I happened to be chatting with an Earth Science prof this morning. He mentioned that enrolment in Earth Science graduate degrees was strongly counter-cyclical (with a short lag). When the job market weakened, more students decided to get a graduate degree. When the job market strengthened, applications for graduate programs dropped.
There seems to be nothing surprising about that. This is ECON 1000 stuff. The main cost of getting a degree is the opportunity cost of lost wages. When you can't get a job, the opportunity cost of getting a degree is low, so more people invest in human capital. And there's presumably nothing special about Earth Science; it's just that mining and exploration fluctuate a lot, so it's easier to see this effect in Earth Science than in other subjects.
But it's very surprising when you compare it to other forms of investment. Business investment is strongly pro-cyclical.
Both human and non-human capital are used to produce goods. Why should investment in human capital be counter-cyclical, and investment in non-human capital be pro-cyclical?
I think there's a simple answer, and that answer tells us something about the nature of the business cycle.
I see the business cycle as a monetary phenomenon. An excess demand for the medium of exchange causes a fall in the volume of monetary exchange. Falls in production and employment are merely side-effects of that reduction in monetary exchange. But barter exchange, and home production, are unaffected by disruptions in monetary exchange. We should in fact see an increase in barter exchange, and an increase in home production, when monetary exchange is disrupted by an excess demand for money, because these are alternative modes of economic organisation.
Investment in human capital is mostly (but not totally) home production. The student's own time is the most important input in the human capital production function. The other inputs that are paid in dollars, like profs and books, are a minor extra.
So investment in human capital will be counter-cyclical, simply because it's (mostly) home production. But most business investment is goods produced by one firm and sold to another firm for dollars. So it's pro-cyclical, because it gets disrupted by the same disruption to monetary exchange that we call "recessions".
There are probably exceptions that prove the rule. My guess is that DIY home renovations by handy Red Green types may be countercyclical too. (New home construction is an intermediate case, because we buy new homes with dollars, but we often rent them to ourselves with no dollars flowing from our right pocket to our left pocket.)
The business cycle is not a saving and investment thing. The business cycle is a monetary exchange thing.
Exactly! If during recessions, money wasn't retaining value at a risk adjusted rate above market investment, people, banks and businesses would naturally invest in a countercyclical way instead of hoarding pieces of paper.
As for the DYI option, other than cosmetic changes, you need permits and you need to review expensive building code books so it may be out of reach for a lot of the unemployed.
It's kind of sad that the rather primordial and naturally counter-cyclical act of improving one's own dwelling during times of low investment and low employment opportunities is blocked by rules and regulations.
I'm sure ton's of people would be competent enough to learn to do it safely with just youtube videos if building code information was made freely available.
Posted by: Benoit Essiambre | December 16, 2015 at 05:42 PM
Benoit: yep! YouTube How To videos are lovely things for fixing cars, where there are few (no?) regulations if it's your own car.
Posted by: Nick Rowe | December 16, 2015 at 06:38 PM
There's a quite interesting new paper that explores your logic on counter-cyclical opportunity costs to study teacher quality: http://www.econstor.eu/bitstream/10419/112949/1/VfS_2015_pid_138.pdf. Then there is also this recent work by Chodorow-Reich and Karabarbounis on the cyclical opportunity cost of employment: http://scholar.harvard.edu/files/chodorow-reich/files/opportunity_cost_employment.pdf.
Posted by: Evan Soltas | December 16, 2015 at 07:12 PM
Nick, nice post - thought provoking.
"We should in fact see an increase in barter exchange, and an increase in home production" - this has important implications for the politics of GDP measurement (if home production is included in GDP, business cycles look less severe, which would suggest there is less need for policy to counteract the business cycle).
Posted by: Frances Woolley | December 16, 2015 at 07:13 PM
Evan: that first paper is directly relevant. Confirms my perspective (which I like, of course!). I'm not sure about the second paper though.
Thanks Frances! (The only obvious benefit of my attending FGSR this morning).
Yep, GDP excludes home production, and your and my work gets counted when we invest in human capital, but the students' work does not get counted.
On the less need thing: Yes, the fact that home production exists as a second-best does make recessions less costly than they otherwise would be. But, for my purposes, I like the fact that GDP is "biased" by excluding home production. It makes it a better indicator of monetary disequilibrium, and so more useful for macro stabilisation.
Posted by: Nick Rowe | December 16, 2015 at 07:39 PM
"So investment in human capital will be counter-cyclical, simply because it's (mostly) home production. But most business investment is goods produced by one firm and sold to another firm for dollars."
Don't businesses engage in various sorts of activities that could be thought of as home production?
Posted by: JP Koning | December 16, 2015 at 07:48 PM
JP: I was trying to think of good examples. If you are self-employed, and own your own machines, or if your workers are on long-term contracts, then using your existing labour and own existing machines to invest in your own business is very much like home production. You are selling the investment goods you produce to yourself, using your own inputs. No money changes hands. So, if I am right, we should expect to see that sort of investment increase during recessions too.
Posted by: Nick Rowe | December 16, 2015 at 08:03 PM
As we say dans la belle France, "Cherchez l'argent!"
Posted by: Min | December 16, 2015 at 10:14 PM
It's not just Earth Science grad students. It's all grad students in the sciences: [Link Here NR] (yes, the link is to a comic, but the data are real).
Posted by: Jeremy Fox | December 16, 2015 at 11:45 PM
Jeremy: Wow! I hadn't realised the correlation was that strong! Click on the link, people!
Economics is a bit weird, I think, because any sort of economic difficulty tends to get more people interested in studying economics. We teachers of economics have a vested interest in "interesting times".
Posted by: Nick Rowe | December 17, 2015 at 07:32 AM
> Business investment is strongly pro-cyclical.
Not all business investment is pro-cyclical, with respect to the firm's micro-level demand.
Retail stores, for example, don't do major renovations during the holiday rush for much the same reason that students don't go to grad school with a booming employment market: the opportunity cost is too high.
What seems to predict counter-cyclical investment is both a smaller-than-normal opportunity cost at present and a normal to above-normal expectation of long-term return. In a macro sense, this would mean a steep yield curve.
With respect to monetary disequilibrium, an excess current demand for the medium of exchange artificially inflates the short-term opportunity cost of an investment. Fewer students would be able to attend grad-school counter-cyclically if they were denied extensions on their undergraduate student loans, strongly suggesting that the (conditional) provision of liquidity is what enables that human capital investment.
Posted by: Majromax | December 17, 2015 at 09:13 AM
Majro: "Retail stores, for example, don't do major renovations during the holiday rush for much the same reason that students don't go to grad school with a booming employment market: the opportunity cost is too high."
Good example of a business doing (mostly) "home production" of investment a la JP Koning's comment. An exception that proves the (my) rule.
Posted by: Nick Rowe | December 17, 2015 at 12:24 PM
Nick Rowe: "Economics is a bit weird, I think, because any sort of economic difficulty tends to get more people interested in studying economics. We teachers of economics have a vested interest in "interesting times".
Not to worry. Your colleagues who advise gov'ts are doing their part. ;)
Posted by: Min | December 17, 2015 at 03:10 PM
The fact that investment in graduate education is pretty much a indivisible, non-scalable investment that you can undertake only once (well, you can do it more than once but diminishing returns set in so fast that your subsequent masters/phds are pretty much consumption goods) probably plays a role.
Posted by: notsneaky | December 17, 2015 at 04:37 PM
I'm assuming Canada has government funded tertiary education?
Nonetheless I'm not convinced that it's right to categorise education as home production. In the case of privately funded education, it seems evident that student loans are a monetary investment and as such add to GDP via the wages paid out to teaching staff etc. in the same way that business investment does. And in the case of government funded education, I would argue the same thing applies, except that it is by means of governments borrowing on behalf of students.
This might be in contradiction to your contention that recessions are primarily monetary phenomena, I can't quite figure it out. I like to think that I'm at least superficially informed by my readings of circuit theory / endogenous money (you know I'm not informed by any standard micro theory :-)), which by definition does not treat the markets for money and goods as separate entities. So if anything, a circuit theorist would have to say that a lack of demand for output is the same as lack of demand for money as the two are inseparable. Something you probably wouldn't agree with.
But anyway, none of that explains why the two types of investment, even if analogous in kind, run counter cyclical to one another.
My guess would be that lack of demand for current output (unemployment) intices people to invest in personal productivity in the hope that, by the time they're done, the main business cycle will have caught up and they can recoup their investment. To the extent that studies are financed by borrowing, whether public or private, they are not foregoing other consumption opportunities and are thus actually actively countering the cycle by creating a boom / bubble (student loan bubble) of their own, albeit much smaller in scale.
So, lack of business investment (caused by increased uncertainty among entrepreneurs) causes the recession which some individuals react to by engaging in investment of their own / becoming entrepreneurs in matters their own.
Posted by: Oliver | December 18, 2015 at 07:24 AM
notsneaky: you are probably right that those things matter, but I don't see how they matter for this question?
Oliver: if you had written: "...circuit theory / endogenous money (you know I'm not informed by any standard micro theory :-)), which by definition does not treat the markets for money and goods as separate entities. So if anything, a circuit theorist would have to say that a lack of demand for output is the same as [AN EXCESS] of demand for money as the two are inseparable. Something you probably wouldn't agree with."
I would totally agree with it. Every market (except barter markets) is a money market.
But this is not the place for a confused debate over what "endogenous" means. (I did a post or two on that in the past.)
Posted by: Nick Rowe | December 18, 2015 at 07:40 AM
No worries, I don't want to go into any discussions about endogenous money, confused or otherwise! I followed those discussions back then. I just felt I had to qualify my comment so as not to come across as completely looney.
Posted by: Oliver | December 18, 2015 at 08:27 AM
@Oliver:
> I'm assuming Canada has government funded tertiary education?
Government subsidized, but not fully funded. Undergraduate students pay tuition but receive a mix of grants and loans depending upon family income. Graduate programs are funded to a greater or lesser degree, where for example a PhD student in the sciences would not expect to pay tuition net of assistantships but an arts master's student might.
Canadian nationals receive a greater amount of provincial subsidy, leading to lower in-Canada rates than apply to international students.
Posted by: Majromax | December 18, 2015 at 10:14 AM
Thanks, Majromax
That confirms my long held suspicion that Canada is a comparatively sensible place!
Posted by: Oliver | December 18, 2015 at 02:26 PM
Another good example of "home" production is work on open source software.
There are two major categories of investment in open source both of which fit your analysis. First is firms paying their employees to fix bugs or add features in open source software that is a complement to their own products.
Second is individuals investing their time and skill into open source projects (sometimes ones they start, sometimes ones they join).
These both have the macro-economic characteristics of investment (increase in capital stock) but without inducing new monetary transactions between entities.
I suppose there are other activities susceptible to similar analysis (e.g. volunteering as a "big brother") but open source is much more visible and has clear investment type effects.
I suggest the overall category needs a better name than "home production" -- of course home production is an important sub-case.
Posted by: Jared Harris | December 19, 2015 at 04:27 PM
Jared: "These both have the macro-economic characteristics of investment (increase in capital stock) but without inducing new monetary transactions between entities."
Key point.
"I suggest the overall category needs a better name than "home production" -- of course home production is an important sub-case."
Agree. Maybe "in house"??
Posted by: Nick Rowe | December 19, 2015 at 08:22 PM