entered the academic job market, which I presume what is happening now. I mean back when he wrote about why economics in not a science. He's a talented writer and I wish he would become an economic journalist, criticizing from the outside, unafraid to say what he really thinks. He would have one big advantage: he would know what he was talking about.

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  18. Luke Lea - an advantage over whom? Just wondering what you mean.

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  19. @Luke Lea:

    Oh no, am I losing my core readership? :-o

    Don't worry, I am still banging the "econ should be more scientific" drum. See this post on teaching more empirics to undergrads, this post on why most modern macro is probably wrong, this post on why rational expectations is not a real scientific revolution, and especially this post on why economics focuses too much on spinning stories and not enough on throwing them out.

    The "job market" has stopped me from posting as frequently as I did before, but I'm not going to stop saying what I think!

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  20. Davis X. Machina said...

    " Good luck. You can't refute a theology."

    Stakes come to mind.

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  21. I noticed people who defend 'The Great Vacation' by switching to a very minor marginal item (UI).

    In terms of global warming, this would be analogous to global warming deniers pointing out that it gets cooler at night, so there is no global warming.

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  22. Uh, what are these "high UI benefits" of which people speak?

    In the mainland US, UI benefits are at most less than 50% of your previous salary--and capped at a relatively low level. (The max for workers in NY State is $405/week, implying an annual salary of $42,120—less than the national real median earnings of a person with a Bachelor's degree.)

    As the WaPo noted (per Wikipedia), "The average weekly payment is 36 percent of the individual's average weekly wage."

    That's not exactly an incentive to stay home.

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    1. Anonymous2:28 PM

      It's a major incentive not to take any job that pays less than half of your last job.

      (Of course, it's not obvious, from an economic standpoint, that this is a bad thing. Do we *want* our unemployed engineers resigned to working the hamburger fry? Wouldn't that reduce our national technological productive capacity in the long-term?)

      And because if you take a job and get fired the first day without getting paid, you still lose all of your unemployment benefits, it's an incentive not to take any job that won't last as long as your benefits.

      So we are talking about a system which provides a major financial disincentive for the laid-off middle class to accept low-level service work.

      The phenomenon is real!

      Delete
  23. Anonymous8:19 AM

    Noah,

    Is it not the case that the Mulligans of the world need to believe this or the whole of the Neoclassical edifice of Marginal Economic Theory is reduced to a tautology?

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  24. Adding on to Ken's comments, from what I've gathered, states also have a sh*tload of demeaning hoops to jump through, to f*ck with people on UI.

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  25. Hi Noah,

    I wrote up another, more applied rebuttal to the "Great Vacation" Theory, found here: https://plus.google.com/111643364718750270983/posts/3JRwfdCs4js

    I would love to hear your thoughts. Keep up the great work -- I love your blog.

    -Joe

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