by Russ Roberts on October 5, 2009

in State of Macro, Stimulus

Krugman insults Arnold Kling (HT: THM)

But what none of the participants in the debate seem to realize is that Arnold is basically reinventing 1934 macroeconomics.

What could be more insulting? Arnold is going back to 1934!!!! Haven’t we learned anything in the last 75 years?

No doubt we have. It is also true that some of the things we knew in 1934 are still true. The hard question is figuring out what goes where. After quoting Schumpeter, Krugman continues:

It’s all there: mass unemployment is necessary, because you have to shift resources away from sectors that got too big, stimulus is a bad thing because it slows the necessary adjustment. And now as then, the whole notion falls apart when you ask why, say, a housing boom — which requires shifting resources into housing — doesn’t produce the same kind of unemployment as a housing bust that shifts resources out of housing.

Arnold defends himself here, pointing out that booms are slow and long and busts are sudden and short. So there is a fundamental asymmetry.

But there is another asymmetry. As the housing market expands in the 1990s through 2006, people are drawn into construction because they see the higher wages. They begin to invest in the skills of the construction business.

When it collapses, they have to decide what to do instead and how long to wait before doing it. There is a chance the construction industry will bounce back quickly. So you wait before taking a lower paying job. Then the question is which lower paying job. Which one is your next best alternative. This is not the same process as being attracted into an expanding industry that is signaling that it wants you by paying you a lot. This is harder and more difficult.

About a year ago, as the financial crisis was beginning, I  was picked up at the airport by a car service for a talk I was giving. I asked the driver how long he had been driving a limo. He said, if I remember correctly, six months. What had he been doing before that? Supervising the construction of extremely large luxurious homes, was his answer. He wasn’t a plain construction worker. He was in charge of the whole project. Why did you leave the field, I asked. He told me that when he saw how many houses had been built above and beyond the sales potential he realized that there wasn’t going to be a demand for his services for about five years. He didn’t want to do nothing for five years (and he was close to retirement, or so he hoped) so he looked around for something else. He chose driving a car, a skill he already had, a skill that was enhanced by a pleasant demeanor, which is part of being a good supervisor and part of being a pleasant person behind the wheel of a limo.

I didn’t ask, but I assume he took a big pay cut. That probably wasn’t easy. He might have been tempted to wait things out by convincing himself that it might take less than five years. But he didn’t. Most people have trouble coming to that conclusion. Unemployment insurance makes it harder to reach that conclusion. So it wouldn’t surprise me that the responses to a boom and bust are asymmetric.


50 comments    Share Share    Print    Email

Previous post:

Next post: