August 25, 2017

Regular readers of my work (assuming there are any) may detect a current of disdain for the economics profession. However, my real problem isn’t really with economists (though some of them really are very annoying), but with economic theory.

There’s nothing wrong with theory as long as it’s scientific theory; and economics, despite the number-work, is not a science. Its theories, not being scientifically constructed, cannot be scientifically tested. Which is how they can persist for so long in the face of evidence to contrary.

Assumptions that may or may not have been accurate at one time can become fossilised within economic theory; thereby exercising an influence over economic policy-making long after times have changed.

There’s an excellent example in an article by Gary Shilling for Bloomberg (the second part of which is here). His subject is the stubborn adherence of central bankers to the idea that high levels of employment carry the danger of inflation (through upward pressure on wages):

“Wages have been either stagnant or declining in the U.S. and other developed economies for more than a decade once inflation is taken into account. Yet, the Federal Reserve and other major central banks remain convinced labor markets are tight, and that a surge in employee costs and inflation are just around the corner. Hence, their recent shift toward credit restraint.

“But inexplicably, policy makers are failing to take into account the many significant economic changes in recent decades that are holding down wage growth.”

Shilling explores six main reasons why the relationship between employment and inflation has weakened so dramatically. The most obvious is the ease with which businesses can now draw upon a global supply of labour:

“Manufacturing employment in the West has seen a dramatic drop as production in the last three decades shifted from developed countries in Europe and North America to developing economies in Asia, where costs are much lower.

“There’s also downward pressure on jobs and compensation in the service sector due to legal, accounting, medical billing and other services being outsourced abroad.”

Even within national labour markets, we’re seeing an expansion of supply. Though the great historical shift of women into paid work is more or less complete, there are further sources of new supply – not least from groups that had previously exited the labour market such as young adults or retirees:

“Indeed, the labor force of those age 20 to 29 has been growing since 2012. At the same time, people over 65 who are employed or actively looking has been rising since the early 1990s. Many seniors are in good health and prefer active work to vegetating in front of the TV. Others, among them many postwar babies born in the 1946-1964 years, have been notoriously poor savers throughout their lives and need to keep working due to a lack of retirement assets.”

Various trends look set to underpin this return to the workplace – for instance, the trend towards less physically demanding work; the backlash against the scammier facets of higher education; and the continued pressure to reduce welfare bills.

Then there’s a much overlooked generational effect:

“…within industrial sectors, wages have been restrained as postwar babies at the top of their pay scales retire and are replaced by lower-paid new recruits.”

On the face of it, the retirement of the babyboomers suggests a tightening of the labour market, but in fact it is giving employers an opportunity to rethink their business models and reduce their reliance on expensive labour (not only through those fresh-faced new recruits, but also outsourcing, automation or simply doing without).

Taking all of this into account does not require new theories, but more careful observation – which is what the best of economics does already. Policy-makers need to catch-up.

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