How many people have lost their jobs?

According to Barack Obama, 600 thousand Americans have lost their jobs since January. Actually, he's wrong: something like 20 million Americans have lost their jobs since January. It's just that most of them found new jobs. Probably the new jobs generally weren't as good as the ones they lost. And almost certainly, more than 600 thousand of them were unable to find new jobs, because many of the new jobs created were filled by new entrants to the labor force or by people who were already unemployed when the year began.

Like almost everyone else I've ever heard, Senator Obama is making the mistake of using a net job loss figure with language that, if taken in its plain sense, clearly implies he is talking about gross job loss. And it seems to me that gross job loss is the appropriate concept: losing your job is a pretty serious bummer, even if you are able to find a new one after a few months.

There has been a lot of talk about Senator McCain and how he has been saying things that aren't true in order benefit himself politically. It turns out that Senator Obama is also (obviously unintentionally) saying things that aren't true, but in this case they benefit his opponent.

Definition

Sex worker:

(1) a prostitute

(2) anyone in a sex-related occupation, including a psychiatrist with a specialization in sexual disorders or a cashier in a convenience store that rents adult videos

(3) someone in an occupational category broader than (1) and narrower than (2), the precise specification of which is known only to the person using the term


Examples of (3):

(a) Anyone who acts in an adult video, is a sex worker, but someone who works in distribution of adult videos is not.

(b) Anyone who has, on camera, actual penetrative intercourse involving an actual male member, is a sex worker, but someone who engages, on camera, in Lesbian sex acts, including those that involve penetration, is not.

(c) Anyone who interacts sexually directly with a client, whether or not that interaction includes an actual sex act, and whether the interaction is in person or over some kind of telecommunication network, is a sex worker, but someone who performs sex acts on camera, for distribution as entertainment, is not.

Where is “Sex” in the NAICS?

This business with Eliot Spitzer is bringing up issues in labor economics for me. In particular, how should we refer to Ms. Dupré’s occupation? Some people insist that she was a “sex worker.”

I have a number of problems with this terminology. For one thing, is there any other occupation where the title includes “worker” and the hourly billing rate can be in the quadruple digits? I mean, there are a few cinematic production workers who make that kind of pay – but they’re known invariably by other titles (actors, directors, etc.) – and a few sports workers – but they’re known as athletes – and quite a few finance workers – known as investment bankers, fund managers, and such – and quite a few…I guess I’d have to call them generic workers, since they can be in any industry…but they’re known as corporate executives – and a few legal service workers known as attorneys, and a few professional service workers known as consultants, and maybe a few health care workers known as doctors and surgeons, and so on.

Which brings me to my second, related point, which is that we don’t normally identify an occupation by the industry to which it belongs. The exceptions are sort of residual categories: we do call some people “health care workers” if we can’t think of anything better to call them, but most people in health care occupations (nurses, for example) would probably find it insulting to have their occupation identified as “health care worker.”

According to Wikipedia, a sex worker is someone (anyone, apparently) who works in the “sex industry.” I have a feeling that many people who work in the “sex industry” would be insulted to be called “sex workers” (rather like nurses, if you call them “health care workers”). I mean, really, doesn’t everyone know that the phrase “sex worker” is a euphemism for “prostitute”? (I know, technically, that’s not the case, but in real life, other “sex workers” seem to use the phrase for themselves only when they’re trying to make a show of their solidarity with prostitutes.)

But here’s the real problem: What the hell is the “sex industry”? And more to the point, what kind of industry is it?

• An information industry? (The adult video industry, as best I can tell, is part of NAICS 512110, “Video production,” an information industry.)
  
  
• A personal service industry? (Officially, Miss Dupré was probably working in NAICS 812990, the “Social escort services” industry, a personal service industry. As to what she was actually doing, it seems to me that prostitution is clearly a service, and it’s about as personal as services get.)
  
  
• A food service industry? (I know that doesn’t make much sense, but where do strip clubs fit in the NAICS? As best I can tell, they are part of NAICS 722410, “Night clubs, alcoholic beverage,” a food service industry.)
  
  
• An entertainment industry? (It’s really tough to find a NAICS code that would actually apply here, but aren’t strippers entertainers? Of course strippers also give lap dances, which are really more of a personal service than a form of entertainment. In fact, in that respect I have to question whether strippers are really more like prostitutes than entertainers.)
  
  
• An amusement and recreation industry? (That’s pretty much just a wild guess. But where the hell do brothels fall in the NAICS? There are legal brothels in Nevada, so I assume they must have a NAICS code.)

As far as I can tell, the whole concept of a “sex industry” makes a mockery of the way we normally classify industries. I don’t have a problem with changing the occupational title of prostitutes to something that has less of a stigmatizing history. But “sex worker” just doesn’t do it for me. I’m going to try “personal sexual service provider” (PSSP for short) and see if it catches on. Otherwise I’ll just call them hookers – a term which doesn’t seem to offend people even though its etymology is rather scurrilous.

Marginal Taxes on the Rich

In response to the opening sentence of my last post, Greg Mankiw asks:

Have you ever turned down a money-making opportunity that you would have accepted if it paid twice as much?

I'll outsource the first part of the answer to "a student of economics," who comments on Greg's post via the comments section of my last post:

Greg asks the wrong question in an effort to get the answer he seeks.

The correct question should be, "would you turn down that opportunity if ALL your other money making opportunities also pay twice as much?"

It's not clear that I would do anything different if all my options improved by the same amount. There are only so many hours in day. In fact, perhaps I would actually work less and play more if I were twice as rich (assuming, of course, all gov't services magically continued without cost).

I do recall once having two job offers at comparable pay, and I'm sure that, if the one I rejected had paid twice as much, I would have taken that one instead. But it's pretty obvious that has nothing to do with taxation; it has to with what other opportunities are available. If both jobs had paid twice as much, I would have made the same choice that I did.

Part-time opportunities are a separate issue. I don't have a clear memory on this point, but it's quite possible that I've turned down consulting work that I would have accepted if it paid twice as much (though again, if all opportunities paid twice as much, I'm not sure how the income and substitution effects would sort out). In my case, though, the example (if there is one) would make my second point: that the incentive effects of higher marginal tax rates are not all bad. If I did turn down an assignment, it would be a job in support of one side or the other in a legal case or an interest arbitration. Given the near zero-sum nature of such proceedings, the negative externalities associated with my activities would have been quite high. In this case, the tax is Pigovian, and I'm confident that it's nowhere near high enough to equate the private rewards with the social value of such work. I've made a similar point before.


[UPDATE: Boy, my two sentences introducing a different topic are generating quite a large tangent. PGL at Angry Bear has this to say.]


UPDATE2: In a Update, Greg gets into the whole income and substitution effects business and argues that he is asking the right question because he is isolating the substitution effect, which is what matters for deadweight loss. But for most real-life examples, he's still wrong. It's fairly obvious in my example of having two job offers, but it's true in a lot of more subtle cases too, that one is not really making a substitution between labor and leisure; rather, one is substituting one labor opportunity for another. Usually, one doesn't have a firm offer for the alternative opportunity, but one has some reasonable idea of what opportunity may become available. If a job offer gets doubled, it becomes unrefusable simply because one will never get another offer so big.

It's true that, to the extent that one has marginal opportunities, as in my consulting example, there may be labor-leisure tradeoff, but even there to a large extent it may actually be an intertemporal tradeoff between different labor opportunities given a more-or-less fixed amount of total leisure over time. And I would reiterate my point that the taxes in these marginal cases are often Pigovian.


[UPDATE3: While we're on the topic, let me point back to this post in which I argue that progressive taxation (though not high overall taxation) can actually encourage entrepreneurial activity.]

Marginal Taxes on the Poor

I've always been skeptical of the importance of the purported bad incentive effects of high marginal tax rates on high income earners. (I won't go into the details now, but I don't think the incentive effects are very strong -- at least at tax rates close to current tax rates -- and I don't think they're all bad.) For some time, though, I have been concerned about the effects of effective marginal taxes on low income earners. The problem is not the taxes they pay to the IRS (which they mostly don't, anyhow) but the effective taxes they pay to various subsidizers, price discriminators, and assistance providers in both the public and private sectors.

It has worried me that there might even be some point on the lower part of the income spectrum where the effective tax rate is greater than 100%. That is, you get more income; you no longer qualify for various assistance and subsidies; you slide up the "sliding scale" of various vendors and service providers who (officially or unofficially) give discounts for the financially challenged; you pay more in FICA and state and local taxes (even if you still don't pay Federal income taxes, which you might); and you end up worse off (even leaving aside any reduction in leisure) than when you had less income.

It turns out this was more than a theoretical possibility. Jeff Frankel (hat tip: Greg Mankiw) quotes Jeff Liebman with a story about a woman who "moved from a $25,000 a year job to a $35,000 a year job, and suddenly she couldn’t make ends meet any more." In her case it wasn't until after the (apparently irrevocable) decision that she discovered what a bad deal it was to make more money, so maybe the incentive effect per se wasn't a problem, but even someone like me, dubious as I am about "justice" as a moral concept, has a sense that this woman has been cheated and that what happened is "wrong." And eventually we have to assume that the incentive effects will matter: presumably Abraham Lincoln was right that you can't fool all of the people all of the time. Moreover, the incentive effects will matter even when the effective tax rate is "only" 80% or 90%. And it can only get worse when we begin to attempt universal health care on a national level.

In theory the solution is to consolidate all forms of public (and ideally, private) assistance into a single, fairly large grant, which can then be taxed away via the income tax at a reasonably slow rate for people who don't need it. That obviously isn't going to happen, and I don't have any other solutions to offer, but Jeff Frankel notes in passing that Jeff Liebman is an economic advisor to Barrack Obama. Given that Senator Obama is now the (not quite odds-on, as of this morning) favorite for the next presidency, I'm heartened that at least one of his economic advisors is thinking about the problem.


[UPDATE: My next post deals specifically with the issue raised in the first two sentences about high income earners. I guess it's hopeless, though, for me to get people to break that thread here and post comments on that more relevant entry.]

Monster Really Scares Me

Just as I finished leaving a comment (not yet accepted as of this writing) on Paul Krugman's blog arguing that UI claims for January remain on balance in the "good news" column and that the personal consumption report is not bad news given what we already knew about retail sales, I learned that the Monster Employment Index (which measures online help wanted advertising) fell by a whopping 9 points (from 169 to 160) in January, after falling an even more whopping (but less surprising given the usual seasonal pattern) 14 points in December and a not so whopping (but still significant because the index has never dropped 3 months in a row before) 5 points in November. That makes a total drop of 28 points, or about 15%, over 3 months. Before December 2007, the index had never fallen by more than 3% over any 3 month period (since it began in October 2003). And note that the 15% drop comes as newspaper help wanted advertising is scraping against an all time low (since 1951, when the Conference Board's index began, but note that in December, it rose slightly from the all-time low in November). Over the past week or two, I had been starting to think that the odds were shifting against recession. Now I'm not so sure. In any case I think we can rule out the possibility that 2008 will turn out unexpectedly to be a year of normal growth. And I'm not so worried about import prices now; I think they'll be offset by a slowing of domestic inflation.


[UPDATE3: OK, now I found the post on Paul Krugman's blog where he said that someone else edits the comments. (I missed it the first time, because it was in an update that I didn't read.) And I notice that one of my comments on an earlier post has suddenly appeared. I guess they decided I was a respectable commenter after all.]

[UPDATE2: I removed the previous update, because Paul Krugman (or whoever approves comments for his blog) did approve my comment. (See link at the top.) I had assumed it wasn't going to be approved, because there were later comments comments already approved, but I guess these things don't necessarily go in order.]

[UPDATE: [removed] ]

Efficiency Wages?

`It's only once a year, sir,' pleaded Bob, appearing from the Tank. `It shall not be repeated. I was making rather merry yesterday, sir.'

`Now, I'll tell you what, my friend,' said Scrooge,' I am not going to stand this sort of thing any longer. And therefore,' he continued, leaping from his stool, and giving Bob such a dig in the waistcoat that he staggered back into the Tank again;' and therefore I am about to raise your salary.'

No Help

Today the Conference Board announced that in August, its Help Wanted Advertising Index fell for the eighth straight month, by a larger-than-expected 8% (using the integer numbers that the Board reports), to its first new all-time low since 1958. ("All-time" in this case means since 1951, when the series began.) This means that major newspapers in the US carried fewer help wanted ads than they did at the depth of the 1958 recession. This is despite the fact that the scale of the US economy, by any measure, has more than doubled since 1958. (In particular, there were about 51 million employees on nonagricultural payrolls in mid-1958, compared to 138 million today.) It's also despite the fact that many of the smaller local newspapers, which used to compete with the surveyed major newspapers for advertising, have gone out of business or been absorbed by the major newspapers during that time.

Part of the explanation is the emergence, over the past decade, of online recruiting as an alternative to newspaper-based recruiting. This is only a partial explanation, though, and it only helps explain the general downward trend in newspaper help wanted advertising over the past decade, not the specific decline this year. Online help wanted advertising, according to the Monster Employment Index, has been (uncharacteristically) roughly flat since March (over which time the Conference Board index* has fallen by 23%), though the Monster index has doubled between October 2003 and today. But in 2003, online help wanted advertising had only 19% of the market share vs. newspapers, so even the doubling doesn't begin to make up for the 36% drop in newspaper help wanted advertising over the same period.

Also this morning, ironically perhaps, we got the news that new unemployment claims fell below 300,000 in the week ended September 22, for the first time since May. There has been no pattern of rising unemployment claims this year while help wanted advertising has been steadily falling. Apparently, the US is experiencing a new kind of economic weakness -- one where the trailing edge of the labor market keeps steady but the leading edge stops advancing.


*UPDATE: Just to clarify, I'm referring to the index of newspaper help wanted advertising discussed in the previous paragraph. The Conference Board also has an index of online help wanted advertising, but I haven't started to follow it yet.

Shorter Case for Labor Cost Targeting

Look, there’s a good chance the s___ is going to hit the fan in the next few years, if not in the next few weeks**, with a crash in the dollar and a takeoff by commodity prices, especially oil. The Fed has 3 choices:

1. It can wait for the s___ to hit the fan and then do nothing.* Bond markets, product markets, and labor markets will lose confidence in the Fed’s resolve for price stability, and the result will be stagflation (a concept with which readers my age and older will be familiar from experience, but younger readers may have to use their imaginations).
   
   
2. It can wait for the s___ to hit the fan and then tighten aggressively. The result will be a major recession.
   
   
3. It can “announce” as soon as possible that it intends to target labor costs, and when the s___ hits the fan, do nothing.* The result, with any luck, will be a couple of years of high inflation rates, with normal economic growth, followed by more normal economic growth along with low inflation rates.
   

I’m just saying, choose what’s behind door number 3. It doesn't really matter if you're a capitalist or a worker or a rentier or a financial technocrat or what. It's just the best choice.


*That is, nothing except for a mild tightening to offset the economic stimulus from the weaker dollar.

**UPDATE: Let's say quite possibly in the next few weeks, if not in the next few days. The following item appears in my email this morning:

Venezuela’s state-run oil company has demanded payment for all future sales of crude and products to be in euros rather than US dollars, according to a letter to customers on September 21.

More about Labor Cost Targeting

Several issues arise in the light of Mark Thoma’s post about my last post. First, there is the distinction between labor cost targeting and wage targeting. Mark brings up the general argument for targeting sticky prices and/or wages (in particular as presented by Michael Woodford). To the extent that wages are stickier than prices, the theoretical argument would call for targeting wages, if one wants a simple policy (although more generally it should be an index of most wages and some prices). The problem with targeting wages is that it makes the inflation rate less predictable by taking away its long-term anchor. If productivity grows quickly, a wage targeting policy would imply a very low rate of price inflation (possibly even deflation); whereas if productivity grows slowly, a wage targeting policy would imply a higher rate of inflation. Productivity growth is notoriously difficult to forecast over long horizons, so the details of the long-term inflation rate become a wild card. I’m not sure I have a theoretically sound argument, but something about having an indeterminate long run inflation rate makes me uncomfortable. Certainly it has the disadvantage of making it harder to price long-term bonds.

In contrast, targeting labor costs would only permit temporary variations in the inflation rate in response to external supply shocks or distribution shocks. For example, a large increase in import prices would cause the inflation rate to rise in the short run, but eventually the domestic price level will adjust, and the inflation rate will go back to its long-run path. It’s true that the relevant long run could be very long: for example, the inflation rate has been higher than the labor cost growth rate for most of the last 16 years, as the chart in my last post shows, because the distribution of income has been shifting gradually toward capital. We don’t know if that shift will continue or reverse or how much longer it might continue, but we can be sure it will end eventually, because income shares can only vary between 0% and 100%. (Historically, income shares have in fact been mean-reverting. Possibly we are in a new regime now in which there has been a permanent increase in capital’s share, but for practical purposes, even if we can’t be sure it will mean-revert, I think we can rule out a large permanent increase in capital’s share beyond its current near-record.)

Which brings me to another point I wanted to make. Several people have objected that targeting labor costs would mean putting a limit on wage growth, potentially further shifting income toward capital. I would call this a “glass half empty” view of labor cost targeting. The “glass half full” view is that labor cost targeting would insist on wage growth (up to a point). Since we’re talking about nominal wages, it’s not clear to me that either of these two views really has much substance to it: no matter what happens to nominal wages, prices can still change in such a way as to render real wages either higher or lower.

It has been suggested that, if the Fed were programmed to react to large wage gains by tightening, that would give workers less bargaining power. But if you look at the past 15-20 years, it looks like the Fed might have been targeting inflation at around 2%; if instead the Fed had targeted labor cost growth at 2%, that means the Fed would have tolerated even larger wage gains than it actually did, so presumably workers would have had more bargaining power than they actually did.

I’m not inclined to give much credence to these kind of arguments about bargaining power anyhow, because the Fed would be targeting aggregate labor costs, whereas wage bargains are made in individual industries (or at individual firms, or, these days, more likely by individual firms dealing with individual workers). If, for example, auto workers are somehow magically able to bargain for a 20% wage increase, the Fed need not necessarily react, unless it expects workers in other industries to get the same wage increase. I don’t see how there is much loss of bargaining power.

It’s also important to realize that labor cost targeting does not necessarily mean reacting directly to labor cost growth in the short run. As I pointed out in my last post, the data in the short run are unreliable, and it wouldn’t be appropriate to put too much weight on recent data that could be revised or could be just a temporary blip. So even if everyone gets a huge wage increase, the Fed’s reaction might be delayed. In general, workers could probably expect enough delay in the Fed’s reaction to make them comfortable driving as hard a bargain as their particular circumstances seem to warrant, since the tightening might well come later on when employers are trying to raise prices instead of when the actual wage increases happen.

Furthermore, to some extent labor costs have a predictable business cycle pattern, and big increases in labor costs are more likely to precede a recession. Since the Fed would want to dampen rather than amplify the business cycle, it would not be well advised to tighten in direct response to a cyclical increase in labor costs. Rather, it should have a forecast of the cyclical behavior of labor costs, and it should tighten or loosen depending on what labor costs do relative to that expected cyclical behavior. Realistically, though, the forecast should also include a lot of other indicators, and the Fed would be concerned with the ultimate level of labor costs at some point in the future. Though unexpected cyclical behavior would be a reason to revise that longer-term forecast of labor costs, it might well be offset by other reasons relating to the other indicators involved.


UPDATE: Another point occurs to me, which sort of ties together some of the points above. With wage targeting, the "damaged bargaining power" school might have a stronger case, because wage targeting would attempt (though with only limited likely success over any short time horizon) to put a constraint -- one that could be anticipated in advance -- on the aggregate behavior of wages at any particular time. With unit labor cost targeting, there is no absolute intended constraint on wage growth, because the intended wage growth would depend on productivity growth, which (a) could not be known in advance, (b) would not be known with any reliable precision until quite a bit later, and (c) might well depend on other aspects of labor negotiations, or for that matter, on wages themselves.

Target Unit Labor Costs

Last year (here and here, with related posts here, here, here, here, here, here, and here – or just read the August 2006 archives and my post from yesterday) I suggested that the Fed should target unit labor costs. Upon additional thought, I still think so. I won’t go through the whole argument again, but I want to note a few important points:

1. I’m referring to targeting a forecast of labor costs (using a “price rule” that would correct for the failures of earlier forecasts), not trying to react to every wiggle in the reported series, which is reported with a lag, quite volatile and subject sometimes to fairly dramatic revisions. The idea is for the Fed to have a long-run stable growth rate of unit labor costs as its ultimate objective, upon which it could be judged after several years of hindsight, when the final revisions come in and the trends become clear.
   
   
2. The main purpose of this approach is to have a simple and easily understood (by the market) answer to the question of how to react to supply shocks. The appropriate response to supply shocks is a matter of great controversy in macroeconomics: should a central bank accommodate supply shocks and let the inflation rate rise temporarily in order to avoid a recession or a slowing of growth (or a boom, in the case of a favorable supply shock), or should it lean heavily against the inflationary impact (or the deflationary impact) of supply shocks in order to pursue an unchanged target inflation rate? The labor cost target settles the question: if the shock is to domestic productivity or to the labor market, then lean against the inflationary impact; if the shock is entirely outside the domestic labor market and production process, then accommodate (except to the extent that you expect the shock to have indirect effects on productivity and the labor market, such as might arise, for example, from sticky real wages).
   
   
3. If the Fed is going to adopt such a policy, now is the time to announce it – or rather, to let the idea of prioritizing unit labor costs find its way into the speeches of Fed officials, since that’s the way the Fed operates. All indications today are that we are heading directly into an unfavorable import price shock. How will the Fed react? The market shouldn’t have to make random guesses. Moreover, there is great uncertainty about the intensity of the shock, and to some extent, the direction (because oil is something of a wild card and could have a big drop in price just as easily as a big increase). We want to know now what reactions to expect when these uncertainties are resolved.
   
   
4. When today’s incipient shocks are fully realized, Fed credibility is going to be a big issue, especially with a relatively short-tenured Chairman and given the market’s response to this week’s Fed action. In the case of a severe adverse shock, if the Fed hasn’t specified in advance how it intends to react, it will face a choice between recession and loss of credibility. That’s not a situation that anyone will enjoy.
   
   
5. As the following updated chart indicates, the Fed can make a pretty good case that it has already been targeting unit labor costs since the early 1990s. (The old talk about a preferred inflation rate between 1% and 2% rings a bit hollow – in addition to being, in my opinion, a less than optimal target range for inflation. But unit labor costs have stayed pretty nicely in that range – although, in my opinion, it’s a less than optimal target for unit labor costs as well, and I would hope the Fed would go maybe for something like 2%.)

From the chart, it looks like we need a slowing of unit labor costs now to continue keeping in line with the target. But given the recent weakness in the labor market and simultaneous recovery in output growth, as well as various factors suggesting a high risk of recession, I think the central tendency of the Fed’s forecasts will be for slower labor cost growth anyhow. All in all, labor costs are still very close to the presumed target, so the priority at this point should be for maintaining stable growth rather than attacking a bulge in labor costs. (And if the Fed were to do as I prefer, and raise the target to 2%, there wouldn’t be any question.)

Revised Smoothed Unit Labor Costs

Perhaps the most striking piece of data adduced by Allan Meltzer in arguing against an easing of monetary policy was “unit labor costs rising at a 5% rate.” It appears that he is comparing second quarter 2007 unit labor costs to second quarter 2006 unit labor costs to get that 5% growth rate. As I argued last year (ironically, arguing against Marty Feldstein, who went on to become Allan Meltzer’s major adversary in the recent debate),

...the right way to analyze these data is neither by comparing years to years nor by comparing fourth quarters to fourth quarters, but by smoothing the quarterly data over time to extract an estimate of the general trend.

I have updated the chart I made last year of the smoothed rate of unit labor cost growth, and the picture has not changed dramatically, though things do look a little bit more inflationary than they did a year ago. Certainly, my smoothed series does not suggest that that the 5% growth rate cited by Allan Meltzer is a very good indication of the general trend. The most recent smoothed growth rate is 2.5%, which, while it is higher than what today’s Fed would probably consider ideal, does not suggest that we are moving into a new regime of rapid labor cost growth.



It might also be worth thinking about what we should expect unit labor costs to do in the immediate future (or in the immediate past that hasn’t yet been reported in the data). Are there reasons to expect productivity growth to accelerate or decelerate? Are there reasons to expect compensation growth to accelerate or decelerate? To the extent that there are reasons for either, they go generally in the direction of accelerating productivity growth and decelerating compensation growth, so they point to a less inflationary trend in labor costs. Simply, the labor market is weak. With employment at a near standstill for the past 3 months, employers have little reason to raise compensation, and any significant output growth will have had to come in the form of rising productivity (since there is no indication that hours worked per employee is rising). Various indicators do suggest that output is still rising at a reasonable rate. (Also, I imagine compensation may take a substantial seasonally-adjusted hit when bonus time comes around for Wall Street and the mortgage and construction industries.) All in all, I don’t see much reason to be worried about rising labor costs.

Help Wanted Advertising Stabilizes

US help wanted advertising, which dropped precipitously during the spring and summer of 2006, appears to have stabilized during the fall. The Conference Board Help Wanted Index was essentially flat from August through November (the latest report), at a level about 20% lower than where it was a year earlier. (Taking online advertising into account would mitigate the decline, but given the normal growth in help wanted advertising over time due to a growing economy, the 20% figure gives a pretty good indication of the amount of deterioration.)

What this means exactly I’m not sure, but in my mind it tends to reduce the chance of a recession. On the other hand, it also tends to confirm the expectation of an economy too weak to please Main Street, and perhaps a little weaker than Wall Street would prefer.

Did I read this right?

From Wednesday’s Wall Street Journal (p. A6, “Labor Costs…”):

The Labor Department reported yesterday that … unit labor costs fell at a 2.4% rate during the second quarter, rather than growing at the originally estimated 5.4% pace.

Quiescence

Lately I’ve been having trouble focusing attention on this blog long enough to do a full post, because…well, you know, there’s a lot going on, etc…. To keep the blog alive, I’m going to try more quick posts, which will hopefully still be good food for thought but not so eloquent or well-reasoned.

Here’s a thought for today: the current condition of the US labor market should not be described as “weak” or “strong” but rather “quiescent.” There aren’t many layoffs going on, and there isn’t much hiring going on. There aren’t many people looking for jobs, and there aren’t many businesses looking for employees. I think most statistics bear out this view of the labor market. I’m not sure what the implications are. I do have some thoughts, which I may address in a later post.

Do labor shortages indicate a strong labor market?

Sorry I haven’t blogged in so long. Lack of ideas, mostly. Plus I’m busy not having ideas on my day job.

Today I have an idea. A lot of anecdotal evidence seems to suggest that labor shortages are a problem in the US today. Yet statistics – note, particularly, help wanted advertising, which is near a 50-year low – show little evidence of strong labor demand. Is this inconsistent?

I don’t think so. If different kinds of labor are complements in production, then shortages of certain kinds of labor could actually make the overall labor market weaker. For example, if individuals with a lot of different skills are required to make a product, then a shortage of one of those skills will depress demand for all the other skills. If chefs are in short supply, the demand for waiters will go down. Is this the kind of thing that’s happening in the US today? It seems plausible to me that shortages of certain technical and managerial skills could be depressing overall labor demand. Just an idea.

In Defense of Labor Cost Targeting

A week or two ago, I made the apparently heretical suggestion that the Fed should target unit labor costs. Brad DeLong picked it up with a link to my subsequent post. Several objections have been raised, and I want to deal with those objections here.

The main objection, coming from Dean Baker and kharris, is essentially – to use my own earlier words – that the unit labor cost series is “subject to revision, and volatile from quarter to quarter.” As I agued in the original post, “This would be a big problem for an intermediate indicator, but not so much for an ultimate target. The important thing is that the long-term trend be predictable…” Unit labor cost depends on compensation rates and productivity. I think the Fed is already pretty good at forecasting the trend in compensation rates. Productivity is more difficult, but this is a problem even if you target inflation.

Granted, the long-term trend in labor costs is probably not (contrary to what I suggested in the original post) as predictable as that of inflation. This is a disadvantage, but it is (I would argue) far outweighed by the advantages, particularly the relative robustness to the effects of supply shocks. Under a price-based (rather than labor cost-based) targeting regime, a huge adverse import price shock (such as a major dollar crash or sudden increase in oil prices) would virtually force the Fed to induce a recession. (Indeed, the Fed may have induced a recession – yet to fully materialize – in response to the more gradual oil price increases of the past few years.) Under a labor cost-based regime, the price shock could feed through to consumer prices without necessarily having a large effect on economic growth or employment. In principle, why should a scarcity in one commodity (such as oil) automatically induce a scarcity in another commodity (money)? Doesn’t a currency “backed by the productivity of the US labor force” inspire more confidence than a currency “backed by the promise of price stability”?

As my thinking has evolved, I would also suggest that a labor cost target should have the form of a “price rule” rather than a “growth rule.” That is, the Fed should explicitly try to correct deviations from trend rather than establishing a new trend when the old one is broken. The “price rule” approach helps with the data volatility problem by letting the Fed allow temporary deviations while credibly promising to maintain the longer-term trend.

Another objection, coming from an avowed non-expert:

When I hear "targeting unit labor costs" what I also hear is "we don't want workers to make more money, ever." To a lay observer like me, the Fed (and its counterparts in Europe) seem determined to prevent workers' wages from rising.

Actually, when I wrote the original post, I asked myself, “Would this regime discriminate against workers?” Would it automatically “take away the punch bowl before workers get to drink?” I think the answer is no. A labor cost target would allow workers to take full advantage of productivity gains, something they have apparently not been able to do under the current regime. Of course, firms could take back that advantage by raising prices, but I’m not sure that’s such a bad thing. In a sense, the current regime has allowed firms to undertake “stealth price increases” by keeping wages down. Under the current regime, the Fed is like, “Oh, hey, we’re just controlling inflation,” and firms are like, “Oh, hey, we’re just trying to keep costs down.” Under my proposed regime, firms would have to own up to the fact that they are grabbing a bigger share of the pie. If there are legitimate economic forces that are granting them that bigger share, then so be it, but let’s bring this process out into the open air of consumer markets rather than burying it in the back room of compensation determination.

Q2 Labor Costs

By most indications US labor costs rose rapidly (by recent standards) in the second quarter. But something is wrong with this picture. Ordinarily one would like to attribute an increase in the price of something (labor, in this case) to either a leftward shift in the supply curve (decrease in supply) or a rightward shift in the demand curve (increase in demand). In the case of labor, there is no evidence that either of these things happened; indeed, the evidence suggests that the demand for labor declined.

I have noted before the dramatic decline in help wanted advertising. It is not matched by the official data on job openings; the latter are roughly flat but certainly show no sign of increasing. New hires, however, did decline in the official data. And aggregate payroll employment growth slowed to an average of 112,000 per month (not enough to keep up with recent average labor force growth) from 176,000 per month in the previous quarter (which is comparable to the average for the prior two years).

This apparent decline in the quantity demanded might suggest that the labor supply curve shifted. That is, there were fewer workers available at any given wage, so firms both raised wages and reduced hiring. But the direct evidence does not support this hypothesis. Labor force participation actually increased throughout the quarter (and also in July, so one cannot reasonably attribute the increases in May and June to sampling error). There was no increase in the rate of unemployment due to voluntary quits. There was a slight decrease in the overall unemployment rate, but the decrease was reversed in July.

Another explanation for rising wages might be an increase in inflation expectations, or a correction for price increases that had already occurred. The argument, I suppose, would be that employers deliberately raised wages because they realized that, given higher prices or higher expected inflation, they would need to do so to retain their desired workforce. Absent an actual increase in quits, however, I find this explanation implausible. If employers were so scared of quits that didn’t actually happen, why did they simultaneously reduce their help wanted advertising? If they decided to spend less on recruitment, why would they be willing to spend more on wages?

My guess is that the increase in labor costs will turn out to be a statistical illusion. Aggregate compensation per hour is reported to have risen at a 5.1% annualized rate for the business sector, but this number is subject to considerable revision. The employment cost index, which corrects for shifts across industry and occupation, shows an annualized increase of 3.6%, still high by recent standards but not quite as troubling. When incentive-paid occupations are excluded, the increase drops to 2.8%, which is roughly the trend growth rate of productivity.

Price Rule?

If the Fed is trying to follow a price rule for unit labor cost based on 1.5% annual growth, it appears they’ve been quite successful.

Revised and Updated Labor Costs Still Tame

Some people will look at the new second quarter figure for unit labor cost in this morning’s productivity report and conclude that labor costs have become an inflation problem. Unit labor cost was up at 4% annual rate in the second quarter and up 3.1% from the same quarter a year ago. As I’ve said before, though, this series is volatile, and the appropriate way to analyze it is to smooth the quarterly changes. Taking into account the revisions and the latest update, my smoothed series now looks like this:



It stands at 1.7%, still quite close to the 1.5% center of the assumed hypothetical target range. In fact, on the off chance that the Fed really is targeting unit labor costs, let me offer my personal congratulations to each of the FOMC members right now for coming so close. Let me also say that, if I believed that the Fed were targeting unit labor costs, I would be pretty confident that we would not see any further interest rate increases, at least not in the next 3 months (and certainly not this afternoon). When the economy is facing a possible recession and your target number is right where you want it, you don’t push things. (As it is, I don’t think the Fed is targeting unit labor costs, and I think there’s actually a significant chance of an increase this afternoon, contrary to the current consensus.)

You might want to look more closely at the second quarter figure. One reason it was so high is that productivity growth was slow. In general, one wouldn’t expect that weak productivity growth in a particular quarter means we should expect weak productivity growth in the future. Applying my smoother to productivity growth, I get a rate of 2.7%, compared to the 1.1% reported for the second quarter. So if we use trend productivity growth instead of the quarterly observation, that shaves 1.6 percentage points off that ugly 4% and leaves us with 2.4%, a much less alarming number.

The other side of the picture is compensation growth. Nominal hourly compensation grew quite rapidly (5.1% annual rate) in the second quarter. Does anyone expect it to keep growing at that rate? I certainly don’t, not after the recent huge drop in help wanted advertising.