Wednesday, September 14, 2016

Another round on the “elephant curve”

A report from the Resolution Foundation has touched off another round of analysis of Branko Milanovic‘s work on global income growth. Much of what they discuss can be found elsewhere. Including here. But I want to focus for a moment on their claim that
we find that the weak figures for the mature economies as a whole are driven by Japan (reflecting in part its two ‘lost decades’ of growth post-bubble, but primarily due to likely flawed data) and by Eastern European states (with large falls in incomes following the collapse of the Soviet Union after 1988).
Not to suggest that these things did not occur; rather, I find weak the argument that they drive the results. In the figure below, I have estimated the “quasi-nonanonymous” GIC. We see there the growth in real per-capita income among country-deciles sorted by their 1988 income percentiles— with and without China. I have not “reshuffled” incomes when including China, so it is as if Chinese growth had been comparable to its 1988 income peers.

In other words, excess growth in China accounts for nearly all of the fast growth in the 20-70th percentiles. The growth which remains to that half of the world distribution is quite modest— about 1.7 percent per capita annually. True, the more developed 70-99th percentiles seem to have grown somewhat more slowly (1.3 percent per capita annually); even including Japan and Eastern Europe as done here, the severe stagnation which the “elephant” misleadingly suggested does not really exist.

Of course, this latter point was already made clear in Milanovic’s work, as he reminds us. Ultimately, there are two points:
  1. The years 1988-2008 had seen considerable change in what it means to be part of the global middle class.
  2. Outside China, the global 10-99th enjoyed only modest growth. To the extent those years saw stagnation among more developed economies, it extended to most of the world. Except China.

Thank Goodness I Did Not Attend GMU

So much Tyler Cowen to criticize here, but I want to focus on one point. The most relevant portion:
At time period zero, a boss hires one hundred workers, who at the time are perceived as being of roughly equal quality and thus are offered the same wage. After a few years on the job, however, some are “keepers,” while others are being paid more than their marginal products.

Because of firing aversion, they are not fired. Because of sticky nominal wages, they also do not take a pay cut. If the economy is imperfectly competitive, and times are good, this nonetheless can be a stable equilibrium.

Now let’s say a negative shock comes along: demand, supply, maybe a bit of both, as is usually the case. At some margin these workers can no longer be carried and the firing aversion of the boss is overcome and they lose their jobs. Then, a few points:
  1. They’re not getting those jobs back.
  2. They’re not worth a comparable wage elsewhere in many cases.
  3. Per hour productivity likely will rise, even adjusting for ex ante measures of changes in worker composition.
  4. Companies won’t want to pay higher wages to lure these workers out of leisure, rather they are branded as less productive than average and properly so.
(all emphasis added)

Do you see the problem here? Cowen treats marginal product as a property of the worker, so the worker is “properly” branded as less productive. Yet if all the original hires— “perceived as being of roughy equal quality”— are in fact entirely identical, then the dynamics are the same— if not the explanation. When the demand shock hits, the marginal productivity of all one hundred hires falls. All one hundred are being paid more than “their” marginal productivity. As soon as a few are fired, however, marginal productivity rises so not all one hundred are fired. Presumably, workers are fired in sufficient numbers to bring marginal productivity in line with the sticky wage. The same wage the fired workers are presumably holding out for!

The fired workers— though identical to those retained except in their new (un)employment status— are branded as less worthy just for their bad luck. The fired workers are worth just as much in that they could step in perfectly for any of the retained workers.

By passing off marginal productivity as a property of the worker, Cowen manages to blame workers for their unemployment.