I didn't get to see Summers give his talk today at the Peterson Institute, but I've just read the transcript and thought there were some interesting ideas in it. The most important, I think, is Summers defense of the administration's position that we don't need a second stimulus as yet. His reason: The level of unemployment is painful and disconcerting, but don't assume that output has dropped in proportion to it. Or, as Summers puts it:
The economic contraction has caused significant job loss. It is noteworthy, however, that the higher than forecasted job losses do not appear to be primarily the result of weaker-than-expected GDP. Rather, it appears that a given level of output is being produced with fewer people working than historical relationships would have led one to predict. In economists' language, there is a significant residual in the Okun's law relationship: The unemployment rate over the recession has risen about 1 to 1.5 percentage points more than would normally be attributable to the contraction in GDP.
To put the point a different way, normally in economic downturns, productivity decreases as firms keep workers employed even as the amount of work declines. This pattern of deteriorating productivity has not been a feature of the current recession. In fact, productivity has increased in this recession, as it did in the last.
One potential explanation for this phenomenon, though by no means a dispositive one, is that the greater financial pressure on firms in this recession has led them to shed cash flow commitments at an unusually rapid rate by laying off workers and leaving jobs vacant. Perhaps an expectation that the recession would be lengthy has also contributed to this behavior.
It's been a while since I took a labor economics course, but my memories roughly jibe with Summers' account: The old rule was that, whenever a recession would hit, a company would hang on to as many employees as possible. I think the reason (again, my memory is hazy) has to do with the fixed costs of hiring people, and a company not wanting to incur those costs all over again if it can avoid it. (There may be some costs to firing as well--severance pay, litigation, future empoyee loyalty, reputational damage, etc.) The upshot is that you have only slightly fewer employees producing a lot less output, so productivity falls. Eventually the recession gets bad enough and you start letting people go. But it's a grudging and gradual process.
But now it seems companies are overreacting rather than underreacting to the initial dropoff in demand: They're firing people immediately, and at a rate and volume that's much greater than is justified by the dropoff. Both because you now have a lot fewer people producing only slightly less output, and because you tend to fire the least productive people first, productivity rises. All of which explains how we could end up with an absolutely horrific labor market picture but only a kinda-horrific GDP picture.
A couple quick thoughts. Frist, this obviously suggests that second-stimulus proponents (like your faithful blogger) may be a little too quick with the trigger finger. As bad as the employment picture may look now, output may soon rebound (as Summers says, many private forecasters expect it to turn positive in the second half of this year) and eventually pull employment up with it. On the other hand, eventually could be a long time. And, perhaps more disconcertingly, if output can pull employment up along with it, can't unemployment drag output down with it? Surely you can only go so long before rising unemployment sufficiently crimps consumption that it kills off whatever growth we're seeing.
I think Summers is on the right track when he says: "A critical question for the next year will be whether or not GDP growth accelerates to the point where employment growth kicks in, leading to a mutually reinforcing positive cycle of spending and income increases." But left unasked is the opposite question: What if unemployment rises to the point where it stifles GDP growth, leading to a mutually reinforcing negative cycle of spending and income decreases? (This may be unlikely given our automatic stabilizers, but is it outside of the realm of possibility?)
The second thing is, Summers' explanation for the aggressive firing we've seen--strained balance sheets--makes a lot of sense to me. But one of the other things I'd guess we're seeing is the effects of increased labor-market flexibility. That is, if it's a lot easier to hire and fire people, then those fixed costs I mentioned above aren't as high. So maybe you just go right ahead and take an axe to your payroll.
The final, related point is: Do we need a new theory of recessions? Summers points out that this is now the second recession in a row where we've seen this pattern of aggressive early firing. For his part, Paul Krugman has picked up on another pattern of recent recessions*: They tend to be caused by the collapse of asset bubbles, unlike postwar recessions prior to the 1990s, which usually came about when the Fed tightened the supply of credit. The two developments seem related: Corporate balance sheets are likely to be stressed out when bubbles burst, which leads to those en masse firings. It feels like it's time to think about how this all fits together.
*Krugman promised to elaborate on this in his Robbins lectures, which I haven't yet read/listened to. So apologies if there's some helpful elaboration that I'm overlooking here.
--Noam Scheiber