Economists Should Not Forget Supply and Demand

A Jule 23 Economist article about how “Generous Unemployment Benefits Are Not Keeping Americans from Work” is not easy to understand.  “[T]here is little evidence,” it claims, “to suggest that the extra $600 a week [from the federal government] is slowing down the labour-market recovery.” One would think that paying more in benefits to non-working workers would, ceteris paribus, decrease their number. Consider the last two paragraphs of the article:

Another signal that employers were struggling to fill positions would be soaring wages. Workers might hold bosses hostage with the threat of settling for benefits instead. Upon first inspection, this seems to be true. Average hourly earnings in the second quarter of 2020 increased by about 7% from a year ago, according to Goldman Sachs. However this is largely because low-paid workers have lost jobs in disproportionate numbers, dragging average wages upwards.

All of this implies that the main factor behind the high unemployment rate is lack of jobs, not an unwillingness to work. Economists normally fight like cats in a bag. But an astonishing 0% of those surveyed by researchers at the University of Chicago disagreed with the idea that “employment growth is currently constrained more by firms’ lack of interest in hiring than people’s willingness to work at prevailing wages.”

Excluding the misleading last sentence, the first paragraph tells us that, in the second quarter, employment decreased and wages increased, which is confirmed by the chart below (shaded area marks the current recession).

Consider Q2. How could employment decrease while wages increased (all compared to the same quarter one year ago)? Assuming a negatively sloped demand for labor and a positively sloped supply of labor, the only way this combination can obtain is if supply has decreased, that is, the supply curve has shifted to the left. The demand curve may also have shifted, up or down (most likely down in the current outlook), but we know that the dominant factor must have been a decrease in supply.

This is easy to see with a standard supply and demand analysis. The chart below pictures the labor market with demand curve D and supply curve S. Employment and the wage rate were respectively L1 and W1 before Q2. For L1 to decrease to L2 and W1 to increase to W2, you need to have a decreased supply, at S’, that more than compensates for any decrease (or increase) in the demand for labor. Playing with S and D should persuade you of that. (You may want to refer to my post “A Frequent Confusion and the Yo-Yo Model” if you need a more detailed explanation of supply-demand analysis—albeit in a product market instead of a labor market.)

What seems to have happened is the opposite of what The Economist tells us. The dominant factor behind the lower employment is that workers reduced their supply of labor, presumably because, with the $600 federal unemployment supplement, many were paid more non-working than working—and no doubt also because many were too scared of the pandemic to go back to work. The higher unemployment rate (not shown on the chart and again compared to Q2-2019) probably results from the workers who, in the states where it does not compromise their unemployment benefits, chose not to go back to work and not to look intensively for a new job. There is certainly a “firms’ lack of interest in hiring” (compared to what it was before) but the dominant factor is “unwillingness to work.” If that were not the case, wages would not have increased.

One way to question this conclusion, besides making strange assumptions about the supply or demand curves, would be to suggest that percent-change calculations with respect to the preceding quarter (as opposed to the same quarter a year before, as was done in the first chart) would be more representative of short-run changes in supply and demand. The following chart shows that doing this does not change the general picture and thus our conclusion for Q2. (The picture for Q1, with a very tiny increase in employment of 0.09%, suggests that the overall demand for labor rose enough to compensate the unemployment effect of the reduction in labor supply. This is likely an artifact of Q1 being very economically heterogeneous, from a slow start in January and February to a catastrophic drop in March.)

This little analysis of the respective effects of labor supply and labor demand is also confirmed by the monthly evolution of employment and wages (see chart below). In the second quarter and the end of the first, employment and wages moved inversely, implying that the supply of labor played the main role, not the demand for labor.

If all that is correct, the burning question is why none of the 43 economists polled by the Chicago Booth School of Business disagreed with the statement that that “employment growth is currently constrained more by firms’ lack of interest in hiring than people’s willingness to work at prevailing wages.” Perhaps these economists were secretly playing with supply and demand curves in their heads, as the comments of Caroline Hoxby and Darrel Duffie suggest. But they should all come out of the closet.

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Is utilitarianism WEIRD?

I suspect it is, at least in the sense of WEIRD as a now trendy acronym for western, educated, industrialized, rich, and democratic societies.

One criticism of utilitarianism is that it implies that we should value the welfare of far away people just as much as we value the welfare of our own family and friends. This, it is argued, goes against human nature.

I agree that it goes against human nature, but I don’t believe that makes it a bad idea. If someone insults me, my human nature is to punch him in the face. Throughout most of history, in most parts of the world, that’s exactly how many people would respond. If they were aristocrats, they might challenge them to a duel.

In rich societies we have tended to move past fighting duels over insults. We’ve risen above out natural instincts, at least in some respects.

Razib Khan recently made this observation:

In The WEIRDest People in the World Harvard’s Joe Henrich makes the argument that the Western Christian Church’s destruction of extended family networks led to the rise of the West. I won’t recapitulate the argument which I’ve outlined elsewhere. But the idea is rather persuasive.

Before proceeding, let’s stop for a moment and consider just how weird this theory is.  Many conservatives (not all) hold the following two beliefs:

1. Strong family values are the bedrock of western civilization.

2. Western civilization is superior to most or all other cultures.

Wouldn’t it be surprising if the success of western civilization were based on the rejection of strong family values?

In many parts of the world you are expected to offer a job to a cousin over a slightly better qualified stranger.  Many of those countries have higher levels of corruption than rich western nations.  And this is not just about Europe vs. non-white countries.  Sicily has stronger extended family networks than Sweden, and is less prosperous.  So one can make similar distinctions even within Western Europe.

The claim that each person’s wellbeing is equally important is a truly radical idea.  Conservatives upset about my dismissal of “family values” might take some solace in the thought that this radical idea may have come from Christianity.  In contrast, utilitarianism is often viewed as a sort of bloodless, secular worldview—almost inhuman. But if the WEIRD hypothesis is correct, then perhaps society can to some extent overcome its natural instincts, and move at least some distance down the road toward valuing everyone’s wellbeing equally.

To be sure, some bias toward family and close friends might be optimal from even a utilitarian perspective, as we are social animals. Babies come into the world defenseless, and hence a strong nuclear family is a useful institution.  Perhaps in pre-historic times a strong extended family was useful to survival, but in modern WEIRD societies there’s no great benefits in extended kinship networks, beyond the nuclear family.  It’s all about balance, and how that balance changes as society evolves and becomes more urban and specialized.

I have not yet read Joe Henrich’s new book, but for those whom have I pose this question.  Is it possible that at least a part of the claim that western societies have become WEIRD another way of saying that western societies have become increasingly utilitarian?  That is, do we increasingly view everyone’s welfare as equally important?

Now I’ll go out on a limb with one further thought—admittedly wildly speculative.  What if Christianity led to utilitarianism, and utilitarianism led to the rejection of certain non-utilitarian ideas in the Bible?  (Stoning adulterers, prejudice against gays, usury is bad, etc.) This is analogous to the view that capitalism leads to prosperity, which leads to social liberalism, which leads to a rejection of the Protestant work ethic that supposedly led to capitalism.  As I said, all wildly speculative.

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CEO stress, aging, and death

We show that increased job demands due to takeover threats and industry crises have significant adverse consequences for managers’ long-term health. Using hand-collected data on the dates of birth and death for more than 1,600 CEOs of large, publicly listed U.S. firms, we estimate that CEOs’ lifespan increases by around two years when insulated from […]

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