Wednesday, August 4, 2010

Five Second ... Sumner on Prices

One of Sumner's best posts just got a follow up. The point is that prices are outcomes, not causes, so you can't reason from a price change without knowing what caused it. Last time he illustrated the point with yogurt, champagne, and movie tickets. This time it's wages:
Massachusetts saw a big loss in jobs in industries like shoes and textiles during the 1980s.  Was the job loss due to high wages?  If so, then why didn’t Massachusetts see a higher unemployment rate?  Economists would use the good old comparative advantage model.  The booming high tech, health care, and finance sectors created lots of high paying jobs.  This raised the cost of living here, and drove out the low paying jobs.  Thus our low wage jobs weren’t stolen by cheaper labor in Mexico or China, they were literally pushed out (or crowded out) by higher paying jobs in other industries.  That’s creative destruction.
Now let’s consider the role of wages.  Although they weren’t the root cause, it is true that high wages were a sort of transmission mechanism between the high tech boom and the loss of low wage jobs.  So why do I object to people saying high wages drove out those older industries?  Because wages change for many different reasons.  They might change because the shoe industry became highly unionized and drove up wages, despite weakness in other areas of the economy.  Or they might change because of the creative destruction process I just described—a high tech boom pushing up the overall wage rate around here.  It makes a big difference which factor is behind the wage change.
So you don't know from interest rates or exchange rates whether monetary policy was loose or tight. Remember, interest rates were high in the 70s because of loose policy (which causes inflation), not tight.

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