Grant me microeconomic efficiency, but not yet

It has always struck me that the first order consequence of making it easier for firms to fire people in the middle of a depression would be that…firms would fire more people. And it has never struck me that this would be desirable.

Now Gauti Eggertsson, Andrea Ferrero and Andrea Raffo have a new paper pointing out that at the zero lower bound, where monetary policy cannot offset the deflationary impact of structural reforms that would otherwise be desirable (lowering mark-ups in product and labour markets), such reforms can be contractionary (by generating expectations of deflation and raising real interest rates).

All of which seems obvious once you think about it, but it needed someone to point it out. And this is a problem for a continent whose leaders refuse to take the demand side of the economy seriously, and are hoping that “structural reforms” will obviate the need for them to rethink their macroeconomic strategy.

Another chance for Paul Krugman to cite St Agustin!

(H/T Eurointelligence, which also links to a report on how the Greek government is saying that there will be no more austerity next year, even under a third bailout. This crisis is not yet over.)



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12 thoughts on “Grant me microeconomic efficiency, but not yet”

  1. Hmm “things being obvious once we think about it”, I d hope the study of economics to a professional level would help debunk such ideas, especially when it comes to macro.
    As usual I have difficulty seeing the premises of these comments, and would have appreciated an historical perspective… e.g. “as problem for a continent whose leaders refuse to take the demand side of the economy seriously”. Yet do we not see some euro area governments run historically large budget deficits, STILL, and led of course by Ireland. An historical perspective here would be interesting.
    And we see that the USA does the exact opposite of what the IMF, Brookings et al plead for i.e. it cuts its budget deficit now .but takes no action on longer public liabilities. Yet most professional economists have been pleading for the exact opposite policy. And despite the ever stronger headwinds from the blunt sequester, the US economy is picking up. Get a multiyear fiscal deal on the Hill into year end, and I’d bet my shirt on an ever stronger path for growth, ceteris paribus (unfortunately we are unlikely to see a grand fiscal bargain anytime soon). So Ricardo rules ok it seems, after a few years of pump priming.
    Ironically the paper that is the topic of this post dates from last May. But in the past few days, we’ve had a number of papers on how demographics distorts macro policymaking. And if there are some “obvious” macro observations, one could be that aging has costs (first for Japan, and Greece top of Europe’s list). Less obvious, but probably still true, is countering those costs with “demand policies” (i.e. ever bigger budget deficits) in an attempt to maintain living standards may not be optimal.
    But hey, how about an historical economic perspective on all these questions?

  2. The concern about generating expectations of inflation in a short-term situation is likely to be more a fear of economists than most of the public.

    India’s current economic woes suggest a similar situation to some of the European peripheral economies where textiles, clothing, and footwear sectors, faced intense competition from cheaper Chinese imports.

    Capital flows can mask the problems only for a time and the lack of a modern manufacturing base in India can be compared with Italy.

    The reality of course is that overdue reforms get attention if at all only at a time of crisis.

    With cross-border flows down, countries such as Italy and Greece has very poor records in attracting FDI. Italy’s foreign direct investment inflows in 2010, at only $9.5bn were a quarter of France’s FDI.

    Making it easy to start a business and a multiplicity of other small things can have a big impact.

  3. @K O’Rourke

    “It has always struck me that the first order consequence of making it easier for firms to fire people in the middle of a depression would be that…firms would fire more people. And it has never struck me that this would be desirable.”

    Too true. At the ‘local’ level, however, we managed to get something right, whether by accident or otherwise.

    One policy measure in Ireland actually has made it considerably more expensive to fire people. My guess is that this policy measure has had some success in retaining workers as part-time or on short time as distinct from being made redundant.

    Previously employers received a 60% rebate of statutory redundancy pay paid to employees being made redundant. The rebate was reduced initially to 15%, and then to zero%, with effect from Jan 2012 (? date).
    Employers now are much more likely to use short-time working during slack demand, rather than make employees redundant and pay the full statutory redundancy pay themselves, with no rebate.
    Paradoxically, the change has also made it almost imperative for struggling businesses to struggle on, particularly those businesses with some equity left in the business. The reason is that the contingent liability to pay redundancy pay, on liquidation, becomes an actual liability, that in turn ranks as a preferential debt together with payroll, revenue debts and floating charges etc (not fixed charges/ mortgages that rank above these).

    In order therefore to avoid losing everything, SMEs must or at least are negatively incentivised to make every effort to survive by retaining employees.
    Some SME owners, naturally, bitterly resent this policy or money saving change. But the change has made, imho, a positive impact on employment or at least lessened an increase in unemployment.

  4. I hope your pension fund is not invested in companies that would not fire people in the middle of a depression – if that’s what’s needed to save the company and preserve some shareholder value. What SME or corner coffee shop could afford to retain staff if sales have plummeted? Large MNCs with strong balance sheets could probably afford to keep staff during a temporary downturn but not during a depression. As a truly great poet Patrick Kavanagh wrote “But come to the test hard reality must, Make the pace on the Rowley Mile”.

  5. In a well-run business anywhere, both good staff and supplier relations are key factors in success and failure.

    Of course as in every sector of life, there are petty people and misers, while the wise businessperson knows that it’s a fair bet that such people are unlikely to get far.

    The recent UK experience of rising employment coincident with falling output shows that business is rational but not in the short-term manner economists expect.

    Firms have reacted to the slump mostly by holding down wages and trying to keep on employees because they wish to be prepared for a recovery with skilled staff (in particular knowing the business and markets).

    The FT today declares ‘Osborne wins the battle on austerity.’

    The anti-austerians grumble that the upturn would have come earlier had Mr Osborne eased up on the fiscal squeeze. This is impossible to prove as economic history offers no counter-factuals.

    What we do know, however, is that the chancellor’s critics overstated the obstacles standing in the way of a recovery. Their position was too extreme and they have found themselves snookered.

    Nor was Mr Osborne ever the wandering axeman of opposition caricature.

    In real terms, data that I culled myself, shows that spending (current and capital) in 2009/10 was £716bn; £720bn in 2010/11; £705bn in 2011/12; £675bn in 2012/13 and it’s forecast at £704bn in 2013/14.

    This data suggests that the calamity howling from the anti-austerians was slightly overdone, methinks?

  6. Real austerity has yet to visit most EU countries and the UK.

    They are just around the corner.

    Japan postponed the austerity adjustments for 25 years and counting. But then someone went to war with them in 2011, and they did not even notice!

  7. Of course it does not matter a bit whether this is helping or not. Quite to the contrary. The real reason why we “need” the bad economy (and therefore the austerity) is to force the populace to accept the “necessary” liberal labor market reforms. It does not matter whether these arguments make economic sense, because unfortunately the population at large, and certainly the media, have already been indoctrinated that liberal free markets are good and necessary for economic growth.

  8. ” … unfortunately the population at large, and certainly the media, have already been indoctrinated that liberal free markets are good and necessary for economic growth.”

    The ‘population at large’? I assume you mean us Sheeple! Can you actually indoctrinate sheep? I donn’o, but you sure can herd them though!

    As for the meeja. Lost cause there. Zombified. I blame those damn swipe phones!

    Markets – whatever they were, have long gone. Did they ever exist – other than in the sad imaginations of economic folk? What we actually have are financial casinos where the boyze gamble with the Sheeples’ money – after they have skimmed their cushy commissions, you understand!

    Austerity is a piece of artful PR guff to disguise the reality of ‘market’ behaviour. Real economies have to dip now and again, and again, and again! Effectively, they eventually stagnate: austerity = economic stagnation (ie: G*P growth stops!). Can’t say that, now can we? Might spook the Sheeple!

  9. Consider Spain & Italy vs Germany. The German view is that Germany recently reformed labour law to make layoffs easier and their low unemployment shows this is a good policy. The problem with this argument is that Spain and Italy attempted similar reforms in the 90s (Italy) and early 80s (or late 70s ???anyway Suarez was PM) for Spain. This matters a lot, because the reforms all apply to newly hired workers. In 2008 a much larger fraction of German than Spanish workers had legally protected job security. The ease of cutting employment depends not only on current law but on lagged law given the grandfathering (in Spain) of workers with job security vs the mere fathering in Germany of those workers.

    In general, the clearest effect of employment protection legislation in the data is just the direct effect that employment declines more quickly in recessions in free market oriented countries. There are others (before the reforms Spain managed a decade of decreasing employment and Italy managed two decades without increased employment (it remained around 20 million). But history and standard economic analysis strongly suggest that the boom not the slump is the time for labour market liberalization. The problem (as with austerity) is that during booms there is no crisis and little pressure for reform.

    Great men create their predecessors and extremely good macro papers draw attention to something Keynes said. Of course the point is not new

    “it would be much better that wages should be rigidly fixed and deemed incapable of material changes, than that depressions should be accompanied by a gradual downward tendency of money-wages, a further moderate wage reduction being expected to signalise each increase of, say, 1 per cent. in the amount of unemployment. For example, the effect of an expectation that wages are going to sag by, say, 2 per cent. in the coming year will be roughly equivalent to the effect of a rise of 2 per cent. in the amount of interest payable for the same period. ”

    The General Theory of Employment Interest and Money Chapter 19
    http://www.marxists.org/reference/subject/economics/keynes/general-theory/ch19.htm

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