And Now You Find Yourself in '82

The Times' David Leonhardt reminds us that the recession of the early 1980's was worse than the current one (so far):

The recession of the early 1980s doesn’t have a catchy name, and almost half of Americans are too young to have any real memory of it. But it was terrible — qualitatively different from the mild recessions of 1990-91 and 2001.

The first big blow to the economy was the 1979 revolution in Iran, which sent oil prices skyrocketing. The bigger blow was a series of sharp interest-rate increases by the Federal Reserve, meant to snap inflation. Home sales plummeted. At their worst, they were 30 percent lower than they are even now (again, adjusted for population size). The industrial Midwest was hardest hit, and the term “Rust Belt” became ubiquitous. Many families fled south and west, helping to create the modern Sun Belt...

So why are public opinion polls showing Americans to be even gloomier about the economy today than they were back then? I think there are two main reasons.

First, the economic expansion that just ended wasn’t as good as the 1970s expansions. The ’70s get a bad rap, and deservedly so in many ways. But median family income still rose 2 percent during the decade, after adjusting for inflation. Over the past decade, it has fallen.

Second, people seem to understand that the worst is yet to come — that the economy has not yet worked off its excesses.

I'd suggest another reason - the reduction in macroeconomic volatility after the mid-1980's (formerly) known as the "great moderation." There were only two recessions between 1982 and the current one, and they were both relatively short and minor, which means that we are much less accustomed to big economic swings now than we were 27 years ago. In 1982, however, the turbulence of the 1970's was still a fresh memory. The "double dip" recessions of 1980 and 1981-82 came only a few years after the severe 1973-75 recession, so perhaps it is not surprising people felt like this:


1982 also saw a bottoming out of the stock market, Floyd Norris recalls.

The (In)utility of Higher Education

Stanley Fish writes:

...I have argued that higher education, properly understood, is distinguished by the absence of a direct and designed relationship between its activities and measurable effects in the world.

This is a very old idea that has received periodic re-formulations. Here is a statement by the philosopher Michael Oakeshott that may stand as a representative example: “There is an important difference between learning which is concerned with the degree of understanding necessary to practice a skill, and learning which is expressly focused upon an enterprise of understanding and explaining.”

Understanding and explaining what? The answer is understanding and explaining anything as long as the exercise is not performed with the purpose of intervening in the social and political crises of the moment, as long, that is, as the activity is not regarded as instrumental – valued for its contribution to something more important than itself...

This ideal, he says ruefully, is on its way out:

Except in a few private wealthy universities (functioning almost as museums), the splendid and supported irrelevance of humanist inquiry for its own sake is already a thing of the past.

He goes on to discuss the argument of a new book, "The Last Professors: The Corporate University and the Fate of the Humanities," by Frank Donoghue. One of the main supporting pieces of evidence is the growing use of adjunct and temporary faculty. That may reflect shifting priorities, but I would partly attribute it to Baumol's cost disease - the relative cost of personally delivered services has tended to rise over time because their productivity growth is slow. That is, the price of professors relative to cars has risen, because the manufacture of cars requires much less labor than it did a generation or two ago, while teaching requires about the same amount of human effort.

I think the broader problem, what Fish describes as a "shift from a model of education centered in an individual professor who delivers insight and inspiration to a model that begins and ends with the imperative to deliver the information and skills necessary to gain employment," is more a consequence of the increasing college wage premium.

(figure swiped from Goldin and Katz). Because the gap in earnings between those who hold college degrees and those who don't has grown significantly over the past several decades, young adults (and their parents) have come to regard college as a stepping stone - or obstacle - to "success." It is not surprising that they therefore believe that universities should deliver some sort of "useful" job-specific knowledge.

Unfortunately, many people inside the university seem to make the same error. There are several reasons why they are wrong -

The economics argument would be that college is really a signaling mechanism, as Christopher Caldwell explained in the Times:

But the education kids are rewarded for may not be the same education their parents think they are paying for. Economists would say that a college degree is partly a “signaling” device — it shows not that its holder has learned something but rather that he is the kind of person who could learn something. Colleges sort as much as they teach. Even when they don’t increase a worker’s productivity, they help employers find the most productive workers, and a generic kind of productivity can be demonstrated as effectively in medieval-history as in accounting classes.

Another argument, that I have made before, is that liberal education develops broadly applicable skills, like critical thinking and writing.

But Fish's view is the one that I like best, that seeking to understand and interpret the world is an enterprise of intrinsic value. I hope someday the college wage premium will disappear, so we can overcome the confusion about what we are really here for.

High Future Energy Prices Now, Please!

The Times reports from the Detroit auto show:

But the return of cheap gasoline has already dampened hybrid sales. Throughout the show, auto executives emphasized that stable fuel prices, or a coherent government energy policy, would help them anticipate what consumers would buy next. Because of wild swings in fuel prices, “Every six months we get called stupid for having the wrong products,” said Robert A. Lutz, G.M.’s vice chairman.

“Far be it for me to be the first auto executive to call for a gas tax,” Mr. Lutz said. “But right now, it’s like fighting obesity by requiring clothing manufacturers to make nothing but small sizes.”

Electric cars did generate the show’s central irony: the models that will most impress Detroit’s new overseers in Washington will also drag down the automakers’ bottom lines for several years.

The Post's Steven Mufson writes:

Goodness knows, President-elect Obama has his legislative hands full. Maybe that explains why he has taken the idea of increasing gasoline taxes off the table, saying that Americans had enough economic burdens at the moment. Nominees like Steven Chu, the Nobel Prize winning physicist who will become Energy Secretary, dutifully echoed Obama's view even though in Chu's case he has long supported higher fuel taxes.

But by failing to raise the gasoline tax, the president-elect risks complicating another problem: Fixing the U.S. automobile industry.

Here's the problem. Obama and leading members of Congress keep saying they want ailing automakers to make more fuel-efficient vehicles. But the automakers in the past made more money on the guzzlers; in the future, they will have trouble charging enough to make money on new cars using costly new technologies for plug-in or hybrid cars. So the car company of the future may be a money-losing operation, just like the car company of the present.

Raising the gasoline tax would increase consumer demand for more fuel-efficient vehicles. That could help automakers charge more for them and make more money on sales of plug-ins, hybrids or more efficient conventional engines. Not surprisingly, Ford and General Motors both belong to the U.S. Climate Action Partnership, which this week proposed a detailed blueprint for a cap-and-trade system for carbon dioxide emissions. Such a system would put a price on carbon and would effectively tax gasoline and all other fossil fuels.

After being burned last summer by sky-high gasoline prices, do Americans really need higher gasoline taxes to get them to buy fuel-efficient cars? Yes, actually. Americans have an astonishingly short memory about gasoline prices. Sales of the Toyota Prius have hit the skids now that gasoline prices are back below $2 a gallon. And sales of SUVs are relatively strong compared to many other models.

(Hat tip: Mankiw). The principle applies more broadly - the best way to induce investments in "green" technology would be policies that credibly ensure that the price of (non-renewable) energy will rise in the future, like a phased-in carbon tax. Done right, this could even have a positive effect on current investment by creating an incentive to replace inefficient equipment before the higher costs kick in. That is, a (future) tax increase could be a stimulus today... not to mention addressing a problem - global warming - that is ultimately far more serious than the recession.

Politically, it isn't an easy sell, but it should be less difficult now, in the wake of a fall in global energy prices, than it will be once they go back up. Chu's comments were not encouraging, but presumably a climate/energy proposal is in the works that will result, perhaps indirectly, in higher costs for transportation fuel. Still, I worry Matthew Yglesias may be right when he says: "my best guess is that Obama’s climate proposals are too ambitious to be enacted and too timid to avert catastrophe."

But if he's wrong, and we get the high energy prices we need, Bob Lutz has got me covered.

At Least We Have a TARP Over Our Heads

Washington Post columnist Steven Pearlstein says the financial sector bailout recapitalization (et cetera) has been a qualified success:

There's been a lot of grousing lately about the Treasury's $700 billion bailout program, which, according to its many critics, has accomplished nothing other than line the pockets of undeserving bankers and their shareholders.

Maybe I'm missing something, but I don't see how it's possible to rescue the banking system without rescuing banks. That's not because anyone thought banks or bankers were particularly deserving of public charity or even sympathy -- clearly they weren't. But by last summer, with investors, lenders and depositors running for the exits, there was a genuine fear that the banking system could collapse and bring the whole global economy down with it. To prevent that outcome, the Treasury asked for $700 billion that it could use not only to mount rescues of individual institutions, but also to try to get ahead of the crisis by taking proactive steps to shore up the financial system.

Sure, you can question how the money was used -- many of us have -- but you can't quarrel with the fact that a financial meltdown has been avoided as a direct result of the government's extraordinary interventions...

Indeed, Calculated Risk finds that some measures of credit market stress have improved considerably.

But, the Times reports, more will be needed...

Guesstimating the Stimulus

Although the details are still in flux, Christina Romer and Jared Bernstein (incoming CEA chair and chief economist for VP-elect Biden, respectively), have put out a rough estimate of the effects of the Obama administration stimulus package.Their estimates are based on a plan of $775 billion, spread over two years, including both spending and tax cuts. Paul Krugman says:

Kudos, by the way, to the administration-in-waiting for providing this — it will be a joy to argue policy with an administration that provides comprehensible, honest reports, not case studies in how to lie with statistics.

But the stimulus is not enough:

So this looks like an estimate from the Obama team itself saying — as best as I can figure it out — that the plan would close only around a third of the output gap over the next two years.

Here are the CBO's projections of the output gap (the difference between potential and actual GDP), assuming no stimulus:

(The graph is from these charts, which accompany the latest Budget and Economic Outlook)

Brad DeLong says:

I agree with Paul that this fiscal boost plan is too small, but I do want to admit that doing this well is harder than it looks. The tax-cut part does not look terribly effective as a stimulus--it is a step toward compensating for higher income inequality and a political play to make it more likely that Republicans will lose politically by trying to block the package rather than a significant boost to employment. Thus I do not think you would want to make the tax-cut part larger. And it is hard to find a lot of additional spending projects that can be ramped up quickly and do a lot of good--relatively soon in that endeavor the short-term fiscal multiplier falls below one. They are trying their best.

At Econbrowser, Menzie Chinn notes that, with the output gap expected to last for a while, we shouldn't be so concerned with the "lags" in implementing infrastructure spending (a point also made by Krugman in this column).

The implicit assumption here seems to be that the recovery will be slow, as it was following the 1990-91 and 2001 recessions. In both of those cases the unemployment rate continued to drift upward after the business cycle peak declared by the NBER. In terms of magnitude, it looks like we're now in a more serious recession, comparable to 1973-75 and 1981-82. Those recessions had bigger spikes in unemployment, but also much brisker recoveries. Unemployment peaked at 10.8% in December 1982 and fell to 8.3% at the end of 1983 - a decline of 2.5 percentage points in 1 year. The unemployment rate declined 1.6 points from May 1975 (9.0%) to May 1976 (7.4%). In both cases, the recoveries were quicker than what is envisioned by Romer and Bernstein or by the CBO.

It may indeed be that the 'jobless recovery' is the new 'normal' pattern. If the dynamics of earlier recessions were driven by manufacturing firms responding to unintended inventory accumulation, improvements in inventory management and the declining share of manufacturing might help explain the changing pattern. However, part of the reason economies can bounce back quickly (Milton Friedman once compared recessions to plucks of a guitar string) is that idle resources can be put back to work fast. And it looks like we will have no shortage of idle resources this time around.

The Celebrated Optimism of Economists

This NY Times headlinecalls to mind a favorite passage from ch. 3 of Keynes' General Theory:

But although the [classical] doctrine itself has remained unquestioned by orthodox economists up to a late date, its signal failure for purposes of scientific prediction has greatly impaired, in the course of time, the prestige of its practitioners. For professional economists, after Malthus, were apparently unmoved by the lack of correspondence between the results of their theory and the facts of observation; - a discrepancy which the ordinary man has not failed to observe, with the result of his growing unwillingness to accord to economists that measure of respect which he gives to other groups of scientists whose theoretical results are confirmed by observation when they are applied to the facts.

The celebrated optimism of traditional economic theory, which has led to economists being looked upon as Candides, who, having left this world for the cultivation of their gardens, teach that all is for the best in the best of all possible worlds provided we will let well alone, is also to be traced, I think, to their having neglected to take account of the drag on prosperity which can be exercised by an insufficiency of effective demand. For there would obviously be a natural tendency towards the optimum employment of resources in a Society which was functioning after the manner of the classical postulates. It may well be that the classical theory represents the way in which we should like our Economy to behave. But to assume that it actually does so is to assume our difficulties away.

The "economists" featured in the Times story are mostly corporate forecasters, and, indeed, Candide-like:

They base their forecasts on computer models that tend to see the American economy as basically sound, even in the worst of times...

Those models also take as a given that the natural state of a market economy like America’s is a high level of economic activity, and that it will rebound almost reflexively to that high level from a recession...

“Most of our models are structured in a way that the economy is self-righting,” said Nigel Gault, chief domestic economist for IHS Global Insight, a consulting and forecasting firm in Lexington, Mass.

That said, though I haven't hazarded any forecasts, I have also been of the belief that the gloominess has been overdone. My reason for optimism is that we seem to be re-learning our Keynesian lessons quickly (most of us, anyway - there are some exceptions of course) and enough of the madmen in authority are on board that we can expect monetary and (soon) fiscal policy to be conducted with due regard for the principle of effective demand.

My Favorite Econ Goof

Marginal Revolution is soliciting nominations for the most famous mistakes of economics. My personal favorite is William Baumol's 1986 American Economic Review article "Productivity Growth, Convergence, and Welfare: What the Long Run Data Show" (link requires JSTOR subscription). In it, he finds that GDP data for 16 countries over the period 1870-1979 validates the convergence prediction of neoclassical growth models. That is, initially poor countries grow faster than rich ones, thereby catching up over time. Looks good, but as Brad DeLong pointed out in "Productivity Growth, Convergence and Welfare: Comment," (AER, 1988 [JSTOR]) the finding suffers from a selection problem. All of the countries in the sample are wealthy in 1979, so, of course, if they started out poor, they caught up. As a way around, with limited data, DeLong instead chooses a sample based on the initial level of income in 1870. Doing so adds several countries like Portugal and Argentina, that did not converge.Some of the nominees at MR have much more cosmic importance, but this case is a good example of how smart people - not just Baumol, but the editors and referees at AER, too - can make mistakes that seem obvious, but only in retrospect after another smart person points them out.

To be fair, it should be mentioned that Baumol did mention the potential issue in a footnote.

Sticky Wages, Flexible Labor Costs?

The version of the "textbook" Keynesian model that I teach my students relies on "sticky" wages, set in advance. One of the less-satisfying features of the story is that the large gains to adjusting wages are left on the table. And yet, my students mostly find it plausible, because it seems consistent with observed behavior. In last week's Times column, David Leonhardt explored the issue:

Jobs are disappearing, bonuses are shrinking and raises will be hard to come by. But the drop in prices, which isn’t over yet, will make life easier on millions of people. It’s possible, in fact, that the current recession will do less harm to the typical family’s income than it does to many other parts of the economy.

The reason is something called the sticky-wage theory. Economists have long been puzzled by the fact that most businesses simply will not cut their workers’ pay, even in a downturn. Businesses routinely lay off 10 percent of their workers to cut costs. They almost never cut pay by 10 percent across the board.

Traditional economic theory doesn’t do a good job of explaining this. During a recession, the price of hamburgers, shirts, cars and airline tickets falls. But the price of labor does not. It’s sticky.

In the 1990s, a Yale economist named Truman Bewley set out to solve this riddle by interviewing hundreds of executives, union officials and consultants. He emerged believing there was only one good explanation.

“Reducing the pay of existing employees was nearly unthinkable because of the impact of worker attitudes,” he wrote in his book “Why Wages Don’t Fall During a Recession,” summarizing the view of a typical executive he interviewed. “The advantage of layoffs over pay reduction was that they ‘get the misery out the door.’ ”

However, there are other margins to adjust, and its far from obvious (to me, at least) that layoffs are less damaging to worker morale than pay cuts. That's why I found the examples of non-wage adjustments in this Times story interesting:

A growing number of employers, hoping to avoid or limit layoffs, are introducing four-day workweeks, unpaid vacations and voluntary or enforced furloughs, along with wage freezes, pension cuts and flexible work schedules. These employers are still cutting labor costs, but hanging onto the labor.

And in some cases, workers are even buying in. Witness the unusual suggestion made in early December by the chairman of the faculty senate at Brandeis University, who proposed that the school’s 300 professors and instructors give up 1 percent of their pay.

“What we are doing is a symbolic gesture that has real consequences — it can save a few jobs,” said William Flesch, the senate chairman and an English professor.

He says more than 30 percent have volunteered for the pay cut, which could save at least $100,000 and prevent layoffs for at least several employees. “It’s not painless, but it is relatively painless and it could help some people,” he said....

At some companies, employees are supporting the indirect wage cuts — at least for now. The downturn hit so hard, with its toll felt so widely through hits on pensions and 401(k) retirement plans and with the future so murky, that employers and even some employees say it is better to accept minor cuts than risk more draconian steps.

The rolls of companies nipping at labor costs with measures less drastic than wholesale layoffs include Dell (extended unpaid holiday), Cisco (four-day year-end shutdown), Motorola (salary cuts), Nevada casinos (four-day workweek), Honda (voluntary unpaid vacation time) and The Seattle Times (plans to save $1 million with a week of unpaid furlough for 500 workers). There are also many midsize and small companies trying such tactics.

To be sure, these efforts are far less widespread than layoffs, and outright pay cuts still appear to be rare. Over all, the average hourly pay of rank-and-file workers — who make up about four-fifths of the work force — rose 3.7 percent from November 2007 to last month, according to the latest Labor Department data.

However,

The magnanimous feeling will probably pass, said Truman Bewley, an economics professor at Yale University who has studied what happens to wages during a recession. If the sacrifices look as though they are going to continue for many months, he said, some workers will grow frustrated, want their full compensation back and may well prefer a layoff that creates a new permanence.

“These are feel-good, temporary measures,” he said.

Update (12/31): Washington Post columnist Steven Pearlstein ponders the merits of sharing the pain through wage cuts.

The Cookie Also Un-Crumbles

I already got what I wanted for Christmas:

Lance, Inc. (Nasdaq: LNCE) today announced that the U.S. Bankruptcy Court for the District of Delaware has approved Lance's bid to purchase substantially all of the assets of snack food company Archway Cookies LLC ("Archway"). Under the terms of the Asset Purchase Agreement, Lance will acquire substantially all of the assets of Archway for approximately $30 million. The transaction is expected to close no later than December 15, 2008. Lance will use available liquidity under its current credit facilities to fund the acquisition.

"We're excited about this acquisition," commented David V. Singer, President and Chief Executive Officer of Lance, Inc. "Archway was founded in the 1930s, and has built solid market share in its niche of soft, home-style cookies. Archway is an excellent addition to our growing portfolio of consumer preferred niche brands. We are looking forward to reopening the Ashland, Ohio production facility, where we intend to produce Archway cookies. This facility will also provide the capacity to support growth in our existing business and capabilities that will broaden the products we can offer our Private Brands customers, thus supporting our growth goals for our non-branded business."

Thanks, Santa! U.S. Bankruptcy Court for the District of Delaware!

The Serious Badness of the 1980's

Macroblog has kindly answered some comments about their comparison of the current recession with past episodes. In response to a comment I left, "considering the 1981-82 recession by itself, rather than in combination with its 1980 little brother, somewhat understates the 'badness' of that period," they say:

The 81–82 recession graphs include data from 12 months before the first day of the recession to 12 months after the last day of the recession, therefore the dates range from 7/1/1980 to 11/1/1983. The 1980 recession ended in July of 1980, so these time periods overlap each other by one month. Including this month does not “understate the ‘badness’ of the period” because the calculations are based solely on the recessionary period being examined. In other words, the time span has no effect in this case. The first day of the recession is set to one. The months before and after are normalized to the first day of the recession. If we were to remove the 1980 recession date and run the time span 10 months before the 1981 recession to 10 months after, the graph does not change in anyway apart from a shorter time span. This is because the data is scaled to 7/1/1981, the beginning of the recession.

That is correct, but it misses the point I was trying to make (so perhaps I didn't make it very clearly). What I was trying to say is: the two recessions, together, represent a very long period of elevated unemployment. There wasn't much "recovery" from the 1980 recession before the 1981-82 recession began. The unemployment rate was 6.0% in December 1979; it peaked at 7.8% in July 1980, before falling to 7.2% at the end of that year. In mid-1981 it began a new climb all the way to 10.8% at the end of 1982. The unemployment rate fell to 7.2% in 1984 (Morning in America*), but didn't make it all the way back down to 6% until August 1987!

I've plotted the BLS nonfarm payroll employment series around the NBER business cycle peak dates of November 1973, January 1980, July 1981 and December 2007. The yellow line illustrates what I was trying to say... in 1980, America was at the precipice of some hard times. Now that the NBER has made its call, we know that we are 12 months out from the last peak. I'd like to hope that our position is more like July 1982 than January 1981 (i.e., I'd rather be at 12 on the green line than the yellow one).

Of course, in the 1980's, we took a certain pride in being "Bad."

*By the unemployment rate, in 1984, people were better off than they were four years ago, but not five.