ZMP workers and output quotas

Imagine, just imagine, that the government put a quota on the total output of, say, cars. Because some rabid environmentalists told them to. The result would be a drop in employment of auto workers. Some of those workers, who had skills useful in other sectors, would be able to find jobs elsewhere. Others, who had little or no alternative skills, would be unemployed.

Would we describe those unemployed car workers as being Zero Marginal Product workers? Not really. They are still exactly as capable of producing extra cars as they were before. It's just that their potential employers are no longer able to sell any extra cars.

Would we describe those unemployed workers as being Zero Value Marginal Product workers? Yes and no. Depends what you mean. The extra cars they could produce would have zero value to the firms trying to sell them, because they aren't allowed to sell any extra cars. But those extra cars would have exactly the same value as before to the people who wanted to drive them, but who now can't, because of the output quota on cars.

Would wage cuts help employment of car workers? Not really. An individual car worker who was willing to work for lower wages might get the job that would otherwise have gone to another worker, but that doesn't help aggregate employment of car workers. Maybe if they all cut wages their employers would use more labour-intensive methods of producing cars. That could help employment of car workers. But it would hurt employment of all the other factors used to produce cars. If all factors used in producing cars cut their "wages", that wouldn't help aggregate employment of all factors (not just workers) used in producing cars.

Now imagine, just imagine, that the government put a quota on the total output of everything, not just cars. Because the environmentalists told them that GDP is bad, and needs to be controlled. Now it's not just car workers who are unemployed. All sorts of workers are unemployed. And the unemployed workers who have skills useful in other sectors can't get jobs in those other sectors. Because there are no other sectors.

Are the unemployed workers Zero Marginal Product workers? No. Are they Zero Value Marginal Product workers? Yes and no. Depends what you mean. The extra output they could produce is still valued by the people who don't have it (who are mostly the unemployed workers themselves), but it's not valued by the firms producing it, because they aren't allowed to sell it. Would wage cuts help? Maybe a little, but not really. If wages of labour fell relative to the wages of land and machinery, firms would maybe use more labour-intensive methods of producing the same total output. But that would simply replace unemployed labour with unemployed land and machinery. If the wages of all factors fell, it wouldn't help total employment of all factors.

Let's push this analogy further. Suppose the rabid environmentalists have heard about tradeable quotas, and that they are a good idea. They issue a fixed number of "GDP permits" to households. Each household can spend its permits on whatever good it likes, at whichever firm it likes.

The Statistics Canada employees who normally measure each firm's contribution to GDP are asked to check that each firm actually receives from households the requisite number of GDP permits. And because of the standard value-added intermediate goods problem in measuring GDP, the Statistics Canada employees convince the environmentalists and government that it's much easier if each firm collects GDP permits equal to the value of its sales, and in turn pays its suppliers with those same GDP permits. So the GDP permits flow all the way down the supply chain to the owners of the ultimate factors of production, and then those households in turn use the GDP permits they earn to buy goods from firms. This makes enforcement a lot easier, since the firms will want to ensure they get the GDP permits when they sell goods, because they need those permits to pay their own suppliers, workers, and owners. It's a bit like the GST (VAT), only in reverse.

The Statistics Canada employees recognise that the tradeable GDP permits are themselves valuable, so measure the prices of goods to include the value of the GDP permits received in exchange. A tradeable permit is just like a tax, and Statistics Canada decides to measure GDP inclusive of indirect taxes like VAT and the GDP permits. So firms compete for those GDP permits, by trying to offer low prices for high-quality goods. And the lower the price, the fewer GDP permits the firm needs to collect when it sells the goods. Eventually the GDP permits become so valuable that the firms are willing to give away their goods for free, except for the GDP permits. And households too are willing to give away their labour for free, except for the GDP permits. "You can drive this car off the lot for 15,000 GDP permits!". "Staff wanted; pay is 15 GDP permits per hour".

Now, the environmentalists in my story may be a bit rabid, but they do understand the stock-flow distinction. They know that a fixed stock of GDP permits may permit many different levels of GDP, which is a flow. It all depends on how quickly GDP permits circulate from households to firms, and back to households again. They introduce the concept of the "velocity of circulation" of GDP permits. Since it's too hard to put a "use by" date on each GDP permit, they decide to adjust the stock of GDP permits in circulation to try to offset changes in velocity. If velocity rises, so GDP rises above the environmentalists' target they reduce the stock of GDP permits in circulation by buying them back. They create a special "Central GDP Permit Bank" just for this purpose. And if velocity falls, so GDP falls below the environmentalists' target, the central bank increases the stock of GDP permits in circulation.

And the environmentalists in my story may be a bit rabid, but they also understand the distinction between nominal and real GDP. Since all goods and labour are now free, except for the GDP permits you need to pay in exchange, all prices are now measured in terms of GDP permits. If the stock of GDP permits is too small, individual firms and households will cut prices in terms of GDP permits, trying to compete for GDP permits against other firms and households. So the value of each permit will rise. And if the stock of GDP permits is too large, individual firms and households will raise prices in terms of GDP permits, since they worry less about competition from other firms and households. So the value of each permit will fall. So the environmentalists use their central bank to adjust the stock of GDP permits in circulation to try to prevent their value rising or falling too quickly.

Then one day the system breaks down. Something causes the velocity of circulation of GDP permits to fall. The central bank fails to respond quickly enough to increase the stock of GDP permits. (Because environmentalist hawks are afraid this would cause the value of GDP permits to drop). So the value of those permits starts to rise, so people hoard even more GDP permits against an uncertain future, which reduces velocity still further.

So we end up with a lot of apparently Zero Value Marginal Product unemployed workers.

Everything changes when you don't just use barter to trade stuff, but have to use money/GDP permits instead.

(This started out as a response to Bryan Caplan. But then I got carried away.)

Comments

[Max]

Very good until you got to the central bank, then you went all neoclassical on us.

[Nick Rowe]

Max: I can't really help that. *Any* theory that tries to explain unemployment as resulting from deficient aggregate demand *has* to recognise the central role of monetary exchange, in my opinion. Otherwise the unemployed workers, and firms who can't sell their output, would just do a big sequence of multilateral barter deals to make themselves all better off, and we would be straight back at full employment, regardless of excess of desired saving over desired investment, or insufficient government deficits, or the central bank setting the interest rate too high, or anything else.

[TC]

"Because the environmentalists told them that GDP is bad, and needs to be controlled. Now it's not just car workers who are unemployed. " There might be something to this tactic...

[Alex Tabarrok]

I always suspected the greens were responsible for the recession!

[Kevin Donoghue]

Nick, as someone who teaches economics, do you not think it's actually quite harmful to be propagating concepts like Zero Marginal Product workers?

[Nick Rowe]

TC and Alex: a really seriously rabid environmentalist who thought that "growth is bad" (actually, a lot of them *do* think that "growth" is bad) would probably want to infiltrate a central bank. And the simplest conspiracy theory always asks "Who dunnit? Why he who benefits!". Suprised we haven't heard this conspiracy theory more. Or maybe I just don't read widely enough!

Kevin: the ZMP theory is a good theory. Sometimes it's even, occasionally, partly, true. And learning it teaches us a lot. That it's VMP that matters, not MP. And that VMP isn't a number, but a schedule. And that VMP isn't something that is stamped on each worker's forehead. It depends on everything else, just like in GE theory. And, unlike GE theory, it also depends on monetary policy. Not that I have covered all of those bases here.

[Leo]

I think this post would be more effective without random environmentalist bashing.

[Kevin Donoghue]

Nick: "...VMP isn't something that is stamped on each worker's forehead."

Quite so, which is why I find it bothersome that an economist can use a phrase like "Zero Marginal Product workers" in the way that Tyler Cowen does. This is how knowledge is destroyed and dark ages ushered in. Would any of Samuelson's students have got away with that?

[Nick Rowe]

Leo: I think it would have been a lot less effective. Have you never heard environmentalists say "Growth is bad"? Or "You can't have economic growth forever in a world with finite resources"? This post wasn't about environmentalism, obviously. I just needed a simple story for my thought-experiment, and environmentalists were the first people who came to mind. I even hammed it up by saying "*rabid* environmentalists" (as opposed to non-rabid, sensible, environmentalists, who do exist). But now you mention it, damn but they fit the bill.

Kevin: I'm sure Tyler understands all that very well (except he sometimes gets a bit wobbly on money). And everything he says could be translated into interdependent schedules. But maybe some of his readers might not.

[scepticus]

"*Any* theory that tries to explain unemployment as resulting from deficient aggregate demand *has* to recognise the central role of monetary exchange, in my opinion. "

One could take a different angle on the same problem and speculate what the implications of permanent full employment would be on an economy using money for exchange.

[Jacques René Giguère]

Nick:
If you replaced "rabid environmentalists", "growth is bad" and "GDP permits by "Chamber-of Commerce-Wall-Street","wage share of GDP" and "money", would that describe the last 30 years?

[Nick Rowe]

scepticus: one could do that, and I have played a little with that in the past. The trouble is, the counterfactual is problematic. What are the implications of monetary exchange for the equilibrium level of employment? Compared to what? Compared to barter? Well, given the very high costs of using barter, we might still be in the Stone Age.

Jacques: Not to my mind. A better analogy, for the last 2 or 3 years, would be the inflation hawks at the Fed.

[Determinant]

Yes, yes it would Jacques, and you beat me to saying it. It accurately describes the current hiring drought. In short firms just can't get value from additional workers. I was going to say that if you replace "environmentalists" with "inflation hawks" you describe a good part of our current paralysis.

First we shoot the inflation hawks, then yank the inflation lever. People who complain about hurting pensioners are gently reminded that if we don't get the young working there won't be anyone to pay those pensions....

[scepticus]

"What are the implications of monetary exchange for the equilibrium level of employment? Compared to what?"

There is a level between barter and money, which is debt. If barter is defined as direct exchange of goods with no deferred payment, then what do we call direct exchange of goods *with* deferred payment and not using money? Tally sticks existed long before people made exchanges using gold.

I think the answer depends very much on the extent to which a single medium of exchange encompasses large numbers of people and the degree to which those people's skills are interchangable. Monetary exchange is not a binary function - you have it, or not. Its a continuum from localised debt/barter/rent/money relationships such as found in the manorial system of the high middle ages (and of course much earlier), right through to today.

Network effects, basically. Scale free or linear? I guess I see money as a process (a social one) that arises from social networks and social change, not as a force that shapes them. I reckon the demographic issues stacking up over the next few decades will validate this view.

How far back in time must one go until one finds no lack of AD?

[Nick Rowe]

scepticus: "If barter is defined as direct exchange of goods with no deferred payment, then what do we call direct exchange of goods *with* deferred payment and not using money?"

"Barter". I swap my apples today for your bananas tomorrow.

But yes, "barter" and monetary exchange with a single money are two ends of a spectrum.

[Winslow R.]

" A better analogy, for the last 2 or 3 years, would be the inflation hawks at the Fed."

You give the fed way too much credit for swapping credits :). Foreign bondholders and their supporters make a better target as the fed hawks have shown no ability to increase/decrease the number of credits bondholders desire to save.

[scepticus]

""Barter". I swap my apples today for your bananas tomorrow."

Well, that's a case of swapping apples for a banana-note which is in theory tradeable.

Then, there's ripple (http://en.wikipedia.org/wiki/Ripple_monetary_system) which doesn't fit your description of barter, but neither does it use money.

[Nick Rowe]

scepticus:

Let there be n goods in an economy.

At one extreme, in a pure barter economy, there are n(n-1)/2 markets. Each of the n goods can be traded for each of the n-1 other goods.

At the other extreme, in a pure monetary exchange economy, there are n-1 markets. One of the goods can be traded for each of the n-1 other goods. That one good is called "money".

If you want to put it paradoxically, "money" is the good that can be traded against every other good. In a monetary exchange economy, there is only one "money". In a barter economy, all goods are "money".

That Wiki article on Ripple is too badly written to be clear. But it sounds as though Ripple is just a standard monetary system, like LETS. The fact that it doesn't use bits of paper, but uses electrons for book-keeping entries, doesn't make a difference.

[scepticus]

Its a stretch to call our current form of money 'a good' when it is in fact just a piece of data. The data/goods distinction is important, money which is just data on electronic balance sheets is unlikely to behave in the same way as physical specie. [disclaimer - I'm not making value judgments here like a goldbug would, just pointing out something important]

Regarding ripple, its not a standard monetary system because it has no money. It may have one or many units of account (in fact possibly as many units of account as there are arcs between nodes), but goods are transferred between parties which don't directly trust one another without any money changing hands. Basically, you and your friend grant each other a line of mutual credit up to some limit, and a network is built from said credit lines between trusted parties. Now goods can be exchanged between any two nodes which trace a path via trusted connections, like linkedin or something.

After the goods have been exchanged the seller and buyer will have had their net credit/debit positions (e.g. their aggregated balance summed over all their connections) altered, and all the intermediary nodes will have simply adjusted the distribution of debt and credit between their connections without any net change in aggregate balance.

Its quite simple really, and requires precisely no money to clear debts because money to clear debt between two trusting parties who know each other (like you and your mum) is not required, and debts only accumulate between pairs of trusting peers.

So,not barter, but no money either.

[Nick Rowe]

scepticus:

Start with standard paper money. When I buy an apple from you, a $1 note goes from my pocket to yours.

Now suppose that paper got too heavy to carry. Or we were afraid of muggers, or something. So we all agree to keep our paper money in personal safety deposit boxes at a central location. And when I buy an apple from you, we send a message to the centre to move a $1 note from my box to yours. Same thing. Physical location is not the same as ownership.

Now replace the boxes with virtual boxes. Just record who owns how many bits of paper in a ledger. Same thing.

Now replace the paper with virtual paper. Keep the ledger. Same thing.

Computerise the ledger. Same thing.

Ripple *sounds to me* like money, because offsetting credits and debits in the network are automatically cancelled by the computer program. I owe you 100, you owe him 100, he owes me 100, so the program wipes them all out. (I'm still not 100% sure if I understand its mechanics though).

[scepticus]

Nick, ledger entries are not goods, they are information, since there is no limit to the amount of ledger entries that can be made but there is a practical limit to the amount of goods and services that can exist.

You have jumped from a case of 'the most marketable good' in a selection of physical goods, to 'paper money', which is just information, without acknowledging this fundamental alteration in the nature of money.

[Nick Rowe]

scepticus: OK. A bit of paper money, unlike (say) gold, has no intrinsic value. But, as long as there is a demand to hold a stock of it, and the supply of that stock is not unlimited, it has value in the market, and is bought and sold, and is a good. Is it a good like all the other goods? No. Can it be seen as a way to keep track of trades, as an informational device? Yes.

I've been reading your blog. Look, you write some good stuff, and are obviously a real thinker. But you also need to read some basic monetary economics too. (Like those computer scientists who wrote all those papers on Ripple).

Could there be an equilibrium in which physical gold is used as money, and a gram of gold could buy a BMW? Certainly, yes. Is the natural rate of interest zero? Almost always no. Should the supply of money be controlled in such a way that the *nominal* rate of interest on safe non-money assets is always zero? Well, Milton Friedman did argue that in "The Optimum Quantity of Money". There's a whole history of people thinking and writing about questions like this for the last couple of centuries. Have we got it right? Probably not. But we are not starting from scratch.

But this post is about ZMP workers and aggregate demand. It's an extended metaphor. And I'm pushing that GDP permit = money metaphor as far, maybe even farther, than it wants to go. It's not about the deep foundations of "what is money?"

[scepticus]

Hey Nick, thanks for taking the time to read my scrawlings. That said, I'm not here to promote my blog so a question directly related to your post if I may.

I realise its a metaphor, but lets stick with it. If the rabid greens really want a smooth steady GDP, surely they'd need to attach expiry dates to the permits? You want each months quota neatly consumed that month, or year, or whatever.

I think you are saying that paper money can provide a high quality simulacrum of a real good, given appropriate conditions. Goods have carrying costs, shelf lives and so forth, so if you hold that paper money can successfully simulate a good by design or by and accident of mass human psychology, does that mean you think negative nominal rates, demurrage and so on are all very valid things for paper money?

The heavy weight placed on the ZLB does make me wonder whether most economists believe their own models, or not.

[Nick Rowe]

scepticus: it's always good to read someone really bright, who's coming at the old stuff from a totally different angle.

"If the rabid greens really want a smooth steady GDP, surely they'd need to attach expiry dates to the permits? You want each months quota neatly consumed that month, or year, or whatever."

Yep. And spent once only, on final GDP. But, it would be really difficult to implement that, because it's hard to tell in practice what's a final good and what's an intermediate good. (Plus, I was prepared to fudge the metaphor so I could tell my story!)

"I think you are saying that paper money can provide a high quality simulacrum of a real good, given appropriate conditions."

Yep. The following differences come to mind.

1. Unlike other goods, it does not have a unique market of it's own. In a monetary exchange economy, *every* market is a market for money, and one other good. That's the medium of exchange aspect.

2. Unlike other goods, it *usually* does not have a price of its own. Other goods are usually priced in terms of money. That's the medium of account aspect.

3. Unlike nearly all other goods, the benefits we get from holding a given quantity of money depend solely on the real quantity. i.e. what matters is M/P, not M. If you double the stock of money, and double all prices (i.e. halve the price of money), the benefits I get from holding it are exactly the same. That is because it's *only* use is as a medium of exchange. That's where the quantity theory of money comes from.

4. Unlike nearly all other goods, and even though we talk about the benefits of "holding" money, if you only held it, and could never spend it, the benefits would be zero. That's not true for other assets like houses and refrigerators. Again, that's because it is a medium of exchange. The benefits of holding an average quantity of money are like the benefits of holding an average inventory. The stock lets you have a different time-pattern of flows in and flows out.

5. A coat keeps you warm and dry. A promise to pay one coat doesn't keep you warm and dry. A promise to pay one coat cannot function as a coat, and so is not a coat. But sometimes, just sometimes, a promise to pay one unit of money can be used as a medium of exchange. The promise to pay money can itself sometimes be money.

"Goods have carrying costs, shelf lives and so forth, so if you hold that paper money can successfully simulate a good by design or by and accident of mass human psychology, does that mean you think negative nominal rates, demurrage and so on are all very valid things for paper money?"

You lost me a bit there. There is no conceptual difficulty in paying either positive or negative rates of interest on paper money. (I'm not talking about paying interest on loans of money, I'm talking about the issuer of money paying positive or negative rates of interest to those who hold money). It's practically difficult in the case of paper currency to pay positive or negative interest. But deflation or inflation can do exactly the same thing. And it's perfectly possible to pay positive or negative interest on deposits in chequeing accounts, which are also media of exchange.

[Nick Rowe]

Money is a good. But it's a weird good. Not sure if my 5 points of weirdness are exhaustive. I may have forgotten some.

[scepticus]

"scepticus: it's always good to read someone really bright, who's coming at the old stuff from a totally different angle."

Thanks:) I like to focus on really old stuff, just to put the really new stuff into perspective...

That said, if that's my angle defined, how would you define yours?

Either way, some counterpoints below:

"1. Unlike other goods, it does not have a unique market of it's own. In a monetary exchange economy, *every* market is a market for money, and one other good. That's the medium of exchange aspect.
2. Unlike other goods, it *usually* does not have a price of its own. Other goods are usually priced in terms of money. That's the medium of account aspect.

"This is somewhat complicated by having many monies (national currencies) isn't it? All monies today tend to be quoted in terms of other monies.

"3. Unlike nearly all other goods, the benefits we get from holding a given quantity of money depend solely on the real quantity. i.e. what matters is M/P, not M. If you double the stock of money, and double all prices (i.e. halve the price of money), the benefits I get from holding it are exactly the same. That is because it's *only* use is as a medium of exchange. That's where the quantity theory of money comes from."

Not if you have fixed income liabilities (or rather, fixed outgoing liabilities?)

"4. Unlike nearly all other goods, and even though we talk about the benefits of "holding" money, if you only held it, and could never spend it, the benefits would be zero. "

Not if you can earn a real rate of interest. Even if you never spend it before you die having more of it increases the feeling of security and one can pass it on to ones progency, so there's a biological imperative to it.

"That's not true for other assets like houses and refrigerators. Again, that's because it is a medium of exchange. The benefits of holding an average quantity of money are like the benefits of holding an average inventory. The stock lets you have a different time-pattern of flows in and flows out."

Might I suggest its actually because houses and refigerators have permanent negative carrying costs and money (here I am talking about bank deposits not paper cash) generally (according to popular opinion) does not.

"5. The promise to pay money can itself sometimes be money."

For sure, especially when it is guaranteed. I think a lot about the difference between so called base money and so called broad money if both are mostly nominal risk free thanks to FDIC.

"There is no conceptual difficulty in paying either positive or negative rates of interest on paper money. (I'm not talking about paying interest on loans of money, I'm talking about the issuer of money paying positive or negative rates of interest to those who hold money)"

Oh but there is, since negative real rates are widely loathed, and negative nominal rates are (as yet) simply beyond the pale. There is plenty of historical evidence for negative real rates, but none AFAIK fo rnegative nominal. Goods however all pay negative nominal rates due to carrying costs, but paradoxicslly can pay positive real rates at the same time.

There is no such case for money AFAIK.

[Nick Rowe]

scepticus: ""This is somewhat complicated by having many monies (national currencies) isn't it? All monies today tend to be quoted in terms of other monies."

Yes. But interestingly, from what my commenters here tell me, there is no market in which Canadian dollars are traded for Australian dollars. First you sell your Canadian for US dollars, then you sell your US for Australian dollars. So the US dollar is itself a money to all the other monies. (Complicated by the Euro, etc.) And the cross-exchange rates are merely mathematical constructs. They aren't actual quotes. They are the product of two other quotes.

"Not if you have fixed income liabilities (or rather, fixed outgoing liabilities?)"

You lost me.

"Not if you can earn a real rate of interest."

OK. That would be a side benefit. Like the fridge manufacturer paying you interest for as long as you own one of their fridges. You own it because it keep your beer cold. The interest merely offsets some part of the opportunity cost of owning it.

"Might I suggest its actually because houses and refigerators have permanent negative carrying costs and money (here I am talking about bank deposits not paper cash) generally (according to popular opinion) does not."

Think in terms of opportunity cost. Both paper currency, and chequable demand deposits pay less interest than bonds. That interest rate differential is the opportunity cost of holding money. The liquidity/medium of exchange services of holding money offset that cost, at the margin, in equilibrium.

[Jacques René Giguère]

scepticus:
"If the rabid greens really want a smooth steady GDP, surely they'd need to attach expiry dates to the permits? You want each months quota neatly consumed that month, or year, or whatever. "
IIRC, in the Priries in the '30's, some local comminities issued scri to be used isude their borders. Often, they had expiry dates to force people to spend them. A kind of monetary policy leading people to do their own fiscal policy. It went around the problem of hoarding without people thinking it was in fact inflation. These experiments were based in part on the Social Credit theory with its religious underpining of "The love of money is the source of all evils."

[scepticus]

"Yes. But interestingly, from what my commenters here tell me, there is no market in which Canadian dollars are traded for Australian dollars. First you sell your Canadian for US dollars, then you sell your US for Australian dollars. So the US dollar is itself a money to all the other monies."

I very much doubt you couldn't sell canadian for GBP and then from there to AUS.

If thats the case then what we have is a network graph in which not all nodes are connected and in which the US is more highly connected than others.

[Nick Rowe]

scepticus: "I very much doubt you couldn't sell canadian for GBP and then from there to AUS."

In the olden days you could, when Sterling was more of a reserve currency. Not so sure now. But remember, trade always gravitates towards the biggest market, aside from things like transport costs.

I agree on the network graph. No model is pure. We still do some barter, also. You might like this: http://worthwhile.typepad.com/worthwhile_canadian_initi/2009/09/the-hub-and-spoke-model-of-money-a-rejoinder-to-arnold-kling.html