Larry Summers' Martin Feldstein Speech

The latest NBER Reporter has the speech Larry Summers gave at the annual NBER "summer camp" for economists. As you would expect, there are some really interesting bits, which provoked a good lunchroom discussion. To my mind it (and this blog post) gets much better toward the end.

The organizing thread is Larry's worries about long term trends in employment and income distribution, and how trends in productivity and innovation affect it. If the word did not have negative connotations, I might term the talk "neo-Luddite," the worry that this time, unlike all the others, technical change, primarily information technology, will be really bad for workers.

Ouch. "Unemployment" figures in the popular press, but it is the fraction of people actively looking for jobs. The far bigger worry among many economists is the rise in "non-employment." One in ten men, 25-50, are simply not working at all or even looking for work.

And as you would expect, these patterns are substantially more pronounced if you are less educated. They are substantially more pronounced if you are in a disadvantaged group than if you are in an advantaged group.
Larry treads lightly, I think, around the issue non-employment raises. If our economy has a rising "skill premium," in economist language, or "doesn't provide good steady jobs to high school grads like it used to," in the more colorful Grease-era nostalgia of, say, the New York Times, or even if the haves are exploiting greater "power" against the have-nots, you would expect to see, and worry about, wages of low-skill people. But you would not expect to see an army of 25-54 year old men not working at all. Wages in Bangladesh are very low.  And 25-54 year old men work really hard. Wages in the US in 1910 were really low, and 25-54 year old men worked really hard. If they didn't, they and their families didn't eat. Which, to be clear, I am not applauding. We're simply trying to understand a phenomenon. How do poor opportunities (if that's the problem) in the US translate into not working rather than working at low wages? Larry:
This is associated with what is also a defining feature of our time. In the United States today a higher fraction of the workforce receives disability insurance than does production work in manufacturing...
These phenomena are related. No one could give a Feldstein lecture without recognizing the possibility that a social insurance program had a distorting disincentive effect and that is certainly the case with respect to disability insurance. But I think it is also fair to say that the evolution and growth of disability insurance is substantially driven also by the technological and social changes that are leading to a smaller fraction of the workforce working.
Casey Mulligan might point out that Social Security disability is only one of hundreds of distortions and punitive marginal effective tax rates pushing people out of work.

And what does that last sentence mean?  "Technological and social changes" are not disabling millions of people -- work is physically safer than ever. Does he mean that  SSDI is a desirable ruse for our government to give up and pay people to not work whose productivity has fallen below a certain threshold?

Anyway, for the rest of Larry's talk he focuses on low wages, which is the deeper driving question. In standard economics  Y=AF(K,L), either more technology A or more capital K raise the marginal product of labor and hence wages.  So why are we now suspecting that technological progress is reducing wages?

Larry put up a suggestive production function Y = F(βK, L + λ(1 ‒ β)K) in which more capital is supposed to lower wages. I spent a few hours trying to work out his "moment's thought," but was unable to verify its conjectured properties. This looks like a good problem set for a micro class or a blogger with more time on his hands.

Next, and getting more interesting, he put up this table of CPI values
    Good or ServiceSeptember 2012 CPI Value (1982-4 = 100)
    College Tuition and Fees706
    Medical Care Services445
    Medical Care419
    All Items231

The issue: Are "stagnant wages" really stagnant in real terms? Well, measured in terms of toys or televisions, not at all. In terms of, say, tuition at Harvard and Chicago, yes indeed.

About televisions,
Television sets at five stand out. That is obviously a reflection of a rather energetic hedonic effort by the Bureau of Labor Statistics.
This is an interesting side note on measurement. Do televisions really cost 1/20th of what they cost in 1980? A TV in 1980 cost about $500. A TV now costs about $500. Every computer I have bought since 1982 has cost $2,000. What's going on? Televisions now are much better than televisions back then. The BLS accounts for this fact by comparing televisions when a new model comes in. Suppose an old tube TV is selling for $500. The first LCD television comes in and sells for $5,000, and a few hedge fund managers buy them. The BLS figures that the LCD TV is the same as 10 old fashioned TVs. LCD TV prices drop to $500, and nobody buys tube TVs any more.The BLS figures that LCD TVs are still the same as 10 tube TVs, so the price of all TVs has gone down by a factor of 10, just as if you could buy a tube TV for $50.

The problem is, early adopters are willing to pay a large premium for new goods. I'm not an expert on hedonic adjustment, but one wonders how it corrects for early-adopter price discrimination.

But on to the real point, really the most interesting of the talk. However measured, "things" have gotten really cheap. They've also gotten a lot better. Many things have gotten so cheap that they are small fractions of our budgets, so further productivity improvement does not show up in cost of living measures. Many services have not gotten cheaper. We count on productivity growth to raise living standards, so the big issue is really productivity growth in services:
In those parts of the economy that are well modeled by the introductory economics textbook treatment of widgets - firms producing a thing with workers with increasing marginal costs in a somewhat competitive industry, such as durables, clothes, and cars - we've seen continuing, very substantial growth in real wages as measured by the purchasing power of things that our economy produces. The reason that [measured] real wages in aggregate have stagnated is that much of what people buy are things where there are issues of fundamental scarcity: energy, the land under the houses we buy, and goods and services that are produced in complicated, heavily public-sector-inflected ways. Medical care and educational services are examples of the latter category....
Larry puts up a chart of where the jobs are going to be in the future,

And you get another part of the picture. The big price growth, and the big employment growth, are happening in heavily government run or government influenced sectors. Like health care.
As a society, we are going to need to come to grips over the next couple of decades with..the propensity for the slow-growing [and fast-inflating!] sectors to end up in the public sector...
Whether the expansion of those sectors as a share of the economy necessitates a growing share of the public sector in the economy, or whether the share of healthcare and education that takes place in the public sector should decline will be a matter of great public debate. As a country, and not without controversy, we do not seem to be moving toward a smaller public role in healthcare. Nor do other countries in the world. But that will, perhaps, change over time.s
Indeed. One conclusion [not Larry's!] you can draw is that greater government involvement has caused lack of competition, innovation, productivity growth and price increase in the sectors it has come to dominate, and therefore is a large part of the cause of stagnant real wages measured by CPI.  I don't have any idea by what economic or political force Larry imagines larger shares of any industry "necessitate" government involvement.

Blog readers will know where I stand. Sectors like health care can have huge productivity improvements if governments get out of them. Services like airlines, package delivery, and telecommunications, have all seen huge productivity improvements when governments got out of them. Service sector like retail that our government never was in (other than to slow down low-cost entrants that serve poor people, from A&P to Wal-Mart) have seen huge productivity gains.

Those improvements benefited the denominator of consumer's real wages, and lowered the numerator of income inequality -- pilots don't get paid what they used to. As Larry points out, the burden of taxation goes with the square of the tax rate, so as the economy shifts to services it is simply impossible for the government to keep expanding. But his (to me) depressing forecast of where we are going remains (to me) sadly true.

Larry closes with the deepest thought of all.
..I invite you to consider how the prodigious change associated with information technology that may be qualitatively different from past technological change may have defining implications for our economy going forward. If I have caused you to reflect on the fact that very substantial relative price changes are likely to be associated with dramatic changes in the structure of employment, the nature of economic activity, and the relative importance of the widget-producing firm in our economy, and to consider the implications this will have for the future of the subject with which I began my career in economics under Marty's tutelage, public economics, then I will have served my purpose this afternoon.
This is a thought that's been on the back of my mind for a long time as well. Our Econ 101 widget company and supply and demand graph are really strained as a description of most modern transactions. Pretty much anything you buy represents not the transfer of a good, but the application of someone's expertise and information. Even getting your car fixed, you are not buying someone's labor as if you or I could do it but just have better things to do. You're buying expertise, information, the fruits of human and organizational capital. There is a Big Paper to be written thinking through how an economy where "things" have become free but services, information, and expertise constitute economic transactions.

The first question is, what distinguishes these new "service" transactions from "widgets?" Larry's list is, from above, "issues of fundamental scarcity: energy, the land under the houses we buy, and goods and services that are produced in complicated, heavily public-sector-inflected ways," and later "sectors where property rights, scarcities, intellectual property, and the like are of fundamental importance."

One line of reasoning looks for a definition by going straight to public choice, and focuses on public-sector-influenced. This does not strike me however to be particularly correlated with widget vs. non-widget. Yes, our government has become, in the apocryphal quote, an insurance company with an army. But other governments have run steel companies, locomotive factories, and oil drilling and refining operations with much the same productivity results as we are seeing in government-provided services.

I find it more interesting to think about the private sector part. What distinguishes medical care (ok, vet, lasik, and plastic surgery; let's think about market economics) and software development from widgets?

I don't think "fundamental scarcity" is it. Energy is turning out not to be fundamentally scarce after all. The long-run supply curve is very elastic. Land in mid-town Manhattan, or in the parts of the San Francisco peninsula permitted for construction by zoning laws is indeed scarce. Land on the outskirts of Las Vegas is cheap.

That leaves "property rights, scarcities" -- scarcity of people with desired skills -- and "intellectual property." To which I might add information and expertise.

So how do we think of a world where things are free and economic transactions consist of performing services for each other -- services that require time (substituted for by software) expertise, and substantial human capital?  That does strike me as the important Big Question. Maybe Larry's production function is a place to start.

This gets us far away from Larry's neo-Luddite worries. Which I don't mean to denigrate. But we sort of know the answer. The returns to skill will be large. The fascinating question is why, after 30 years of a rising skill premium, the production of skill seems not to have flooded the market, driving down that premium? Are the government involvement in education, and the disincentives to work Larry mentions perhaps even more powerful disincentives to human capital accumulation than they are to getting up to go to a miserable minimum-wage job?

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