Max Huppertz—The Decline in Labor Force Participation: Speed Bump, Hysteresis, or "I, Robot"?

Max Huppertz is a student in my “Monetary and Financial Theory” class and has his own Tumblr blog, Liberal Animation. Of all my current students, Max is the one whose writing reminds me most of Noah Smith’s style on Noahpinion. To get a full picture of Max’s sense of humor, you will have to go to his blog Liberal Animation, but the guest post below shows the depth of Max’s analysis. Max:

Evan Soltas had an interesting post about labor market tightness a couple of weeks ago. His main point is that, looking at the quits rate, you might think that labor markets are pretty tight right now. That might be a sign that, overall, there’s not a lot of unused economic capacity, or at least, not a lot of unused capacity that matters (more on that below). If you think that’s the case, you’d reach very different policy conclusions when it comes to monetary tightening than someone who thinks there’s still plenty of slack in the economy.

Quite a few people have given their 2 cents already. John Aziz makes a point about the potential benefits of overshooting: it might create jobs for some of the long-term unemployed.

Evan may have a good reason for disregarding the long-term unemployed. John’s proposal might be all we need. But if neither of the two is completely right, we may be in trouble.

Why does Evan think that the long-term unemployed don’t matter? He says that if they don’t compete with more active members of the labor force, they can’t hold back wage growth or interfere with employer/employee matching (because they won’t keep people from quitting a job they don’t like for one they enjoy). Which is a valid point.

But in the medium to long run, a drop in lower labor force participation seems like somewhat of an issue. And participation is down:

It seems to me that there are three possible reasons for this, and three scenarios how this could play out:

  1. The decrease in labor force participation is transitory. In that case Evan’s assessment is correct, although you could still argue that the possibility to overshoot is a risk worth taking, given its potential benefits.
  2. The decrease is more or less permanent, due to labor market hysteresis. In that case, overshooting alone might do the trick.
  3. The decrease is more or less permanent, and it’s a (labor!) demand trend. In that case, we might have a real issue on our hands.

1) Will it all be over soon?

Evan seems pretty convinced that the long-term unemployed “really can’t matter much in a macroeconomic sense”. I think that statement makes sense only if you assume that, in the long run, labor force participation will return to its pre-crisis level. Else, I would like to see an argument as to why we should ignore the fact that 3% of the total US labor force decided to take some time off. Changes of that magnitude are the ones that tend to matter little now, but a lot if they turn out to be persistent over several years’ time.

2) The UI forever (well, kinda…)

Just so we’re clear: economists have a somewhat peculiar interpretation of the word permanent. When I say that the drop in labor force participation might be permanent, I don’t really mean forever. I mean, “for around ten years or so”. Which is substantially longer than recovering from the recent crisis will take (hopefully, anyway), and thus covers a much longer time span than scenario one. So why might participation be depressed for a whole decade?

There are a few stories you could tell that might lead to scenario two. Maybe people lost a lot of human capital while they were unemployed, and have genuine trouble finding a job. Or maybe, employers regard long-term unemployment as a signal. Long-term unemployment might indicate that you’re not the kind of person people would want to employ. Granted, it might also mean you were just unlucky and got laid off at a time when it was really hard to find a new job. But so long as employers have plenty of ‘good’ applicants to choose from – people who aren’t sending out the long-term unemployment signal – they might be okay with rejecting you anyway.

I’m not sure how likely this scenario is, but if this is the one we’re in, definitely overshoot! Temporarily overheating the economy may raise inflation a little, but it would also mean more job openings and fewer people applying. Making job applicants scarce would provide an incentive for employers to take a closer look at the long-term unemployed, and to figure out whether what happened to them was just bad luck – or whether they’re actually bad apples.

3) Rise of the Robot Lords

What if the long run equilibrium level of employment is actually decreasing over time? Take a look at the bigger picture:

For a while now, there has been stagnation and quite a substantial drop in labor force participation, even before the dot-com bubble. If employers desperately needed these people, wouldn’t you expect them to raise wages and try to lure some of them back into the game?

I know this sounds a little like a sci-fi cliché, but if falling demand for labor due to increased mechanization were responsible for discouraging workers from even trying to find a job, overshooting will at best give a temporary boost to labor force participation. After that, we’re back to the downward trend.

The remedies for this kind of situation are very different from what we need to do in the other two cases. Increasing the general level of education would be a good idea (it generally is, but especially in this case).

Rethinking the social safety net would be another (this is probably worthy of a post of its own, but let me give you my intuition). Many of the labor-intensive industries of today might rethink their business model once robots become more cost-effective. What happens if mechanization puts us into a position where the vast majority of workers in classic manufacturing jobs (cars, steel) – and possibly also a fair few in the service sector (eventually, burger-flipping robots will be the norm) – are no longer needed? And when, at the same time, the new ‘employees’ – machines – won’t ever ask for pensions, or unemployment benefits? Well, it seems to me that indefinite unemployment insurance, or a guaranteed basic income, might not be so Utopian in this scenario.

Faced with this kind of affluence, society might well decide that the dangers of ‘paying people to be unemployed‘ are far outweighed by the benefits of getting much closer to what John Rawls would call a well-ordered society. And, especially in a highly educated society, I think we have reason to believe that people actually want to work, instead of being on the dole. As Jeffrey Smith nicely said (referring to Arno Duebel, a German who had been living off unemployment benefits for 36 years straight):

The actual mystery, though, is not the existence of someone like Arno, but rather, given the relative generosity of many European welfare states, their relative scarcity.

By the way, labor force participation isn’t just down for low-skill workers; this may be an issue that affects us all, even those with a college education (albeit to a lesser degree): tumblr_inline_n48vd0Ne7I1r57lmx.png

Like I said, this deserves a post of its own.

Humans good, robots bad?

I think that the third scenario is the one we want to be in. Any kind of job that a robot (or machine in general) can do better then a human – why not let it do it?

But it’s also the most difficult one to come to terms with, politically and ideologically. The left would need to give up part of its struggle for the ‘working class’, at least in the classical meaning of the word – factory workers, hard manual labor, that kind of thing. The right, on the other hand, might need to concede that in this kind of environment, maybe having a basic income won’t annihilate the US economy.

Issues like these would have to be dealt with during the next few years and decades. Or, who knows, maybe we are in scenario one, and Evan is right, or two, and John is right. But if not – and there are good reasons to believe this – we might want to start thinking about the implications.