Friday, August 3, 2012

How to Unscrew a Generation

A Newsweek article by Joel Kotkin highlights why monetary policy is so important

Newsweek asks: are the Millennials really "screwed"? While I can't speak for fellow undergraduate blogger Evan, I would like to declare that I would strongly prefer that the economy not turn me into an inclined plane wrapped helically around an axis. And for this reason, as a member of the Millennials, my strongest demand is that monetary policy starts to effectively target nominal GDP.

This may surprise some readers who believe that structural factors are the reason holding back my generation. That would be an understandable first impression from the Newsweek article. But remember that the housing bubble popped in 2006 and the proximate cause of the recent recession was actually monetary policy failure. So instead of seeing the article as a list of damning reasons against taking action on monetary policy, I saw it instead as a list of damning reasons for taking further action, and why a failure to do so will have serious long run implications for growth.

Let us start with labor markets. Kotkin claims that younger workers are being hurt by the longevity of their parents who aren't leaving the workplace:

One key reason: their indebted parents are not leaving their jobs, forcing younger people to put careers on hold. Since 2008 the percentage of the workforce under 25 has dropped 13.2 percent, according to the Bureau of Labor Statistics, while that of people over 55 has risen by 7.6 percent.
"Employers are often replacing entry-level positions meant for graduates with people who have more experience because the pool of applicants is so much larger. Basically when unemployment goes up, it disenfranchises the younger generation because they are the least qualified," observes Kyle Storms, a recent graduate from Chapman University in California.

But this argument is missing something. If medical advances raised the number of years people could work, most economists would call this an aggregate supply increase, not a reason why younger workers should suffer. If anything, it should at least increase aggregate growth. Yet the article suggests just the opposite. This is because there is a bigger problem: a lack of aggregate demand. There's plenty of slack in labor markets with unemployed graduates, we just need some more nominal GDP to take advantage of it.

The above passage also highlights another perspective on hysteresis and why aggregate demand shortfalls have serious long-run implications. Besides causing the formerly employed to lose their skills, unemployment also causes the not-yet-employed to miss the chance to gain new skills. Those outsiders become "disenfranchised", and never have the chance to learn. This is especially problematic if human capital, like regular capital, exhibits diminishing marginal returns. What this means is that the additional human capital gained by current workers is less important for long-run growth than the initial capital gained by newer workers. The first bit that new workers learn has a higher impact than just marginally increasing the human capital of existing workers. So when people talk about "labor-mismatch" and a shortfall in human capital, remind them that aggregate demand is critical in developing and organizing the skills of new generations of workers, thereby fostering long run growth.

Another reason unemployment devastates human capital is because it forces highly educated individuals into jobs typically reserved for lower-skilled workers:

More maddening still, the payback for this expensive education appears to be a chimera. Over 43 percent of recent graduates now working, according to a recent report by the Heldrich Center for Workforce Development, are at jobs that don't require a college education. Some 16 percent of bartenders and almost the same percentage of parking attendants, notes Ohio State economics professor Richard Vedder, earned a bachelor's degree or higher.
"I work at the Gap and Pacific Pak Ice, two jobs that I don't see myself working long term nor jobs that are specific to my major," notes recent University of Washington graduate Marshel L. Renz. "I've been applying to five jobs a week and have gotten nothing but rejections."

This then spills over to actual low-skilled workers, who find themselves competing against overeducated peers in a ever-worsening trend. College graduates like Renz work in jobs that neither let them invest in further human capital or take advantage of their current human capital. While they get trapped, high-school graduates and dropouts fall even farther behind in the human capital race, resulting in more social problems on their way down.

The worst effects of the "new normal" can be seen among noncollege graduates. Conservative analysts such as Charles Murray point out the deterioration of family life—as measured by illegitimacy and low marriage rates—among working-class whites; among white American women with only a high-school education, 44 percent of births are out of wedlock, up from 6 percent in 1970. With incomes dropping and higher unemployment, Murray predicts the emergence of a growing "white underclass" in the coming decade.

In many ways, this white underclass has already developed. As Evan noted a few months ago:

To summarize the findings, Ip's missing 5 million are disproportionately young (ages 16-19), male, nonwhite, and of low educational attainment as compared to their respective fractions in the American labor force.
...By sex, 3.6 million men and 2.3 million women are missing from the labor force. Given that men compose 53 percent of the labor force, men are 15 percent overrepresented relative to women. Interestingly, the ratios of under- and over-representation between men and women has remained roughly constant as the number missing has grown -- and this is true for most of the other demographic breakdowns.By age, 1.3 million Americans between the age of 16 and 19 inclusive and 5.0 million above the age of 20 are missing from the labor force. Given that those between 16 and 19 compose 3.7 percent of the labor force, the young are 7 times overrepresented relative to the working-age. By ethnicity, 4.6 million white Americans, 0.8 million black Americans, 0.8 Hispanic Americans, and 0.6 million Asian Americans are missing from the labor force. Given that these ethnicities compose 71, 10, 14, and 5 percent of the labor force respectively, white Americans are 5 percent underrepresented, black Americans are 14 percent overrepresented, Hispanic Americans are 18 percent underrepresented, and Asian Americans are 90 percent overrepresented.FRED doesn't seem to have population data on the number of college and high-school degree-holders, or those with some college, but just by comparing the declines in their labor force participation ratios, it is obvious that high-school graduates are significantly overrepresented in the missing millions relative to college graduates and those with some college.

Recent micro-level analyses strongly suggest that contractionary monetary policy systematically increases inequality, adding to the underclass. This further destroys any possibility of fostering human capital. Given that the first few years of human development are enormously important to a child's later success, how does one expect healthy future generations if they don't have a proper environment in which to grow? Yet, this lack of human capital might not be quite as important as the lack in, well, humans:

Inevitably, young people are delaying their leap into adulthood. Nearly a third of people between 18 and 34 have put off marriage or having a baby due to the recession, and a quarter have moved back to their parents' homes, according to a Pew study. These decisions have helped cut the birthrate by 11 percent by 2011, while the marriage rate slumped 6.8 percent. The baby-boom echo generation could propel historically fecund America toward the kind of demographic disaster already evident in parts of Europe and Japan.

Instead of leveraging higher population growth to support the large stock of pension liabilities, we're getting slower population growth because of poor monetary policy. At least we can rely on more immigrants, right? Not if the current republicans have their way:

Right now, politics is just another place where American millennials are getting screwed. Republicans want to deport young Latinos while cutting investments, such as roads and skills education, that would benefit younger voters. Democrats, meanwhile, seem determined to mortgage the future with high spending on pensions, predominantly for aging boomers; cascading indebtedness; and economic policies unfriendly to the rapid growth necessary to assure upward mobility for the new generation.

If you look carefully at that paragraph, you can see a whole host of reasons why stable aggregate demand would improve aggregate supply policy.  First, good monetary policy can help with the investment problem, as it can increase R+D spending by helping risk-averse firms plan for the future. This would partially counteract the drop in public investment that has been the result of entitlement spending.

Second, and potentially more importantly*, stable aggregate demand could change the perception of immigrants from "job stealers" to productive workers. The problem with immigration is that if the monetary authority fails to stabilize aggregate demand, an increase in the labor force may crowd out existing workers from their jobs. But because immigration expands aggregate supply and increases total factor productivity growth, it actually raises the nation-wide standard of living.  As a result, stable aggregate demand would greatly alleviate the political opposition to low-skilled immigration and raise the possibility of reform. So libertarians who are in favor of liberalized immigration should also be scrambling for stable aggregate demand. Otherwise, the politics of immigration will never allow for real action.

Immigration is especially important because it's one of the low-hanging fruits that Lady Liberty still has within reach. The Newsweek article tries to use Tyler Cowen's "The Great Stagnation" to provide evidence that the problems we face are all structural, but immigration is a fruit that still hangs low. Yet as a society, we refuse to eat.

Allowing these increased flows of legal immigration may also help solve the political problem highlighted in the Newsweek paragraph. The problem with entitlement spending is that there is an increasing number of older voters, causing entitlement reform to become "a thoroughly rigged boomer game, providing guaranteed generous benefits to older public workers while handing the financial upper echelon a 'Wall Street boondoggle'" More immigrants would lower the average age of the population, forcing the parties to cater more to the needs of young people. Also, better monetary policy, by reducing inequality, would empower immigrants and other working class young individuals to have a stronger voice in politics, giving us a better shot at addressing the serious issues of public finance that we face today.

So while, yes, we do face serious structural problems, we can't hope to truly address them without an adequate monetary policy response. Stabilize aggregate demand, and the dust will settle. Then we can know what we truly need to do. Otherwise we may have to settle for a much more stagnant future:

Once known for their optimism, many millennials are turning sour about the future. According to a Rutgers study, 56 percent of recent high-school graduates feel they would not be financially more successful than their parents; only 14 percent thought they'd do better. College education doesn't seem to make a difference: 58 percent of recent graduates feel they won't do as well as the previous generation. Only 16 percent thought they'd do better.
This perception builds on the growing notion among economists that the new generation must lower its expectations. Since the financial panic of 2008, "the new normal" has become conventional wisdom. Coined by Mohamed El-Erian at Pimco, it's been used to describe our world as one "of muted Western growth, high unemployment and relatively orderly delevering."

We cannot afford to lower our expectations and ignore how monetary policy has failed an entire generation. So Ben Bernanke, if you dare not act for the sake of your mandate or for the sake of your reputation, act for the sake of a generation. For the high school graduates worrying about the value of a college degree, for the college graduates struggling to make ends meet, for those everyday workers struggling to buy groceries, and for your own two children and all of their peers, for their sake, I beg that you act.

*Full Disclosure: I am a 1.5 generation immigrant. My parents are 1st generation immigrants.


  1. Hi Yichuan,

    Excellent article, and thanks for the links. Your point about a shortfall in aggregate demand contributing to a reduction of potential output for an entire generation -- our generation -- is sobering.

    One way to think about it is to say that the aggregate numbers don't reflect the extreme nature of recessions. Although nominal GDP is 11 percent below its pre-recession trend, it doesn't follow that everyone's nominal wages have been cut 11 percent, nor that the welfare cost is proportional. It depends on the distribution of individual declines in nominal income, assuming diminishing marginal utility of income.

    The cost inflicted on those on the margins of the workforce, people who fail to get jobs or those who lose them, lose all of that employment income. Those who hold onto their jobs are relatively OK by comparison. Neither NGDP nor consumption does an inadequate job as an assessment of welfare costs.

    That is my rebuttal to Lucas' famous argument that the welfare cost of business cycles is small, also.

    1. Evan,

      I'm happy to link to your blog, a lot of it is good timely analysis that, while possibly written by others as well, is provided on a much more frequent and accessible basis from your blog.

      Your point on wage cut heterogenity is important and related to a statistical problem that I've been thinking about. A core point is that even if a variable, x, has a symmetric distribution, x^2 can have a skewed distribution. So even if shocks to NGDP are moderate and symmetric, the actual swings in welfare can be much more severe.

  2. Double negative in the third paragraph... "inadequate" was supposed to be "adequate."

    1. If we're nitpicking grammar, I would strongly prefer that "I would strongly prefer that the economy did not turn me into" be changed to "I would strongly prefer that the economy not turn me into." "Did not" is incorrect because the verb should be in the present subjective mood, where do support is not used for arcane reasons.

  3. I agree with Evan Soltas. A very good post, Yi-chuan Wang. The key to getting the United States economy on track is a solid stabilization of investment.

  4. I'll acknowledge not having read your entire post (too long), so you may have mentioned this same idea, but here's a thought about monetary policy.

    Give the Fed the authority to add a rebate/surcharge to all commercial transactions. The rebate would be applied when the economy needs help (like now); the surcharge would be applied when inflation is a threat.

    One thousand more words about this here:

  5. I'm a fledgling undergraduate blogger myself, and I gladly pledge my pen (or keyboard) to bringing more attention to monetary policy. I'm glad to see the bright minds of my generation shining so early.