Tuesday, November 4, 2014

Business opinion and the representative firm

Here's Paul Krugman:

Business leaders often give remarkably bad economic advice. . . . Success in business does not seem to convey any special insight into economic policy. . . .
National economic policy, even in small countries, needs to take into account kinds of feedback that rarely matter in business life. For example, even the biggest corporations sell only a small fraction of what they make to their own workers, whereas even very small countries mostly sell goods and services to themselves.

The suggestion that business experience conveys no special economic policy insights is, frankly, totally absurd. It's way too easy for economists to say "Only we economists can truly understand the economy" when there are people who interact daily with capital and labor markets, forecasts, pricing, and policy. But Krugman has a good point about considering feedback, which is not likely to be something that business people are used to doing.

But the biggest problem, which Krugman does not mention, is that people who run businesses are inclined to think (or at least say) that the best economic policy is the one that helps their business. A recent example that comes to mind is Dow Chemical's ongoing effort to secure a ban on natural gas exports. Since it would be bad form to write an op-ed openly arguing that policy should be made to privilege your personal interests, we have Andrew Liveris (the CEO) making up some bad economics to portray the idea as being in the "national interest." The op-ed is a fantastic specimen. It has the usual misguided obsession with manufacturing and some standard sloppy counterfactuals about job creation. I really love the part where he blames 1990s energy price volatility on letting energy markets be driven by "legislation instead of market forces" in the context of his request for anti-market legislation. But this selfless champion of the public interest is spending big money to secure the policy.  Liveris probably has a better understanding of economics than his arguments would suggest, but he will always advocate policies that help his company (like any good CEO).

This problem generalizes because the data on firm dynamics tell us that there is no representative firm. Everyone knows this, but the representative firm intuition is really hard to shake--particularly in political dialogue. There is no business person or union or advocacy group whose interests are representative of "business" or "workers," let alone representative of the economy as a whole. In a given month, the net jobs number is just a residual object, the difference between jobs created by business expansions and jobs destroyed by contractions. It's a very small number compared with the gross flows, which means that there is massive heterogeneity among firms.

Firm dynamics also makes a lot of arguments quantitatively silly. Liveris cites a BCG study finding that some sort of manufacturing renaissance will create 5 million jobs (whatever that means); he also claims that high gas prices in the 1990s destroyed 300,000 jobs. But every quarter, US establishments both create and destroy 6 to 7 million jobs. Every month we have hires and separations in the vicinity of 4 million. The forces that cause daily, pedestrian reallocation absolutely dwarf anything you can accomplish with a specific policy, whether it's immigration policy or natural gas export policy. With so many jobs being destroyed by idiosyncratic shocks, it's hard to justify any policy that is designed to protect a few hundred thousand jobs in a specific industry.

So I think that when a prominent business person prescribes policy, we should first ask how likely it is that their prescription is based on their own narrow interests. Then, we should ask if their narrow interests have any hope of being representative of the Social Planner's problem. If they're talking about a couple million jobs over a few years, chances are that the Social Planner just wouldn't care.

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