Daddy, Where Do Jobs Come From?

September 14th, 2012 at 8:49 pm

In discussions about the Fed actions yesterday, it occurred to me that many of the explanations that link the Fed’s moves to stronger job growth leave out a number of steps in the middle.  It’s of course not the case that the Fed buys MBS or announces they’ll keep rates low and jobs that weren’t there before suddenly appear.  There’s a chain of events that needs to occur and there’s plenty of slip twixt the cup and the lip.

So let’s talk about the process of job creation, both in normal times and in times like these.

Demand for labor is so-called “derived demand,” derived from the demand for goods and services that firms sell to consumers and investors.  That can be anything from a Snickers bar (consumer good) to a steel bar (intermediate good) to barroom (investment good).  As I explained in greater detail here, in normal times, job creation is a function of a virtuous cycle where growth generates income which drives consumption, signaling investors re new opportunities, generating more growth, etc.

But, of course, stuff happens and the cycle breaks down.   There are big market failures, like the Great Recession.  There are high levels of inequality that divert growth from reaching enough consumers to generate robust demand throughout the economy.  There are inflationary supply shocks (e.g., an oil disruption) that sharply reduce real incomes.

When that stuff happens, monetary and fiscal policies are needed to reset the cycle and a key part of that process is avoiding layoffs and adding new jobs.   So how does that work?

With the Fed, it works through lower interest rates.  The Fed has a number of tools to lower the cost of borrowing, the idea being that this leads people to take out loans and make new investments that they wouldn’t have undertaken at higher interest rates.  And those new investments are associated with new jobs.

So, a homebuyer takes advantage of a low mortgage rate, leading to jobs for homebuilders and real estate agents and furniture suppliers.  A factory owner takes advantage of low rates to replace old equipment, creating jobs for machine manufacturers.  An auto dealer invests in a redesigned show room, a buyer takes advantage of that dealer’s low rates and buys a new car there, employing designers, salespeople, and auto suppliers.

And those are just the direct jobs.   The newly employed construction worker goes out for lunch near the job site, and the diner needs to add another worker (the jobs multiplier effect).

Those are the links in the chain between monetary policy and jobs, but there are weak links.  Low mortgage rates won’t do much if the recession itself was a function of a housing bubble that left us with excess housing stock and deleveraging households (relatedly, with millions of homeowners underwater, the opportunity to refi into lower rates–another source of new demand–is also blocked).  Even with very low borrowing costs, unless they see more consumer demand, investors won’t see much return from taking on new projects.  And with global opportunities, they can span the globe for better returns in economies where demand is stronger.  In fact, corporate profitability in this recovery has largely been driven by foreign, as opposed to domestic, profits.

What about fiscal policy?  How does that chain work to create jobs and what are the weak links?

Well, though economists tend to discuss fiscal policy as a lump, it actually comes in a lot of different flavors and they’re not all created equal in terms of bang-for-buck job creation.  Basically, the more indirect they are—the more links in the chain between the policy and job creation—the less effective they are.

For example, for a stimulative tax cut to create a job, a) the recipient must spend, not save, the money from the cut, and b) she must spend it on domestic goods (I mean, of course, that’s what has to happen for the tax cut to create a job here as opposed to in China).  Again, if you’re in a deleveraging cycle, step “a” is a problem.  Also, if your tax cuts go to wealthy people who are not income constrained in the first place, don’t expect much in terms of job creation.

Other fiscal measures have more reliable job-creation chains.  Increasing unemployment benefits or food stamps helps because those folks typically spend the money.  And new infrastructure is a pretty direct way to go.  Same with state fiscal relief.  I remember during the Recovery Act, mayors cancelling planned layoffs the day they received Recovery Act funds.

The punch line is a simple one, but it’s one that seems to have been forgotten amidst our increasing love affair in America with laissez-faire economics: the more direct the policy measure—i.e., the fewer links in the chain between the policy and the job—the better it will work.

I’ve seen these processes at work close up and I’ve come to view this simple insight as a lot more important than I think most economists realize.  Even Keynes had relatively little to say about implementation and the relative effectiveness of different types of stimulus.   He famously quipped that if the government can’t find something useful for people to do, just pay one group to bury bags of money and another group to dig them up.

Ha-Ha.  Very helpful, Sir K.  But I actually think the great man was onto something.  The most direct way to create jobs, the only surefire way to be sure that stimulus will work, is direct job creation.  Everything else, including all the Federal Reserve stuff, involves crossing your fingers and hoping the chain holds.

Of course, we live in a dark age where any fiscal policy to create jobs is viewed as European socialism, despite the fact that Europe’s gone even more austere than we have.  And even among the majority of economists who understand the need for stimulus, direct job creation by the government reeks of an earlier age, invokes boondoggles, and is way too interventionist.  They’d rather give a tax cut and let consumer sovereignty and market forces take over.

They’re not crazy to feel that way.   It would be better for consumer demand to signal which industries should expand and which should shrink.  But we just don’t always have that luxury, especially in a global economy where investments can flow abroad and import leakage dampens the impact of domestic tax cuts on job growth.  And we especially can’t count on that sort of stimulus when households are deleveraging.

So, the next time we hit a recession, I’m going to be out there advocating for, if not direct jobs in the public service, something as close to that as we can get, like infrastructure, fiscal relief to states, and subsidized jobs for the disadvantaged.

In fact, I’m not going to wait until the next recession.  I’m starting now!


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16 comments in reply to "Daddy, Where Do Jobs Come From?"

  1. D. C. Sessions says:

    One word answer: “customers.”

  2. Jake says:

    Yes, by all means start now educating how fiscal policy will create jobs here in the USA. But, respectfully, include a chapter covering the point at which the cost of those jobs in terms of debt creation gets addressed. Until that cost of job creation is addressed, I fear many people (all of whom have good jobs or a good retirement) will staunch your effort. Prof. Krugman who has performed heroically in advocating for fiscal stimulus seems to overlook at what point and how the increased debt arising from that stimulus gets addressed.

  3. Seattle Alex says:

    You should be required reading for politicians JB. Your ability to simplify complex topics would benefit quite a few R ‘s immensely… keep fighting the good fight!

  4. Rima Regas says:

    That is one inspired piece you wrote, Jared!

    We need to teach basic economic and social ethics concepts from an early age. The biggest barrier to implementing public policies in times of trouble is… us! Too many of our citizenry are willing to accept austerity over stimulus due to ignorance. Most people accept the notion presented by the GOP that a budget for the nation is the same thing as a household budget. All too many people buy Ron Paul’s crazy Fed and gold standard theories out of ignorance, too. The same is true of most Americans’ views on government and its place in society. Citizens of other nations are puzzled by the way Americans view government as some sort of alien among us.

    Better education would also lead to a much better understanding of how enormous the current administration’s achievements are, given that they not only managed to snatch us from the abyss, but did so under the tremendous duress of an obstructionist Congress.

    In other words, we’re lucky to have had Obama. Thirty million unemployed, or thereabouts, do not help an economy improve. That’s likely at least how many we would have had, had the government not stepped in at the start of the recession.

  5. Rima Regas says:

    Oh, and great title! I will tweet and share on Google+ every day!

  6. fausto412 says:

    @Jake Krugman has addressed the point at which the debt needs to be addressed many times. The boom, not the slump as Keyenes said. Krugman has said unemployment below 7% is a definite requisite because even talking about the debt.

    See the national debt just needs to be managed. As long as as growth in gdp outpaces the growth rate of the debt and the rate of tax revenues we’ll be fine. People obsess about this stuff because the only budget they ever deal with is their personal one which is nothing like managing an economy.

    Good post JB.

    • Jake says:

      Thanks for the reference. But I would think economists could give us a model that would show debt rate of growth slowing and then beginning to decrease in the long-term. I haven’t seen anybody doing this. The Taylor Rule interrelates employment with fed policy rates. I’m saying we need a “rule” described that will interrelate debt stablization with something like revenue growth as a per cent of GDP growth. Maybe it is out there. I’ll keep looking. If not, then maybe JB can give us something.

      • Jared Bernstein says:

        Briefly–and this is not a complete answer to your question–but it gets to the nub: if the deficit/GDP get below ~3%, the debt/GDP will start to fall. That 3% represents “primary balance” where incoming revenues pay for current services, ie, everything except interest costs on the debt.

        • Jake says:

          Thanks very much for this info. Is it at least theoretically possible that fiscal stimulus will grow GDP faster than it will increase the deficit thus making a contribution to reaching “primary balance” sooner? I don’t know. But this kind of discussion seems to be the piece that is lacking in the debate over using fiscal stimulus to create jobs. In othe words, the debate needs to cover two points at the same time as in, “Fiscal stimulus will create jobs in the near and medium term, and reduce the deficit in the medium and long term as we approach primary balance.” I just don’t hear people who advocate for fiscal stimulus making that kind of two pronged argument for it. Maybe its out there and I’m just missing it.

  7. Brad F says:

    You have written in the past about the consumption/demand aspect of our economy:

    Given we are consumption driven (70%), I assume this implies something different than an alternate country at 50%. However, I dont know what this means, and how job creation impacts growth in these two settings.

    Could you elaborate on this point at some time? That is a lot of Starbucks Frappuccino’s and iPhones.

  8. Russ Abbott says:

    It was once said of California that its economy consisted of people taking in each other’s laundry. In what sense are all jobs like people taking in each other’s laundry? We talk about demand, but demand requires that the people who are creating the demand have a source of income. But what is that source of income other than someone else’s demand?

    One answer might be that ultimate demand comes from government borrowing, which does not require any downstream demand. But obviously that’s not a viable long-term solution. So where does this leave us?

    Imagine a group of people on an island. Fortunately for them, the island provides for their basic needs without them having to do any work. They just pick food off the trees. Will an economy develop? Will some people be willing, for example, to give other people massages in exchange for jewelry that the massage recipients create? Is the ultimate source for all jobs the work that we each can do to make the lives of others more pleasant and enjoyable? That would suggest that the source of all jobs is what we discover we can do to raise someone’s standard of living. It also requires, of course, that there are things that everyone can do to raise other people’s standard of living–otherwise they would not be able to pay for the increased standard of living they are receiving from others.

    Not only that but there would have to be specialization. If we each just took in each other’s laundry there would be no point in exchanging laundry. There would inevitably be overhead (keeping track of whose laundry is whose) that would make the process less efficient than doing one’s own laundry.

    Having gone through that example, I guess my theory of where jobs come from is that a job is a service that I can perform (a) that I can do more efficiently/effectively than others and (b) that has enough value for others that they are willing to pay me to do it. The recipients of my service will pay me with the income they generate by doing services with the same two properties. (a) They can perform those services more efficiently/effectively than others and (b) Others find those services worth paying for.

    So in answer to the original question, a job arises when one person is able to perform a desired service more efficiently/effectively than others.

    That, of course, raises the question of what those desired services might be. There are services based on the fact that people can be delighted by having them performed, e.g,. a massage, jewerly, entertainment, etc. And there are auxiliary services, e.g., services like accounting, transportation, upstream manufacturing etc., that facilitate the performance of the more basic services. Ultimately, the economy seems to depend on our ability as human beings to find ways in which our lives can be improved and that we are willing to pay for.

  9. Andrew says:

    I like this. Mostly.

    If our goal is to create jobs, create them. Well done.

    But is this really our goal? Should it be? Sure, if there is work that needs to be done, we should do it. But at some point, perhaps, we with productivity gains brought by automation, we will simply need fewer people to do the work required to produce the needs and desires of the population. The labor participation rate has fallen fast, but there doesn’t seem to be any shortage of products to buy.

    Imagine a magic machine that made what we needed without human intervention. Should we all continue to work in order to earn money to buy things that the machine produced? This is a silly notion, of course, but think about simple changes that could allow us to adjust to economic ups and downs and increases in productivity without consuming things we truly don’t want or need. What if the federal government simply wrote off student debt? What about a cut in the work week from 40 to some lesser number of hours? Or one might even hand out stipends to ALL citizens, perhaps pegged to inflation. This IS, in a limited sense, what Social Security is, and it doesn’t seem to have hurt the country or seniors one little bit.

    No, we let the Fed trade bonds at banks for cash that the banks don’t want or need and hope that it trickles down. Genius.

  10. Josh says:

    So, these jobs for the disadvantaged, what if they amounted to more staff, part time and full time, at city colleges? College educations are the one thing we know get everyone out of poverty, so why are they making all these cuts to Junior colleges? Because Calworks for example, there is no longer money for paid work on campuses for those on county welfare programs. All the things described here, have been and are currently being decimated, from programs which work, in the San Francisco City college system. But, what better place to start?

  11. Calgacus says:

    Good, but “Even Keynes had relatively little to say about implementation and the relative effectiveness of different types of stimulus” is unjust. Keynes, as opposed to most “Keynesians”, wanted targeted demand mangagement like the JG, like the direct job creation Bernstein supports. Not “Keynesian” aggregate demand management, which sets itself up to fail. Pavlina Tcherneva has written several papers around this point, like Keynes’s Approach to Full Employment: Aggregate or Targeted Demand?

  12. katie says:

    I’d also like to see you address the question: “Daddy, where does money come from?”.