Saturday, April 24, 2010

On Downturns

This is a continuation of the analysis of downturns and managers in Productivity Sense and Nonsense, and More Productivity Sense. In essence, a sizable portion of the economy that was generating, thought to be generating, or thought it would generate substantial profits is discovered no longer, not to, wasn't, or won't, be generating them. Assets may have to be marked down and past investments written off, present ones reduced, and future ones abandoned. May be because these may be dependent on interest rates which may restore or increase profitability as they fall. The economy has had a hole blown in it that cannot be filled in short order.

As we left it, prices and wages are unchanged but quantity and profit has been reduced. In addition, due to fixed costs, profitability has been reduced. In the worst case, this can lead to high rates, loan calls, default, bankruptcy, asset liquidation, mergers, and sale of firms, when values are already distressed, but set this aside for now. Fallen assets and wealth, lowered profits and profitability, and excess capacity and reduced future expectations delay recovery. Prices and wages are sticky, and this can result in unemployment for some time, but this does not cause output to fall or prevent it from falling initially.

Managers would like to sell more to increase their profits and profitability, but as most everything is overcapacity, they can do so only at the expense of others. They may be tempted to lower prices to increase quantity, but this is by no means certain. If their customers come to expect lower prices in the future they may delay rather than accelerate purchases setting up deflationary expectations. Cuts in prices and wages may further intensify this into a downward spiral.

If real wages rose at an increasing rate, buyers would be more inclined to delay, but while sellers may be willing or forced to sell inventory below cost, they are not likely to produce below cost, so eventually price declines reach a limit of wage declines. Prices, initially more elastic than wages, would fall to the point their elasticity matched that of wages. The duration of the production cycle would throttle the rate of decline since sellers will want to make sure their costs are covered. Only when prices and wages have stabilized will the downturn end. At this point, there is little more incentive to delay. If prices fall, wages also fall, and attempts to save more fail as they do so. In this case, rising real wages do not terminate deflation but are triggered by it, and that they eventually cease to rise that end it. So while sticky wages result in unemployment, and less sticky prices can result in deflation, sticky prices and wages eventually prevent total implosion.

Finally employment income and output stabilizes at its new lower level. The workforce continues to increase and productivity rises, leading to increasing output and rising unemployment until output grows fast enough to add more workers than by which the workforce is growing.

Monday, April 19, 2010

On Minimum Wages

Most of the poor do not earn the minimum wage and most of those that do are not poor, so raising the minimum wage may not be the most efficient means of helping the poor.
If you want to help the poor give them money. The easiest way of doing that is giving everyone a minimum amount of money and taxing back that above the minimum. The reason this is done through wages rather than directly is to encourage productive work. The down side is it misses those unable to do so. No solution is without its problems. Providing money without a minimum wage would discourage work. A negative income tax would be more efficient in distribution but less efficient in collection. Encouraging lower productivity work would encourage employment but discourage innovation.

We could use more information on the poor that don't earn the minimum wage, and whether they are retired, disabled, unemployed/unemployable, employed at higher wages but seasonally or limited hours, students, single parents, large families, or experienced a capital loss. Just as low wage may be a poor measure, poor may be as well.

I can see three scenarios, 1) there are no gains only losses, those with lower productivity lose their jobs, 2) employers are labor short and forced to pay them more than their productivity, there are gains for workers but costs to employers whether passed on to customers or not, or 3) employers are labor short and invest to raise their productivity, gains all around.

I place little emphasis on scenario 2. I don't believe the employer will accept lower profits other than temporarily and if the employer can raise prices, they have raised their productivity. The argument against a higher minimum wage is not that it doesn't much help the poor but that it will mean more unemployment among the unskilled, fortunately that falls mostly on the non-poor. It will help the skilled somewhat, and innovation can help everyone more. Still, there is little evidence lower real wages (due to inflation) increase unskilled employment. Mostly, it just causes people to leave or not enter the workforce, but this is likely due to the minimum being below the market wage in substantial portions of the country.

One should equate wages to the marginal productivity of the work, not that of the worker. This is why raising the minimum wage can increase productivity; it can induce the investment necessary to do so. This is not without cost, and there are limits to what it can achieve, but this may be a better reason to support it than helping the poor.

A minimum wage can be useful if it leads to productivity boosting investment, or as a demarcation between welfare and work, but those are fairly limiting roles for it.

On Rising Debt

Debt service may be a better measure than debt unless one assumes some more or less constant reversion to a mean discount/interest rate. It is at least useful to consider the two, debt service and discount rates, separately. There are, of course, good debts and bad debts though the portion is adjustable through discount rates.

A borrower will look at it in terms of debt service. If it isn't rising neither they or their lender will be too concerned about repayment. If it is rising, they are either optimistic, speculative, or desperate, and the means to turn debt into equity, and the lender better know which, whether reasonable, and what the collateral is valued at.

A lender will look at it in terms of interest rate. Lower rates may mean increased wealth or reduced investment opportunities or increased risk aversion. If it is falling, borrowers are not borrowing enough and it is contractionary for the economy, but will lower debt service and allow the pursuit of lower return or riskier activities. In general I would say it is a case of dismal expectations or people would be investing in equity rather than debt, but perhaps not as dismal as feared, leading to better equity returns in the future.

Since no one is forced to borrow or lend, borrowing, in terms of debt service, must be seen as, a possibly unwarranted, but fundamentally optimistic act, and retreat from it as either the payback of a successful result or a failed one, but one must be wary of exuberance and despair, conscious of the investment being undertaken, and aware it can't grow without limit. A falling rate should be seen as concurrently negative but hopefully prospectively positive event.

Overall, the change is more significant, but the rate can change faster than the debt. Demographics, fiscal and monetary policy, risk aversion, or available investment opportunities may all alter preferred levels so the result can be difficult to interpret.

Is debt good though? Certainly the rate will determine whether it can be repaid or not, but ideally should the amount of debt change? I think not. Ideally, demographics are stable, the economy grows at a steady rate and offers a steady stream of investment opportunities and a steady return, and booms and busts don't occur. In such a world, there would be no reason for debt to change, but it isn't an ideal world. It might be rather boring if it were. What needs to be asked is whether optimism or pessimism is warranted or not. If not, debt should be headed in the opposite direction. Sudden changes may be necessary, but they are suspicious.

More Productivity Sense

A manager, when faced with a reduction in demand, responds with a reduction in supply. He takes his input prices as market driven and by setting the productivity of some to zero, allows the productivity of the rest to stay at or return to their previous level. This frees resources for else where while maintaining competitiveness. This is normally the correct response. The manager knows his demand is falling; he cannot be expected to know most everyone's demand is falling. To expect different behavior under different conditions which are unclear may be to much to ask. Moreover, maximizing employment and work is not the main goal of society; maximizing living standards is. While reducing wages, work sharing, or tax redistribution can increase equality, it is just redistribution and doesn't increase living standards.

In a downturn, the economy itself has become less productive. The engine of the economy has failed and the train is coasting and slowing down. Most of it was only boxcars being pulled along by it and redirecting fuel to the boxcars won't accomplish anything. Only another engine will power the economy. The problem was not that the engine ran into trouble; all engines run into trouble. The problem was there were no other engines to reduce the load on that engine and prevent it from failing and take up the slack from it. About the best that can be done is support and sustain those laid off until the economy can reabsorb them and allow low rates and inflation to promote economic adjustment and growth of small but profitable businesses.

Saturday, April 17, 2010

Changes in the Standard of Living

Comparing standards of living across time is essentially an impossible task due to changes in circumstances, conditions, lifestyles, and technology, but is still fascinating to think about. A clever way of considering this is to ask, if your income and wealth were doubled, but you would have to live in the past, how far back would you be willing to live. By this meaning your rank in society would be equivalent of the current rank of someone with double your current income and wealth. One should assume no future knowledge after being transported back to then. Inevitably there is some preference due to what we know occurred back then, such as growth during the 1950s, but one should try to set this aside as if you did not know. One problem is it may actually be more growth rather than level that attracts someone, but in this case how far in the past would not be a meaningful measure. Assume all consumption would be in the products available then with lifestyles changed to accord with what was available. For example, twenty years ago there would be no internet, or at least world wide web, so all the time spent on it would have to spent on other things like going to the library or on television. For someone that grew up with it, it is probably difficult to imagine what life must have been like without it, so age may limit how far back one is willing to go. Nor should one consider this a vacation, but a permanent one way trip since every time could be interesting if we could always go home. So this is primarily about what value you place on changes in lifestyle and technology over that time and how much you are willing to give up as well as get in exchange. For it is not just a matter of giving things up but appreciating other things like less population and density, more local social activities, and a slower pace of life. While technology changes, there is always some earlier technology to substitute with a reduction in utility like paper for the internet, or landlines for cellphones. So how far in the past would you be willing to go?

I don't see much of a problem going back 30 years for double the income and wealth despite the vast changes the lack of the internet and primitiveness of pcs would impose. I could do without gps and cellphones. On the other hand 50 years with its lack of air conditioning and microwaves would be pushing it although I could live in some pretty nice areas and eat out to compensate. Going through the energy crisis again wouldn't be much fun though, not only the crisis itself but the poor growth of the period as well. From this, I subjectively judge the real growth rate of the standard of living to be more than 1/50, 2%, but less than 1/30, 3.3%, which is quite close to measured real gdp per capita changes. Thus I see little mismeasurement in the official statistics as a result. Your feelings may differ.

Productivity Sense and Nonsense

One often hears "workers are paid according to their productivity" and "the least productive workers are laid off first". These are mutually incompatible statements as commonly used. Either workers are paid according to their productivity, meaning no productivity basis exists for determining which are laid off, or they are paid on bases other than their productivity and laid off on that basis. Productivity is just output over input. If workers are paid for their productivity, the input, their wages, has been adjusted to equalize productivity among workers, so how can some be less productive than others? Individual productivity may be difficult or even impossible to measure, but that would just mean it is irrelevant to pay and both statements are false. It may be difficult to anticipate when hiring, but new hires that don't work out are often terminated, and if not, wages can be adjusted by raises or their absence over time. There is only one sense in which these statements can be understood together.

In a downturn, what changes is the relative desirability or values of outputs, not inputs. The price usually doesn't even change much, but the quantity demanded. It is the work that becomes less productive, not the worker. Prices are sticky and wages are even more sticky. The worker that is laid off is no less productive than the co-worker that stays behind, rather, the workers that suffer layoffs are less productive in the sense of being less desired than workers that don't suffer layoffs. Productivity is an industry concept, only wages are an individual one. It is not productivity the manager uses in selecting which workers to lay off, rather, it is desirability the market uses in selecting which industries to reduce. Managers could reduce prices and wages to maintain quantity and employment, but some costs are fixed, some work has to be done, and some are other inputs over which they have no control, so it is easiest to treat both prices and wages as fixed and allow quantity and employment to fall. So what criteria do managers use in layoffs when all their workers have become less productive in the sense of desired? They may choose to layoff those with the highest wages to minimize number of layoffs and keep those more able to improve or less likely to demand their productivity or cause trouble, or they may select on connections or influence, pliability or sociability, seniority, or even age, race, and sex, but it is not productivity, per se, in the common sense of the meaning. Layoffs are fundamentally about discrimination. This is probably why most managers dislike doing it, or at least the good ones.