A Low-Pressure Economy Is Not Only Dark But Invisible in the Horserace Noah Smith is Running…
I think the estimable Noah Smith gets this one wrong. He writes:
Noah Smith: Cracking the Mystery of Labor’s Falling Share of GDP: “Economists are very worried about the decline in labor’s share of U.S. national income… https://www.bloomberg.com/view/articles/2017-04-24/cracking-the-mystery-of-labor-s-falling-share-of-gdp
…For decades, macroeconomic models assumed that labor and capital took home roughly constant portions of output—labor got just a bit less than two-thirds of the pie, capital slightly more than one-third. Nowadays it’s more like 60-40. Economists are therefore scrambling to explain the change. There are, by my count, now four main potential explanations for the mysterious slide in labor’s share. These are: 1) China, 2) robots, 3) monopolies and 4) landlords…”
There is, in my view, a fifth—and a much more likely—possibility: the low-pressure economy.
The first misstep Noah takes is in saying that 100% of national income is divided between “labor” and “capital”. It is not. Entrepreneurship, risk-bearing, innovation, monopoly rents, and other factors are rolled into the non-labor share as well. It’s not the labor share and the capital share. It’s the labor share and everything else.
Suppose that you were not attached to sophisticated economic theory but just believed in the basic Adam Smith supply-and-demand: when something is in high demand, its price goes up; when something is in low demand, its price goes down. How then would you interpret the graph above at the top of this post?
You would say:
- Hmmm. In the late 1960s Lyndon Johnson created a high-pressure economy—he did not want to raise taxes to pay for fighting the Vietnam War, and did not want the Federal Reserve to raise interest rates. Then Richard Nixon continued the policy, naming Arthur Burns his own partner in his attempt in 1959 to persuade Eisenhower to create a high-pressure economy for the 1960 campaign, to run the Federal Reserve. And so the labor share went up.
The 1973-1975 oil shock recession and then the 1979-1982 Iran Revolution plus Volcker Disinflation recessions gave a further large negative wallop to the pressure the economy was under. And so the labor share fell.
It may have been “morning in America” from 1984 on in Reagan campaign commercials, but that was definitely not the case as far as the labor market was concerned.
When the labor market became tight again in the internet boom of the late 1990s, lo and behold the labor share jumped back up again.
But the recovery from the recession that followed the dot-com boom and 9/11 was a disappointing one. And the labor share fell.
And then came the financial crisis and the disappointing recovery since. And the labor share fell some more.
Noah Smith’s quadriad of “China, robots, monopolies, and landlords” is needed only if you have a strong belief that there is one unique macroeconomic equilibrium point about which the business cycle fluctuates and to which the economy returns rapidly after a business-cycle shock creates a high- or a low-pressure economy. It is certainly convenient for economic model builders to believe in such a tendency for a rapid return to a unique macroeconomic equilibrium.
But where in the real world is there any evidence that there is in fact such a thing?
IMHO, the low-pressure economy is the leading horse in the race to understand why the labor share today is lower than it was in the late 1960s or the late 1990s. Yet Noah Smith does not even see it as in the race…