Index - EMU - Monetarism/Swedish Crisis - Business News - Internetional Times

Stocks and jobs

The Economist 99-01-16 (utdrag/excerpts)
Jag hade inte läst detta när jag skrev mitt Brev till Ledarsidan

Once, not long ago, economists thought the significance of the stockmarket for the economy at large was marginal. This view has changed, especially in the United States, and understandably so.

The dramatic growth of American mutual funds has helped to spread the ownership of equities across the country. The market’s current, historically unprecedented, valuations have greatly raised the worth of these dispersed shareholdings.

The resulting growth in the wealth of ordinary Americans is seen as a chief cause of strong demand in the economy, and one of the main factors in the economy’s prolonged expansion.

This connection between Wall Street and Main Street undoubtedly matters, but it does not seem to account for the most puzzling thing about America’s unstoppable growth. This mystery lies not on the demand side of the economy but on the supply side.

Most expansions end not because demand fails but because it succeeds too well, growing beyond the capacity of the economy to satisfy it. This leads to inflation, and obliges the Fed (in America’s case) to restrain demand by raising interest rates.

An obvious place to look for signs that capacity is getting overstretched is the labour market.

The relevant branch of standard theory, developed simultaneously in the late 1960s by Milton Friedman and Edmund Phelps, implies that every economy has a certain rate of unemployment, determined by the way its labour market works, below which inflation tends to rise. (RE: NAIRU)

For the United States in the second half of the 1980s this so-called natural rate of unemployment has been estimated at roughly 6.5% of the labour force.

By the mid-1990s the actual rate of unemployment had fallen to less than 6%, with little sign of inflation. Since then it has kept on falling. In December it fell to 4.3%, bringing the average for 1998 to 4.5%, the lowest since 1969. And still inflation seems pretty well under control.

From this you might simply conclude, as some have, that standard theory is bunk.

Another possibility is that something on the supply side of America’s economy has changed, reducing the natural rate of unemployment. Given that the standard theory had until recently seemed well-grounded both in principle and in fact, this is worth exploring.

Supply-side cycles

One big change in the American labour market is that workers these days are better educated: the proportion of the population without a high-school diploma fell from roughly 35% in 1980 to less than 20% in 1996, and the proportion with a college education rose from 15% to 25%.

This improvement in the quality of labour should indeed have cut the natural rate of unemployment - but studies suggest that any such fall would be a lot less than a tenth of a percentage point a year, sufficient by now to have cut the natural rate only to a little under 6%. If the natural-rate theory is still correct, something else must be going on as well.

One of the theory’s co-founders, Edmund Phelps, a professor at Columbia University in New York, has recently made a startling suggestion about what that something else might be: the strength of the stockmarket.

This is a new departure for natural-rate theories. Up to now they have tried to explain movements in the natural rate by looking at long-term structural changes in the economy - such as the increase in the proportion of educated workers.

Mr Phelps’s thinking on the stockmarket moves the focus to the possibility of shorter-term, and perhaps cyclical, fluctuations in the rate.

How might changes in equity prices affect the labour market, other than through the demand side of the economy?

Stockmarket valuations implicitly combine the two things that make assets a desirable investment: the current rate of profit and the price that investors will pay for those profits. (Market capitalisation per unit of fixed capital is, in fact, the rate of return on capital multiplied by the price-earnings ratio.)

When the market is highly valued, assets are worth more than they cost (that is, equities are dearer than the underlying assets). So additional fixed investment makes sense.

This can affect the labour market in several ways. Some capital-goods industries, especially construction, are more labour-intensive than average. So a shift in the mix of output towards higher investment tends to increase employment at any given level of aggregate demand - in other words, the natural rate of unemployment goes down.

Also, in Mr Phelps’s view, firms have to invest in their workers (through training and in other ways) in order to create functioning employees. A highly valued stockmarket says either that the profits from this investment (as from investment of every kind) have gone up, or that the market value of those profits has gone up, or both. Firms will hire more workers - again, at any given level of aggregate demand.

All this could help to explain America’s apparently miraculous achievement in combining very low unemployment with very low inflation.

But there is an obvious snag: what happens if or when the stockmarket tumbles?

Not only would demand then fall because of the ordinary “wealth effect”, but the supply side of the economy would deteriorate too, causing lower employment at every given level of demand.

Unemployment might then rise surprisingly fast.

Conceivably, depending on the relative strengths of the demand-and supply-side effects, the economy might face both rising joblessness and higher inflation. If so, the past five years will come to seem even more of a golden age for the American economy than they do already.

Anm. Edmund Phelps presented his paper, “Behind the Structural Boom: The Role of Asset Valuations”, at the annual conference of the American Economic Association earlier this month. It will be published in the AEA’s Papers and Proceedings in May.

Top of Page
Början på sidan