This Excess Capacity You Keep Talking About…What is It?

May 26th, 2011 at 4:55 pm

A fair question, and one that begs for a bunch of graphs, the assembling of which is especially fun.

Those of us worried about current economic conditions (that’s you, Brad) talk a lot about how the economy has “excess capacity,” it’s not at “full employment,” and other such catchy phrases that imply economic resources, including people, machines, structures, are not currently being fully utilized.

It sounds obscure but it’s actually really, really important.  If the job market is “too loose,” meaning there are a lot more people seeking jobs than finding them, wage growth tends to slow and living standards stagnate.

Here’s a look at two pictures of job market weakness.  First, the share of the population employed is a basic measure of labor market demand.  It’s very cyclical, as you can see, falling in downturns and climbing in recoveries, but it tanked in the Great Recession and while it’s stopped falling, it’s yet to start making up lost ground.

The drop in the employment rate from the peak is about four percentage points and to get even half of that back, given today’s working age population, would mean about 5 million jobs.  That there is some “excess capacity.”

You can see the similar dynamic at work on the net job creation side of the ledger.  The Economic Policy Institute calculates how many payroll jobs there would be out there if trend job growth continued apace, uninterrupted by the nasty recession.  Answer: a lot.

What about some measures from the macroeconomy?  The GDP gap concept in the next figure is much like the jobs concept in the last one: it shows how much more national income would exist if GDP hadn’t taken a dive in the downturn.

Finally, if the economy is “overheating”–nearing or surpassing full capacity–core inflation climbs to levels well above where it is now (in the interest of getting a cleaner read of price pressures, the core leaves out two volatile components: food and energy prices).  It’s climbing off the floor, for sure, and that’s a good thing–shows there’s some life out there.  But it’s well below capacity constraint levels.

Source: BLS

(See more important figures on capacity, including the unemployment rate, here and here.)

So what does this all mean vis-à-vis current policy?  Some things are improving, including some very important ones, like jobs.  Other, like employment rates, really aren’t yet.  Nothing here on housing, but, believe me, I’ve got some ugly pictures on that too (actually, some signs that we’re close to the bottom of that correction—but clearly no boost from the sector).

I think the best way to answer that policy question is this: those who have these pictures in mind worry a lot more RIGHT NOW about jobs and wage deficits than about budget deficits.  That ‘right now’ is in caps to imply that, yes, I also worry also about sustainable budgets, but that there’s a timing imperative here.

There will come a time, when we’re closer to full capacity, to shift our policy focus to reducing budget deficits, and there’s nothing wrong with designing that path now…I’m all for it.  Just don’t start down it just yet.

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5 comments in reply to "This Excess Capacity You Keep Talking About…What is It?"

  1. ereinion says:

    Jared,

    This is an insightful post. However, I think it is still counterintuitive and abstract for people who are not used to thinking like economists. I would understand this point a lot better if you answered the following questions:

    1) “Excess capacity” means that we were doing/buying a lot of things before the downturn that we are not doing/buying now. Correct?

    a) What were those things? b) Why did we stop doing them? c) Were they things that were good for us or bad for us? d) Should we be trying to start doing these things again, or should we be trying to do different things? e) Who should get to decide what things we should start doing? f)If the right answer is that we should be doing different things than before, who should bear the cost of figuring out how to do those things, and who should get the benefit?

    2) People say that before the recession we had a “debt bubble” and a “housing bubble”, and that is why we were doing so well.

    (a) Is that true? Was it a case of an “overheated” economy, or something else? (b) If it is true, aren’t bubbles supposed to pop? (c) So if we only had full capacity because of “bubbles”, is it possible to get back to it without “bubbles”?

    3) People feel that we are now “paying the piper” for excesses earlier this decade. Is there any truth to this? If so, in what sense?

    If you read this, thanks!


    • Robert King says:

      Excess capacity means that insufficient demand exists to warrant expansion of output. Therein lines the main problem we are facing today. Where did the demand go? When times were good we thought they would never end and we borrowed money to buy. Now things are bad and we think it will never change so we are saving and paying off our loans, not spending. But we don’t have it to spend either. The fundamental problem we have is there is too much money (demand) in the hands of people who would like to invest instead of in the hands of those who would like to spend it. You can’t keep feeding money to the 400 at the top who own more than the bottom 50% and expect them to want to buy anything when they already have it. This is the same reason businesses that want to create jobs can’t get a loan. Unless there is a higher demand for products it doesn’t make sense to loan them money. Keynes said it; you can’t push a string, you have to pull it.


  2. Sam Leven [PhD[ says:

    Some “conservative” solutions to promoting fuller, more productive activity:
    1] PUT CAPITAL GAINS “ON THE CLOCK”. Any gain from transactions completed in 72 hours should be taxed at 90 %; 1 week at 80%; 1 month at 65%; 3 months at 50%.
    Why would conservatives not wail? If transaction over 2 years old were taxed at 25% [the Ryan magic number] and over 10 years old at 15% — REAL INVESTORS would receive rewards and R&D would receive an [implicit] tax credit.
    2] RECYCLE FED QE2 PROCEEDS INTO STATE/MUNICIPAL CONSTRUCTION BONDS. This would subsidize infrastructure repair/enhancement [[by lowering bond rates and, in many cases, improving bond ratings]. Construction/reconstruction would boom. Could the Fed “prioritize” failing water and road systems — and public housing “green” renovation and light-rail transit — without controversy? I suspect Ben Bernanke and you are smart enough….
    3] PROVIDE ENHANCED G.I. EDUCATION BENEFITS THROUGH GRADUATE SCHOOL — ONLY AT PUBLIC INSTITUTIONS. A back-door means of supporting flagging budgets, especially for pure research [hence, development of General Purpose Tech].
    Why would this be supported by Milton Friedman’s boys [as you, likely, know].
    Part of the potential shortfall, as you know Jared, is DUP [directly unproductive production] — profitable exploitation of regulatory failures {SEC and CFTC derivatives laxness] and “insider information” [asymmetries]. While hedge funds and major financial institutions “allocate” now non-scarce capital, they’re able to obtain “paper profits” through insured “swaps”, et. al. Returns are high, risks are “low” [with implicit AIG-like guarantees], transaction cost “premia” finance bonuses.
    You may recall that Bhagwati and others labelled similar transactions [supported by liberals] as DIRECTLY UNPRODUCTIVE PRODUCTION. Their concern was not that these were low-multiplier, trust-reducing, and short-term-focused programs — BUT THE PRINCIPALS ARE THE SAME.
    Capital is not, as you know, “sitting in banks”; it’s earning safe, “healthy” returns in purely financial fictions that are GOVERNMENT-SPONSORED MARKET FAILURES.
    Blaming hedge funds for observing government disinterest in fraudulent transactions is as silly as it would be to punish Warren Buffett for importing an FDA- studied and -approved “XYZ” which is EQUIVALENT TO HEROIN.
    Perhaps demonstrating, through “conservative” means, Keynesian benefits of promoting productive long-term employment and human- and physical-capital improvements might lead to… a NEW COUNCIL OF ECONOMIC ADVISERS — YOU, BRAD DE LONG, and PAUL KRUGMAN!
    Thanks for reading.
    Hope this helps.
    Happy to help if you think I can.
    Sam


  3. Fr33d0m says:

    It is striking to look at that first chart and note that the peak of employment to population stood at about 58% from the 50s to the late 70s. And that the absolute peak of between 64% and 65% was reached in 2000. The drop since then has been dramatic but still has come barely short of the 58% held in the 3 decades shown at the beginning of the chart


  4. Bob Wyman says:

    The key is in your closing comment. The question isn’t *whether* we should reduce deficits but rather *when* we should do so. Clearly, now is not the time but that time will certainly come.

    A failure to distinguish between *what* policy is right *when* a policy is right is, I think, the cause of much non-productive debate.

    A great deal of energy is spent arguing over which of Keynes or Hayek is right when what we really should do is accept that both of them are often right but, at any one moment, one of them is more right than the other. The debate then should be over “who is right today…” Everyone gets their turn. Today, Keynes is right. Hayek’s day has been and will come again.


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