Evan Soltas on Kurzarbeit and the Changing Sector Composition of the U.S. Economy

by Reihan Salam

We’ve often discussed kurzarbeit — Germany’s short-term work initiative designed to mitigate rising unemployment — in this space, and I’ve endorsed pursuing a similar strategy of channeling resources that would otherwise go to unemployment benefits to keeping workers engaged. But now Evan Soltas elaborates on why kurzarbeit might not work as well in the United States:

When microeconomic differences generate macroeconomic differences, they require public policy differences. In Germany’s case, the inefficiencies of the labor hoarding encouraged by Kurzarbeit are offset by the losses generated from unemployment — skill atrophy and search frictions — given the violent volatility of trade volumes. That would probably not be the case in the United States, where recessions tend to induce large-magnitude changes in sector composition — that is, when a recession reduces employment sharply in a particular sector, that change in demand for workers tends to be permanent, and thus work-sharing would effectively delay the inevitable and be inefficient public policy.

The larger point Soltas is making, however, is that the changing sector composition of the U.S. economy will likely have an impact on underlying growth potential. It is widely understood that some sectors are more amenable to productivity increases than others. This is why inter-sectoral labor flows from agriculture to industry tend to be accompanied by rapid economic expansion, as Dani Rodrik often reminds us. But when inter-sectoral labor flows go from industry to non-tradable sectors plagued by Baumol’s cost disease, growth often slows. Barry Eichengreen, Donghyun Park, Kwanho Shin recently discussed this phenomenon in the context of fast-growing economies that run into a wall and plateau as they transition to a more service-oriented, consumption-driven state.

As economies converge, further productivity gains become more difficult to achieve because merely mimicking best practices is no longer an adequate strategy. This is the central argument behind Brink Lindsey’s excellent essay on “Frontier Economics“: at the frontier, investment is necessarily less efficient because there has to be more trial-and-error in new managerial practices, new products, etc. Yet experimentation of this kind plays a far more important role in frontier economies that in those that still have room to converge. Per our previous post, this dynamic presumably contributes to some structural downshifting in growth levels. The question whether we can keep our economy sufficiently open to the kind of trial-and-error experimentation that gives rise to productivity breakthroughs. In Lindsey’s view — which I share — this implies that regulation is particularly problematic in frontier economies. Unfortunately, the political dynamics push in a different direction. 

It could be that the U.S. is experiencing a durable productivity shock: going forward, our economy will be more heavily tilted towards less productive sectors (e.g., public employment and our heavily subsidized health sector) than it was before. People will then point to the postwar U.S. growth record as evidence that we can raise tax and spending levels dramatically without doing any economic damage, ignoring the fact that the postwar U.S. economy had a very different sector composition. This in turn will further ratchet down growth levels. This is just one scenario, of course. But I fear that it is a plausible one.