Must-Read: Nick Rowe: New Keynesians Just Assume Full Employment

Posted on by Brad DeLong

Must-Read: More on Nick Rowe’s self-assumed Sisyphean task…

Look: the standard New Keynesian model is a version of the Prescott RBC model, minimally tweaked to deliver Old Keynesian qualitative behavior. Its purpose is to show that the methodological straitjacket demanded by Prescott has no implications other than making it much harder to fit the data.

It has no other proper purpose.

Nick Rowe’s criticisms are correct:

Nick Rowe: New Keynesians Just Assume Full Employment: “Anyone with even an ounce of Old Keynesian blood… if they understood what the New Keynesians are doing, would be screaming blue murder that we are teaching this New Keynesian model to our students as the main macro model, and that central banks are using this model to set monetary policy…

I’m now going to make this point so simply and clearly that any New Keynesian macroeconomist will be able to understand it…. Only consumption…. Self-employed hairdressers, cutting each other’s hair…. All goods are services… labour the only input… counsumption, output, and employment… all the same thing. And… prices and wages… the same thing too…. No exogenous shocks…. No growth…. A constant population of very many, very small, identical, infinitely-lived agents, with logarithmic utility of consumption, and a rate of time-preference proper of n.

The individual agent’s consumption-Euler equation, with r(t) as the one-period real interest rate, is therefore:

C(t)/C(t+1) = (1+n)/(1+r(t))….

Assume the central bank sets a real interest rate r(t). Suppose the “full employment”… equilibrium is… 100 haircuts per agent per year consumption, income, and employment. Forever and ever. The central bank’s job is to set r(t) such that C(t)=100, for all t. Inspecting the consumption-Euler equation, we see that this requires the central bank to set r(t)=n for all t. Assume the central bank does this…. [But] setting r(t)=n for all t only pins down the expected growth rate of consumption… to zero…. It does not pin down the level….

Suppose initially we are at full employment. C(t)=100. Then every agent has a bad case of animal spirits. There’s a sunspot. Or someone forgets to sacrifice a goat. So each agent expects every other agent to consume at C(t)=50 from now on…. His optimal response… if he expects the central bank to continue to set r(t)=n, is to cut his own consumption immediately to 50 and keep it there. C(t)=50… is also an equilibrium with r(t)=n. So is any rate of unemployment between 0% and 100%.

What can the central bank do to counter the bad animal spirits? If it cuts r(t) below n, even temporarily, we know there exists no rational expectations equilibrium in which there is always full employment. All we know is that we must have negative equilibrium growth in consumption for as long as r(t) remains below n. It is not obvious to me how making people expect negative growth in their incomes from now on should cause everyone to expect a higher level of income right now from a higher level of everyone else’s consumption right now. Sacrificing a goat sounds more promising as a method of restoring full employment. Did every other New Keynesian macroeconomist already know about this, and just swept it under the mathematical rug? Didn’t I get the memo?

Here’s Gali:

Under the assumption that the effects of nominal rigidities vanish asymptotically [lim as T goes to infinity of the output gap at time T goes to zero]. In that case one can solve the [consumption-Euler equation] forward to yield…”

Bull—-. It’s got nothing to do with the effects of nominal rigidities. What he really means is “We need to just assume the economy always approaches full employment… otherwise… we will eventually get hyperinflation or hyperdeflation, and we can’t have our model predicting that, can we?” That Neo-Wicksellian/New Keynesian nonsense is what the best schools have been teaching their best students for the last decade or so…

The way out I prefer to take is to say: Look: the central bank doesn’t set r(t) = n for all t–it follows some reasonable feedback rule to stabilize the economy. Want to know what are reasonable feedback rules? They are the ones that stabilize the economy. Unhappy with that? Go back to Lloyd Metzler’s version of IS-LM, and recognize that the New Keynesian model is a jerry-rigged minimally-tweaked RBC model…

Best Business Books 2016: Economy

Posted on by Brad DeLong
Best Business Books 2016 Economy

Over at Strategy+Business: Best Business Books 2016: Economy: The Crisis Is Over: Welcome to the New Crisis:

  • Robert J. Gordon: The Rise and Fall of American Growth: The U.S. Standard of Living since the Civil War (Princeton University Press, 2016) http://amzn.to/2eYBETT

  • Adair Turner: Between Debt and the Devil: Money, Credit, and Fixing Global Finance (Princeton University Press, 2015) http://amzn.to/2fahiHY

  • Jacob S. Hacker and Paul Pierson: American Amnesia: How the War on Government Led Us to Forget What Made America Prosper (Simon & Schuster, 2016) http://amzn.to/2ekuOdg

It’s been quite a decade for the global economy. The popping of the American housing bubble in 2006, the subprime mortgage financial crisis and its spread to Wall Street in 2007–08, the collapse of the world economy into the first global recession in decades in 2008–09, the knock-on eurozone financial crisis that began in 2010, and a slow, often faltering recovery — it’s been a tumultuous 10 years. And the period has produced a bumper crop of excellent economics books by academics, journalists, and practitioners who have attempted to grapple with the extraordinary macroeconomic disaster. They have examined why it happened, how to fix it, what it means, and how to avoid a recurrence of anything even remotely as hellish. Read MOAR at Strategy+Business

Functional finance vs. conventional finance: What’s really at stake?

Posted on by Bridget Ansel
Photo of the Marriner S. Eccles Federal Reserve Board Building in Washington.

One pole of current debates about U.S. fiscal policy is occupied by the “functional finance” position—the view usually traced back to the late economist Abba Lerner—that a government’s budget balance can be set at whatever level is needed to stabilize aggregate demand, without worrying about the level of government debt. At the other pole is the conventional view that a government’s budget balance must be set to keep debt on a sustainable trajectory while leaving the management of aggregate demand to the central bank. Both sides tend to assume that these different policy views come from fundamentally different ideas about how the economy works.

A new working paper, “Lost in Fiscal Space,” coauthored by myself and Arjun Jayadev, suggests that, on the contrary, the functional finance and the conventional approaches can be understood in terms of the same analytic framework. The claim that fiscal policy can be used to stabilize the economy without ever worrying about debt sustainability sounds radical. But we argue that it follows directly from the standard macroeconomic models that are taught to undergraduates and used by policymakers.

Here’s the idea. There are two instruments: first, the interest rate set by the central bank; and second, the fiscal balance—the budget surplus or deficit. And there are two targets: the level of aggregate demand consistent with acceptable levels of inflation and unemployment; and a stable debt-to-GDP ratio. Each instrument affects both targets—output depends on both the interest rate set by monetary authorities and on the fiscal balance (as well as a host of other factors) while the change in the debt depends on both new borrowing and the interest paid on existing debt. Conventional policy and functional finance represent two different choices about which instrument to assign to which target. The former says the interest rate instrument should focus on demand and the fiscal-balance instrument should focus on the debt-ratio target, the latter has them the other way around.

Does it matter? Not necessarily. There is always one unique combination of interest rate and budget balance that delivers both stable debt and price stability. If policy is carried out perfectly then that’s where you will end up, regardless of which instrument is assigned to which target. In this sense, the functional finance position is less radical than either its supporters or its opponents believe.

In reality, of course, policies are not followed perfectly. One common source of problems is when decisions about each instrument are made looking only at the effects on its assigned target, ignoring the effects on the other one. A government, for example, may adopt fiscal austerity to bring down the debt ratio, ignoring the effects this will have on aggregate demand. Or a central bank may raise the interest rate to curb inflation, ignoring the effects this will have on the sustainability of the public debt. (The rise in the U.S. debt-to-GDP ratio in the 1980s owes more to Federal Reserve chairman Paul Volcker’s interest rate hikes than to President Reagan’s budget deficits.) One natural approach, then, is to assign each target to the instrument that affects it more powerfully, so that these cross-effects are minimized.

So far this is just common sense; but when you apply it more systematically, as we do in our working paper, it has some surprising implications. In particular, it means that the metaphor of “fiscal space” is backward. When government debt is large, it makes more sense, not less, to use active fiscal policy to stabilize demand—and leave the management of the public debt ratio to the central bank. The reason is simple: The larger the debt-to-GDP ratio, the more that changes in the ratio depend on the difference in between the interest rate and the growth rate of GDP, and the less those changes depend on current spending and revenue (a point that has been forcefully made by Council of Economic Advisers Chair Jason Furman). This is what we see historically: When the public debt is very large, as in the United States during and immediately after the Second World War, the central bank focused on stabilizing the public debt rather than on stabilizing demand, which means responsibility for aggregate demand fell to the budget authorities.

We hope this paper will help clarify what’s at stake in current debates about U.S. fiscal policy. The question is not whether it’s economically feasible to use fiscal policy as our primary instrument to manage aggregate demand. Any central bank that is able to achieve its price stability and full employment mandates is equally able to keep the debt-to-GDP ratio constant while the budget authorities manage demand. The latter task may even be easier, especially when debt is already high. The real question is who we, as a democratic society, trust to make decisions about the direction of the economy as a whole.

J.W. Mason is an Assistant Professor of Economics at John Jay College, City University of New York.

Bayesianism versus Smoothing: In Which I Surrender Unconditionally to Cosma Shalizi

Posted on by Brad DeLong
Surrender alesia Google Search

I think it is time for me to issue an unconditional intellectual surrender to Cosma Shalizi. Watching Nate Silver and his now http://fivethirtyeight.com over the past two election cycles has convinced me that the Bayesian framework he throws around his model is a major obstacle to people’s understanding what is going on.

What is going on is made up of three things:

  1. Polling–that is, asking people what they think of the election candidates in a structured way.

  2. Aggregation–so that you are not just using one sample of 1000 to assess the current mood of the electorate but instead have something like 1/5 of the sampling standard error.

  3. Smoothing–imposing structure on the time series, both that it ought to be close to “fundamentals” and that it ought not to change too quickly.

But next to nobody reading Nate Silver and company’s “nowcast”, “polls-only”, and “polls-plus” forecast probabilities as they evolve overtime gets any sense of how the sausage is made.

It remains the case that the decision theorist in the subbasement dungeon of my brain whimpers that Bayesian posterior probabilities are what we ultimately want.

But, these days, when it says that, I gag and shorten its chain:

  1. I point out to it that what we really want as decision theorists are not Bayesian posterior probabilities but rather the misnamed “risk neutral probabilities” that are posterior odds times the utility of the outcome.

  2. I point out to it that if we are betting against other minds we need to know in what ways their information sets might be superior to ours and what disadvantage that puts us at: that invulnerability to a Dutch Book is a third-order consideration in a world in which others might will know of jacks of spades that will piss in your ear on command.

  3. And I point out to it that the answer to the frequentest question, “how different might our conclusions have been had we drawn a different sample?” provides much more insight into whether our procedures are converging to something sensible than any ex-ante Bayesian proof that we knew in advance, before we start the analysis, that our procedures must converge.

So go visit Sam Wang: polls, aggregation, soothing, plus not unreasonable random drift strike zones are more helpful than three different sets of posterior odds–given my suspicion that there is right now no action from the 538.com stuff on the truck side of the polls plus odds…

Must-Reads: October 31, 2016

Posted on by Brad DeLong

Should Reads:

Must-Read: Edward Filene (1931): Successful Living in This Machine Ag

Posted on by Brad DeLong

Edward Filene (1931): Successful Living in This Machine Age: “Mass Production is not simply large-scale production…

…It is large-scale production based upon a clear understanding that increased production demands increased buying, and that the greatest total profits can be obtained only if the masses can and do enjoy a higher and ever higher standard of living. For selfish business reasons, therefore, genuine mass production industries must make prices lower and lower and wages higher and higher, while constantly shortening the workday and bringing to the masses not only more money but more time in which to use and enjoy the ever-increasing volume of industrial products.

Mass Production, therefore, is production for the masses. It changes the whole social order. It necessitates the abandonment of all class thinking, and the substitution of fact-finding for tradition, not only by business men but by all who wish to live successfully in the Machine Age. But it is not standardizing human life. It is liberating the masses, rather, from the struggle for mere existence and enabling them, for the first time in human history, to give their attention to more distinctly human problems.

Recessions happen. But how often?

Posted on by Bridget Ansel
A man demonstrates outside the Lehman Brothers headquarters following the firm’s 2008 collapse.

Recessions, unfortunately, are inevitable. Even more unfortunately, economists have not been very good at figuring out when or how they will happen. But with the recovery from the Great Recession now in its eight year, some scholars and policymakers are wondering if a recession in the United States is due to hit sometime soon—basically because the current recovery is about to die of old age.

Not surprisingly, there is very little consensus on the timing. Neil Irwin at the New York Times points to research that finds the probability of a recession happening in a given year isn’t affected by how long the current expansion has been going on. And according to a paper from Glenn Rudebusch at the Federal Reserve Bank of San Francisco published earlier this year, the probability the current U.S. expansion will end is 23 percent. So in a given year it would seem that there’s a little under a one-in-four chance that the U.S. economy will slip into a recession.

Does that mean that any concerns about a recession happening anytime soon are overblown? Not exactly. As Josh Zumbrun at the Wall Street Journal shows, if the probability of a recession happening in a given year is independent of the age of an expansion, then the probability of a recession in the next few years will be fairly high. Using the San Francisco Fed’s estimates, Zumbrun shows that the probability of not having a recession in at least one year over a four-year period is 35 percent.

But recessions don’t just die of old age; something has to kill them. The last two recessions happened due to the bursting of two asset bubbles: first the dot-com stockmarket bubble in the early 2000s and then the housing bubble starting in 2006. But a look at the data doesn’t seem to show the building of any sort of major speculative asset bubble that could do significant damage to the U.S. economy. Of course, few economists, financial analysts or policymakers predicted the recessions that were caused by the bursting of the past two bubbles.

Still, the causes of the last two recessions were the exceptions to the rule since the end of the Second World War. In every other postwar expansion, the Federal Reserve has been the culprit behind the end of the expansion. Ryan Avent points this out at The Economist and notes that with interest rates near zero, central banks that are more concerned with keeping inflation quite low are likely to accidently end a recession.

Whether the next recession happens due to the bursting of a bubble that no one currently can discern or a premature interest rate hike or perhaps something else entirely, policymakers need to be ready to counteract its effects. On November 15th, Equitable Growth will be hosting an event focused on thinking through policy choices for combating the next recession when it inevitably hits. Recessions are an unfortunate eventuality, but that doesn’t mean policymakers can’t be ready for them.

Supply chains and equitable growth

Posted on by Austin Clemens

AP Images

About the author: Susan Helper is the Frank Tracy Carlton Professor of Economics at the Weatherhead School of Management at Case Western University.

The U.S. economy has undergone a structural transformation in recent decades. Large firms have shifted from doing many activities in-house to buying goods and services from a complex web of other companies. These outside suppliers make components, and provide services in areas such as logistics, cleaning, and information technology. Although this change in the structure of supply chains began decades ago, neither public policy nor business practice have adequately dealt with the challenges posed by this restructuring. As a result, weakness in supply chains threatens U.S. competitiveness by undermining innovation and contributes to the erosion of U.S. workers’ standard of living. This essay suggests policies to promote supply chain structures that stimulate equitable growth—that is, policies that both promote innovation and also insure that the gains from innovation are broadly shared.

The role of supply chains
in the U.S. economy

A supply chain links companies, often in multiple industries and multiple locations, to design, produce components, assemble and distribute a final product, such as a car, a computer, or a restaurant meal.1 For much of the 20th century, a significant part of the U.S. economy was characterized by supply chains that were vertically integrated.2 Beginning in the 1970s and 1980s, large firms in many industries began to sell off assets and outsource work. Today, a lead firm typically designs products and directs production by multiple tiers of suppliers in many locations, but does not own most of these suppliers.3

Delivering equitable growth

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Supply chains made up of these financially independent firms are now the largest driver of firms’ costs. The average U.S.-based multinational firm buys intermediate inputs that comprise about 75 percent of the value of its output; a domestically owned firm buys intermediate inputs equal to about 50 percent of output value.4 Contrary to the common impression, most of these suppliers are domestic, even in manufacturing.5 These outsourced supply chains differ from vertical integration in that the lead firm does not own supplier facilities. The lead firm benefits from this arrangement by gaining access to products made by suppliers with experience in making similar products for multiple customers and by not being responsible for subsidiaries’ fixed costs.

These supply chains also typically differ from economists’ model of perfect competition, in which transactions between firms are at arm’s length and the only information that crosses firm boundaries is price information. In contrast, many suppliers make products specifically tailored to meet the needs of the lead firm and frequently exchange information with the lead firm regarding designs, production processes, and future plans. Lead firms find this arrangement advantageous because they are able to quickly obtain components tailored to their specific needs. The complementary disadvantage is that firms are often unable to change suppliers easily.

On one hand, sharing suppliers with other lead firms has significant benefits, such as shared knowledge across customers and reduced fixed costs. On the other hand, lead firms may lack incentive to invest in upgrading the supplier’s capabilities if that supplier may also use those capabilities to serve a competitor. Firms’ success depends upon having robust networks of suppliers, but no one firm is responsible for keeping these networks healthy.

Implications of supply chain
structure for innovation

Because innovation is concentrated in manufacturing—two-thirds of private-sector research and development is performed in manufacturing—this section looks at supply chains in manufacturing only (data is not readily available for innovation in other sectors.)6

Firms with fewer than 500 employees are an increasing share of manufacturing employment, accounting for 42 percent of such workers in 2012. These small firms struggle at each phase of the innovation process. They are only 15 percent as likely to conduct research and development as large firms. Small firms also struggle to obtain financing and a first customer to help them commercialize a new product or process. Finally, small manufacturers have trouble adopting new products or processes developed by others, due to difficulty in learning about and financing new technology. As a result, small manufacturers are only 60 percent as productive as large firms.7

A skeptic may ask why large lead firms cannot innovate enough to support their entire production network. But problems such as reducing the vibration of a wind turbine requires holistic problem-solving; a machine composed of many parts that exert strong forces on each other cannot simply be divided into one problem for the gearbox manufacturer to solve, one for the rotor manufacturer to solve, and another for the assembly team to solve. Limiting innovation to lead firms deprives the supply chain of insights that come from being very close to a particular type of production or use.8 In addition, long-term supplier-customer relationships built upon trust and collaboration best facilitate progress toward these goals; lack of such relationships accounts for many of the problems U.S. industries face in moving new technologies from lab to market.

Implications of supply chain
structure for job quality

Workers are employed in supply chains in a variety of ways. Instead of being hired directly by lead firms as regular employees, workers may be hired by temporary help agencies and are often referred to as “contingent workers.” Alternatively, they may be hired as regular workers at supplier firms or as independent contractors.

A variety of studies find that these forms of outsourcing of employment, especially as carried out in the United States, typically create undesirable outcomes for workers in areas such as wages, benefits, job security, and safety.9 Contingent workers earn 10.5 percent less per hour and 47.9 percent less per year than non-contingent workers, and are more likely to suffer workplace injury.10 Workers employed at suppliers, even as regular workers, generally earn less than workers at lead firms, which tend to be larger.

Wages are typically lower at suppliers than at lead firms because of the barriers to innovation discussed above, which reduce productivity; the absence of pressures to reduce wage differentials within a firm due to norms of fairness; and greater pressure on wages at outside suppliers, which are more easily replaced than are internal divisions.

Market and network
failures in supply chains

Three forms of market failure contribute to the central tendency of U.S. supply chains to suppress innovation and make jobs worse:

  • Free-rider problems between firms. When a lead firm makes investments in upgrading its suppliers—by providing technical assistance to suppliers, training supplier workers, or helping them invest in new equipment—some of this improved capability will often spill over to benefit a supplier’s other customers, including the lead firm’s rivals. Lead firms thus have less incentive to invest in their suppliers than would be socially beneficial.11
  • Siloes within firms. Internal conflicts between departments within a lead firm can mean a focus on finding suppliers with low prices rather than on those providing high quality and innovation. An easy way for firms to evaluate their purchasing departments, for example, is the extent to which they reduce the price per unit they buy. A purchasing agent could thus be rewarded for choosing a supplier whose costs are $1,000 less than a rival supplier’s—even if that supplier’s skimping on quality control later causes the shutdown of a production line that costs the operations department $100,000. It may seem unlikely that sophisticated companies would fall prey to such problems, but quality and innovation are harder to measure than prices, and their benefits often accrue to departments other than purchasing.12
  • Profit protection. Outsourcing of work often reduces workers’ access to profits earned by the lead firm. Organizational structures tend to minimize wage differentials within firms, due to both norms of fairness and to a desire to promote cooperation within an organization. Firms with a high degree of market power have lots of profits to protect, which they often do by adopting policies that make their suppliers interchangeable, even at a cost to efficiency.13

The result of these market failures is an emphasis in the United States on arm’s length rather than collaborative governance of supply chains, and a hollowing out of productive eco-systems, as firms set up incentives for their purchasing departments that privilege supplier firms that can win competitive bidding wars. These “winners” tend to be small firms with low expenditures on overhead costs, covering such things as salaries for managers and engineers and worker training. In extreme cases, such as garment production or janitorial services, competition is so fierce that firms compete in part by violating laws on safety, minimum wages, overtime, and disposal of toxic waste. In the rare instances in which these firms are caught, they often can file for bankruptcy and re-open under another name.14

Policies to promote innovative
supply chains with good jobs

Outsourcing has its advantages, principally in making possible a potentially efficient division of labor in which specialist firms can achieve economies of scale and diffuse best practices by serving a variety of customers. Yet lead firms’ zealous embrace of the non-collaborative version of this strategy has resulted in significant weaknesses in innovation and job quality in the United States. Tackling these challenges will help address some root causes of wage inequality and productivity stagnation in U.S. manufacturing and service industries. Policies in five areas will help:

Encourage firms to adopt collaborative supply-chain practices

Public support for economic growth has long focused on the diffusion of physical technologies, yet the diffusion of operational insights may be just as valuable. Evidence suggests supply chains with more collaborative practices are more innovative.15 The next Administration should use its convening power to encourage lead firms to take steps such as:

  • Offer suppliers assurance that they will receive a fair return on investments they make in new technologies and in upgrading their capabilities. In order to become partners in innovation, suppliers need to develop better capabilities in product and process design, and to upgrade equipment.
  • Promote information-sharing and make changes in their own operations as a result of supplier suggestions. A key insight from the Toyota Production System is that firms and workers who are close to production have access to information not easily available to those at the top of the chain.16 Firms that establish mechanisms to learn from their suppliers can significantly improve cost and quality.
  • Use a “total cost of ownership” approach when making purchasing decisions. Firms should consider impacts of sourcing decisions on quality and innovation as well as on price per unit purchased.17 Forming long-term, collaborative relationships with highly competent suppliers may be in a firm’s best overall interest, yet purchasing departments are not always incentivized to consider these benefits.

Nurture productive eco-systems of firms, universities, communities, and unions

One reason for the struggles that small- and medium-sized U.S. firms face is that they are “home alone,” with few institutions to help with innovation, training, and finance.18 For reasons of both equity and efficiency, these firms should not depend solely on their customers for strategic support.

Policies that nurture small firms, local universities, their communities, and unions could help the firms leverage their advantages over their larger brethren in nimbleness and strong community ties. Germany’s Mittelstand (medium-sized firms) are the backbone of the German manufacturing sector due to the help they get from community banks, applied research institutes, and unions.19 In the United States, the unionized construction sector has developed structures that create good jobs and fast diffusion of new techniques, even though the industry remains characterized by small firms and work that is often intermittent. Building trades unions work with signatory employers to provide apprenticeships, continuing education programs, and portable benefits.20

Federal technology assets should be better deployed as well, continuing the work begun by the Obama White House Supply Chain Innovation Initiative.21 National labs can be encouraged to work with small as well as large firms, for example, and the Manufacturing Extension Partnership can expand its efforts to work with entire supply chains (rather than firms one by one) to identify sources of inefficiency. A century ago, the federal government played this role in agriculture by funding land grant universities, which led not only to the creation of knowledge, but also created durable networks of researchers and practitioners through which such knowledge could quickly spread.22

Promote formation of supply chains in industries that advance national goals

The free-rider problems discussed above are likely to be particularly acute in forming collaborative supply chains for new products, such as improved solar panels or wind turbines. These industries face additional market failures leading to underinvestment in addressing climate change. The Obama Administration’s Clean Energy Manufacturing Initiative helps to move new technologies out of the laboratory and into production. It would be useful to explicitly address the incentive and information issues in supply chains for producing and installing these products. The next administration could convene firms throughout the supply chain to engage in value analysis to improve product designs, to uncover hidden pockets of inventory, and to adopt total-cost-of-ownership techniques.

Promote good jobs and high-road strategies

Much research documents the ways that firms can utilize “high-road” policies or “good-jobs” strategies to tap the knowledge of all their workers to create innovative products and processes.23 High-road firms remain in business while paying higher wages than their competitors because their highly skilled workers help these firms achieve high rates of innovation, quality, and fast response to unexpected situations. The resulting high productivity allows these firms to pay high wages while still making profits that are acceptable to the firms’ owners. Collaborative supply chain governance plays an important role in providing the stability needed to support these strategies, from which lead firms also benefit.

Dis-incentivize low-road production strategies

Even in collaborative scenarios, wages are often less than in the old vertically integrated model. The corrosion of labor union power enables outsourcing, and the increase in outsourcing has, in turn, further decreased workers’ bargaining power.

Thus, as important as it is to “pave the high road,” it is also important to “block the low road.”24 The Department of Labor has begun to take advantage of modern supply chains’ emphasis on “just-in-time” delivery, recognizing that reduced inventories make regulators’ threat to shut down suppliers for violation of wage and hour laws a more potent threat.25 New policies could combine such sticks with some carrots. The federal government could offer technical assistance, for example, to help small garment manufacturers move away from the existing low-road model, in which ill-trained workers typically do one simple operation to a garment and then pass it on to the next worker. Instead, these firms could adopt a more agile production recipe, one that involves more broadly trained and higher-paid workers collaborating in teams—a high-road model sustained by greater productivity and reduced lead times.

Government should implement collaborative supply-chain practices within its own purchasing, building on the Obama Administration’s nascent efforts to measure total cost of ownership and to ban supply chains with recent violations of labor and other laws from selling to the government.26

Current outsourcing practices allow lead firms and their suppliers to reap the benefit of paying workers only when needed, while the risks of being left without earnings are borne by workers. Several proposals could improve the balance here: encouraging work-sharing in downturns (which would make hiring regular workers less costly), continuing to improve the portability of benefits across firms, and promoting schedule stability.

Retooling supply chains for equitable growth

Decisions about how to structure supply chains matter greatly for working Americans, yet this topic rarely takes a front seat in policy discussions of how to address rising inequality and stagnating productivity. In order to promote equitable growth, policymakers must understand how the economic pie is created—not just how it is divided.

Fundamental changes in the way supply chains operate threaten U.S. economic competitiveness by undermining innovation, and erode American workers’ economic security. The rise over the past few decades of supply chains with small, weak firms leads to an increased presence of firms that innovate less and pay less. It is unlikely and undesirable, however, that the United States would return to the often bureaucratic and stifling vertically integrated supply chains of the mid-20th century.

We can do better. This essay outlined government and corporate policies to promote both more innovation and better job quality in supply chains. In particular, more collaborative supply chains and better-supported local eco-systems could significantly improve the viability of “good jobs strategies.” The way the economic pie is created affects the way it is divided.

(For more detail on these proposals and the analysis behind them, see Susan Helper and Timothy Krueger, “Supply chains and equitable growth,” Washington Center for Equitable Growth, September 29, 2016.)

Unemployment insurance reform: a primer

Posted on by Austin Clemens

AP Images

About the author: Till von Wachter is a professor of economics and the associate director of the California Center for Population Research at the University of California-Los Angeles.

The Unemployment Insurance system provides temporary and partial earnings replacement for workers that have become unemployed through no fault of their own and are actively searching for work. To facilitate reemployment, the UI system is complemented by job search assistance and training services. Within a common federal framework, states set the main parameters of the UI system and are responsible for financing benefits via payroll taxes, though federal funding has played an increasing role, especially in economic downturns.

In the United States, and most other developed countries, unemployment insurance is the main program helping to buffer the shock of layoffs and unemployment. The UI system provides vital benefits for laid off workers and families to weather the high and persistent costs of layoffs, especially in recessions. By preventing cuts in consumption, UI benefits can also function as an automatic stabilizer in economic downturns. Given high layoff rates even in normal economic times, the insurance provided by UI also plays an important role by supporting a well-functioning, dynamic labor market.

The need for common sense and
evidence-based unemployment insurance reforms

While most observers agree that the current structure of the unemployment insurance system is fundamentally sound, there is also widespread agreement that the UI system is in need of reform. There are several major issues to be addressed, First, the current UI system suffers from financial instability that risks compromising its major role as adjustment mechanism in recessions. Second, the coverage of UI has eroded over time, with a declining fraction of workers receiving lower benefits amounts. Third, UI does little to avert the large, long-lasting earnings losses among reemployed workers. And fourth, there are persistent questions about the effectiveness of UI and related programs to quickly reemploy job losers.

Delivering equitable growth

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The good news is that, in many ways, unemployment insurance appears to be an ideal target for bipartisan reform. First, there is a set of straightforward, common-sense goals for a well-functioning UI system. These goals include, among others: that UI should provide a sufficient buffer to avoid financial difficulties after layoff, especially for families with children; that UI should encourage speedy reemployment of the unemployed; that UI plays a clear role in economic downturns, and hence should not be at the discretion of local or federal politics; and that UI should be financial sound.

Second, Unemployment Insurance reform is an almost ideal example of the potential for evidence-based reform. There is a lot of high-quality evidence on the working of the UI system. A lot of the additional evidence needed for more-informed policymaking can potentially be obtained at arm’s length, especially in a data-rich environment. The following “primer” discusses and summarizes core pieces of recent evidence on job loss, unemployment, and the current UI system, and then relates them to a series of reform proposals. The reform proposals can be grouped into those that deliver a basic “tune up” of the current UI system, and those that provide more fundamental “modernization.” These are summarized here:

“Tune-up” (minimal) reforms:

  • Prevent erosion of benefit generosity by mandating minimum UI benefits
  • Institutionalize federal emergency unemployment compensation
  • Fix outdated system of data collection to enable evidence-based policies
  • Expand coverage of UI to fit structure of modern workforce
  • Resolve financing short-falls in states’ UI trust funds by modifying tax base

Modernization reforms:

  • Institute functioning system of job sharing to prevent costly layoffs
  • Experiment with wage insurance to aid workers returning to employment

These proposals will be related to the issues they resolve and the evidence they rest on after a brief primer on the main available evidence about the UI system.

A primer on evidence about
the Unemployment Insurance system

A few key themes arise from extensive research on core aspects of the Unemployment Insurance system.27 While additional research is needed, the good news that the much of the data needed is potentially available at low cost from the UI system itself.

Point 1: The current benefit levels and durations appear appropriate. An increasing number of studies have shown that current Unemployment Insurance benefits provide an important buffer against consumption losses for a substantial number of unemployed workers. While a large number of studies have established that UI also tends to prolong unemployment and hence reduce tax revenues, it appears at current levels that the social benefits outweigh the budgetary costs. Recent research also gives clear guidance that UI benefits should be extended in recessions, and when they should be targeted to certain groups of individuals.

Point 2: The coverage of Unemployment Insurance has eroded over time. It is well known that on average only half of the unemployed receive UI benefits, substantially limiting the program’s scope to insure individual earnings shocks and provide an automatic stabilizer. This is partly because up until recently UI rules in most states explicitly exclude certain groups of unemployed—those engaging in full- or part-time education, those seeking part-time employment, or those with low earnings. Partly it arises because of a low take-up rate of benefits among those eligible.

Point 3: The effects of layoff are felt long after unemployment. An increasing amount of evidence suggests that the effects of job loss are felt long beyond reemployment, including effects on earnings, health, and child outcomes.28 Children of job losers suffer from the consequences even as adults. Overall, research suggests UI benefits only make up a small portion of the earnings lost at job loss.

Point 4: Current reemployment efforts show mixed success. While many programs aiming to aid Unemployment Insurance recipients to find work are successful and sometimes cost-efficient, increasing evidence suggests that substantial hurdles for successful reemployment remain, especially for older and longer unemployed workers. Especially for these individuals, longer UI benefits do not improve and may even reduce job quality. Although the evidence is mixed, an ongoing concern is UI may damage reemployment prospects by lengthening the unemployment spell.29

Point 5: The federal-state relationship needs to be fixed. Although in principle the nature of Unemployment Insurance taxes should lead state UI trust funds to balance over the business cycle, reductions in UI tax rates and a low tax base have led to financing shortfalls. As a result, benefit extensions during recessions have been increasingly financed by ad hoc federal measures. To partly resolve budget short falls, several states have begun cutting benefits. Currently, political constellations at the state level have led to a patch-work of UI reforms, exposing similar workers to different UI systems. The current system also suffers from a wasteful lack of data-sharing that prevents meaningful management and study of the UI program.

Proposals for “tune up” (minimal reforms)
of the Unemployment Insurance system

Policy analysts and researchers have discussed the need to modernize the unemployment insurance system for some time. This discussion received momentum during the Great Recession. The result has been a series of well-articulated proposals, and convergence on a list of basic fixes. Several of these reform proposals have made it into President Obama’s Budget Proposal for fiscal year 2017, which begins in October 2016. The following is a list of the core proposals, including a brief summary of their justification.

Prevent erosion of benefit generosity by mandating minimum duration of 26 weeks

The issues. Partly to counter funding difficulties in the aftermath of the Great Recession, several states have cut benefit durations below the typical 26-week mark. Similarly, there is substantial heterogeneity in benefit levels across states. Yet, there are no compelling reasons why similar workers in different states should be treated different by the Unemployment Insurance system. Research provides justification for the optimal generosity of UI benefits, and when these should vary with characteristics of workers or local labor markets. Hence, the choice of benefit parameters and how they vary in the population or over time should not be a function of the local political process or short-term funding needs.

Proposed changes. Federal law should mandate a minimum amount of potential duration of Unemployment Insurance benefit of 26 weeks, an average effective replace rate of 50 percent of benefits (with gradual adjustments of the maximum benefit amount), and a dependent allowance to support families with children with higher consumption commitments. To ensure states update their laws, the federal government can limit the credit for the State Unemployment Tax employers receive against the Federal Unemployment Tax.

Institutionalize federal emergency Unemployment Insurance benefits as function of local unemployment

The issues. Research clearly indicates that Unemployment Insurance benefits should be extended in recessions. This is because the benefits to workers at risk of exhausting their benefits are greater, the inefficiency costs are not larger and perhaps smaller, and the potential of stimulating effects is greater. The experience in the aftermath of the Great Recession has shown that leaving extensions of UI benefits to the political process can lead to gaps in coverage that are damaging to affected workers. For most recessions, there is no evidence indicating a need for wasteful and potentially harmful discretion.

Proposed changes. The federal Emergency Unemployment Compensation program should be made a permanent program. A straightforward way to achieve is to reform the current Extended Benefit program and make it 100-percent federally financed. In the course of such a reform, the trigger structure should be modified to keep the fraction workers covered by UI approximately constant over the business cycle.

Fix outdated system of data collection to enable evidence-based policies

The issues. To maintain daily operations of their Unemployment Insurance programs, states collect information on workers’ wages, UI claimants’ benefits, and their employers’ UI taxes. This information is vital for an efficient administration of the UI system, including understanding which parts of the system are cost effective. Yet the current law only requires states to share the data with federal agencies for extremely limited purposes. Moreover, many of the data sets lack basic information, such as on worker age or gender. Ample experience now exists to cheaply handle and combine sensitive administrative data.

Proposed changes. The data collection should be modernized by adopting four complementary strategies: enhance data collection by states; establish a national data clearinghouse of Unemployment Insurance data at either the U.S. Bureau of Labor Statistics or the U.S. Census Bureau; support these changes by providing a common software and offering moderate grants for upgrade hardware; and establish a protocol to allow to access the data for research purposes and to improve the UI system. It is important to include an enforcement mechanism to ensure states’ compliance with this requirement.

Expand coverage of Unemployment Insurance to fit structure of modern workforce

The issues. The current Unemployment Insurance system does not serve a large fraction of the unemployed. This is partly due to changes in the structure of the workforce, with increasing amounts of low-wage workers in unstable jobs or rising part-time employment especially among women. Through incentives provided by the American Recovery and Reinvestment Act of 2009, a substantial number of states have now made benefits more easily accessible by adopting a range of proposals.

Proposed change. A reform should provide pathways to harmonize eligibility for Unemployment Insurance across states and increase take-up rates among eligible individuals. There is little justification for the current patchwork of eligibility, and meetings of state and federal UI officials should provide a system of best practices for eligibility requirements and outreach. Eligibility requirements should include those proposed in the American Recovery and Reinvestment Act, among them allowing for training of UI beneficiaries, enabling part-time workers to claim benefits, enhancing the mobility of working couples by making moves for family-related reasons a qualifying event for UI, and instituting the alternative base period. In addition, some of the gradual restrictions imposed over the last three decades to lower UI payments should be reviewed and possibly modified as well.30

Resolve financing short-falls in states’ UI trust funds

The issues. As a consequence of growing wages (and hence benefits) and low taxable wage bases that are not indexed to covered wages, just 25 percent of earnings covered by Unemployment Insurance laws nationally are currently subject to state UI payroll taxes. The minimum taxable wage base, set by the federal government, is currently $7,000 and has not changed since 1983. Similarly, the net federal tax rate—as defined under the Federal Unemployment Tax Act, or FUTA—has been 0.8 percent for more than 30 years, depressing revenues that pay, among others, for UI administration by federal and state agencies.31 Many states’ UI taxes—as defined by their State Unemployment Tax Act, or SUTA—have remained low as well, and states have increasingly resorted to borrowing to finance UI benefits in recessions. Hence, even without the large increase in UI payments during and after the Great Recession the financial soundness of the UI system was steadily eroding.32

Proposed changes. Several sensible reforms of the complex financing system have been proposed. One is to raise the federal taxable wage base, index it to wage growth, and correspondingly lower the FUTA tax rate.33 Another is to institute federal penalties for states that fail to carry sufficient forward balances in their trust funds during expansions.34 And a third is to prevent payroll taxes from rising in the midst of a protracted recovery by extending the 2-year window until FUTA tax credit expires, institutionalizing interest wavers, and encouraging states to also delay automatic tax triggers aimed at balancing their trust funds.

Additional proposal worthy of consideration but not discussed further here

There are additional interesting proposals meant to fix additional shortcomings of the current unemployment insurance system. In addition, there are challenging open questions that have not yet been addressed. These proposals and open questions include, among others:

  • A modernization of the administration of Unemployment Insurance, including information technology used to administer claims, which is found to be often outdated and underfunded by the federal government35
  • A reform of firms’ UI tax rates to better internalize the costs of layoffs, reduce the cost to the UI system, and achieve similar cost of layoffs across states
  • An optional private unemployment account to cover the self-employed or independent contractors36
  • A “job seeker allowance” to aid young workers not qualifying for UI because of a lack of earnings history37

Proposals for innovation of
the Unemployment Insurance system

Even if sufficiently modernized according to these basic reforms, Unemployment Insurance as it is currently designed can neither prevent nor buffer much of the large and lasting earnings losses due to layoffs. This also affects the UI system’s efforts to reemploy workers, who may wait too long to engage in the long process of rebuilding their careers. Yet several innovations of the existing UI system have been proposed that could greatly expand the reach of UI without the need to establish a new program.

Institute a functioning system of work sharing to prevent costly layoffs

The issues. An increasing number of U.S. states have instituted programs of work sharing—also called short-term compensation, or STC—that allow workers to draw pro-rated UI benefits while on the job as an alternative to layoff. Evidence from other countries suggests work sharing can achieve substantial reductions in layoffs. Yet, take-up of the programs by employers in the United States has been low, partly because of restrictive program rules and partly because of a lack of awareness about the program.

Proposed changes. Several policy options are available to strengthen the use of STC across and within states, especially during recessions. One would be to continue to incentivize adoption of the program, with 100 percent of STC outlays funded federally for the first three years after adoption, or alternatively require states to establish STC programs. To raise attractiveness to employers, during this period states should be required to not charge employers for their uses (meaning there should be no experience rating). Another policy option would be to encourage states to share best practices and harmonize their efforts in outreach, and consider targeting employers using industry-level indicators of economic activity or those in the WARN system.38 A third policy option would be to encourage widespread use of short-term compensation during recessions when Extended Benefits are turned on by having STC benefits 100-percent federally financed; by suspending experience ratings; and by not having STC benefits deducted from workers maximum UI eligibility. Finally, research should continue to assess what prevents adoption of the STC program, and best practices for eligibility requirements should be developed.

Experiment with wage insurance to aid workers returning to employment

The issues. Since Unemployment Insurance only insures a minor fraction of the total earnings risk of job losers, its role as insurance mechanism and automatic stabilizer in recessions is substantially below potential. As a result, a growing number of researchers have suggested complementing the current UI system with a system of wage insurance. Wage insurance is likely to provide substantial additional insurance value. In addition, it may provide cost-savings by lowering UI payments. And it is unlikely to further reduce wages, and may raise them by shortening unemployment.39 Yet, currently little is known on potential effects of wage insurance.

Proposed changes. A series of proposals have been made to extend existing wage-insurance plans for trade-related layoffs to all workers covered by Unemployment Insurance.40 Given the evidence on job loss, introducing a version of wage insurance is sound policy, but an experimental evaluation will be important to better understand the effects. Policy parameters should be set with core facts in mind—for example, average wage losses of displaced workers with three years or more of tenure from good employers in a recession are about $15,000 per year in the first couple of years,41 so $10,000 over two years replaces only 30 percent of the loss.42 Similarly, insurance benefits should be extended to workers earning more than $50,000 on their new job since this would exclude substantially affected middle-class employees and their families from insurance.43 Since most evidence suggest that earnings losses last at least three years, and likely many more, a proposal with sharp limits has to educate workers about the long path to recovery.

What new administrative data reveals about access to consumer credit and the U.S. economy

Posted on by Austin Clemens

AP Images

About the authors: Kyle Herkenhoff is an assistant professor of economics at the University of Minnesota. Gordon Phillips is the C.V. Starr Foundation Professor and Academic Director of the Center for Private Equity and Entrepreneurship at the Tuck School of Business, Dartmouth College.

The aim of this essay is to provide several pertinent facts about the way unemployed households in the United States use consumer credit and the way bankruptcy flags affect job finding rates and business creation. These facts can be used by policymakers, including legislators and central bankers, in order to better understand the implications and feasibility of both consumer credit regulations and monetary policy.

The basis for these facts is a new dataset whose construction was funded by the National Science Foundation, implemented in large part by one of the co-authors of this essay, Gordon Phillips, and University of Maryland finance professor Ethan Cohen-Cole, and recently analyzed in joint work with the other co-author of this issues brief, Kyle Herkenhoff.44 There were four major observations and implications that came out of our dataset:

  1. Credit cards are a form of unemployment insurance
  2. Expansionary monetary policy (lowering interest rates) may give unemployed consumers more ‘breathing room’ and allows them to find jobs at higher paying, larger, and more productive firms
  3. Access to consumer credit facilitates self-employment as well as the transition into hiring an entrepreneur’s first employee
  4. Bankruptcy flags disrupt job finding, business creation, and reallocation of workers across jobs

In the remainder of this essay, we explain each of these findings, the circumstances under which they obtained, and the implications for policymakers and lawmakers.

Credit cards are a form
of unemployment insurance

Our first main finding is that consumer credit (credit cards, personal revolving loans, and other forms of revolving credit) has an effect on unemployed households that is comparable to unemployment insurance. In simple terms, being able to borrow allows unemployed households to search more thoroughly for a job. Just like unemployment insurance, credit cards and other forms of revolving credit allow unemployed individuals to “hold themselves over” by, say, buying groceries, or in economic terminology, it allows them to “smooth consumption.” Therefore, consumer credit allows them to find better job matches, and, as a consequence, they are paid higher wages.

We begin with a sample of 3 million workers. We first focus on a set of 20,000 displaced workers, some of whom have significant amounts of credit limits, while others have very limited consumer credit access. We use exogenous increases in credit that result from the removal of bankruptcy flags and from automatic increases in credit to isolate credit increases that are not related to an individual’s job prospects and their underlying employability or quality. We find that the more credit unemployed workers have, the longer they take to find a job. Among those who find a job, they find jobs with higher wages.

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These findings suggest that consumer credit acts in a very similar way to unemployment insurance. Existing unemployment insurance studies find that unemployment insurance protracts unemployment durations, and workers generally find higher paying jobs. (This is true in the United States and Europe;45 European estimates, however, are sometimes insignificant or negative).46 The similarity between the way unemployed individuals use consumer credit and unemployment insurance suggests that households have some degree of private insurance against job loss through credit markets, and that government programs in which consumer credit is extended to unemployed individuals rather than as a transfer payment may produce similar disincentive effects.

Expansionary monetary policy may give unemployed
consumers more breathing room to find better jobs

What are the implications of our findings for monetary policy? The new dataset allows us to measure the impact of consumer credit access on labor market outcomes for the first time. Our results suggest that if interest rates are lowered, or if the government provides some more “breathing room” for unemployed consumers, then they may take longer to find a job, and they may ultimately find better job matches. A direct consequence of this mechanism is that if the government lowers interest rates then the unemployment rate may initially increase. With lower interest rates, and a greater ability to smooth consumption, households may be able to hold themselves over while searching more thoroughly for a job.

Consequently, the duration of unemployment and the unemployment rate will initially be higher following an interest rate decline. Yet the wages of those workers who find jobs will be higher because they are searching more thoroughly and finding better matches. Thus, our research suggests that a central economic-performance indicator of the Federal Reserve should be the wages of new hires, not necessarily the unemployment rate. We believe that by focusing on measures of match quality, the Federal Reserve can take into account the role that credit plays in household job-search decisions as well as have a more complete picture of the health of new labor market matches.

Access to consumer credit facilitates self-employment as
well as the transition into hiring an entrepreneur’s first employee

Consumer credit is not just used to facilitate a thorough job search, it is also a critical component of financing for the self-employed and job creation.47 To examine the importance of consumer credit for the self-employed, we build another new dataset with 200,000 individuals who have previously filed for bankruptcy and link these individuals to Internal Revenue Service entrepreneur tax records with administrative employment histories, credit histories, and so called SS-4 IRS business ownership data.

Using this dataset, we are able to follow individuals over time and observe all possible employment transitions, comprised of: transitions in and out of working for another business; transitions in and out of self-employment; and transitions in and out of owning an employer firm in the Integrated Longitudinal Business Database, or ILDB, which is the merged dataset of SS-4 ownership records with firm employment.48 Our main source of exogenous variation in credit access comes from the removal of consumers’ bankruptcy flag.49 We show that following bankruptcy flag removal, individuals receive a large increase in consumer credit access. Following this large, discrete, and unanticipated increase in consumer credit access,50 we find what we call the “credit access effect.”

Bankruptcy flags disrupt job finding, business
creation, and reallocation of workers across jobs

We show, for the first time to our knowledge, that consumer credit is critical for making the leap from a non-employer business to an employer business. In other words, consumer credit facilitates the hiring of the first initial employee, allowing individuals to make the transition out of self-employment into becoming a job-creating entrepreneur. Specifically, we find that:

  • Flows into self-employment increase disproportionately after credit access improves. Those individuals who start new businesses earn 4 percent more Schedule C Net Income ($1,000) versus comparable bankrupt individuals who have not yet had their bankruptcy flag removed.
  • Following the discrete rise in credit access, these individuals are more likely to become employer firms in the Integrated Longitudinal Business Database
  • New-firm owners in this database borrow $40,000 more using mortgages and home equity lines of credit

These findings suggest that consumer credit matters for the subgroup of individuals who want to start a business, and moreover, it matters disproportionately for those individuals who want to grow their businesses.

A crucial fact for subsequent mortgage regulation is that self-employed individuals who make their initial hire borrow $40,000 more than the control group, and they primarily use mortgage credit to facilitate this transition. In particular, they borrow using home equity lines of credit and other forms of high-interest-rate revolving credit.

This is an important set of facts for regulatory institutions, such as the Consumer Finance Protection Bureau, because this implies that restrictions on access to mortgage credit have direct implications not just for “mom-and-pop” self-employed individuals but also for those who intend to grow rapidly and hire additional employees. Consumer credit may not be the only source of financing for these businesses, but our results indicate that it is, on average, an important part of the debt portfolio of young, growing firms.

The United States is currently witnessing a long-run trend decline in startups.51 By further curtailing or restricting consumer credit, startup rates (and in particular high-growth startup rates) may drop. Our research therefore calls for follow-up studies on regulations that the CFPB may consider, and in particular, mortgage restrictions, especially home equity lines of credit.

Using the same dataset, we are able to measure the impact of bankruptcy flag removal on employment prospects and wages as well as on self-employment and business income. Our final policy relevant finding on the topic of consumer credit is that bankruptcy flags are likely misallocating workers across sectors. Using the same dataset of 200,000 individuals who previously filed for bankruptcy, we are able to study the way bankruptcy flag removal affects labor markets, self-employment, and earnings. We notice four broad patterns following bankruptcy flag removal:

  • Individuals flow into formal sector unemployment-insured jobs. In simple terms, following bankruptcy flag removal, individuals find jobs that qualify them for unemployment insurance. These jobs provide a safety net to the worker in the case of job loss.
  • Those who flow into formal-sector jobs after bankruptcy flag removal earn significantly more and are extremely attached to the formal sector. In simple terms, they earn more and are less likely to end up non-employed than are other comparable individuals without a flag removal.
  • Individuals flow out of “informal” sector self-employed jobs. In simple terms, individuals leave self-employment after bankruptcy flag removal, and they subsequently find jobs in the formal sector.
  • Individuals also flow into “informal” sector self-employed jobs (as mentioned above). With greater credit access, nascent entrepreneurs can quit their formal sector jobs and use credit to finance their ideas.

The main policy implication of our bankruptcy-flag removal findings has to do with the current debate over the use of credit checks by human resource departments.52 Our results indicate that after bankruptcy flag removal, there is a significant amount of reshuffling of workers across sectors. In economic terms, there appears to be reallocation, although whether this is a welfare-improving reallocation remains to be determined. Based on the wages of new hires and their subsequent job transitions (especially the fact that they do not exit to non-employment), our findings suggest workers with bankruptcy flags are not going to the jobs that value them the most. We therefore suggest to policymakers who are considering credit-check bans to consider the impediments that bankruptcy flags generate for self-employment, formal-employment, and new employment in their cost-benefit analyses.