Saturday, 2 April 2011

Investment and unempliyment: why not fight about it

John Taylor argues that the most effective way to reduce unemployment is to raise investment as a share of GDP. His blog post is Higher Investment Best Way to Reduce Unemployment, Recent Experience Shows. He argues for a negative relationship between unemployment and investment. But Paul Krugman isn't having a bar of this. See here and here. What is the role of housing in all of this? Taylor responds in Investment and Unemployment: A Reply. Justin Wolfers thinks this looks like fun and comments here and here. Taylor responds here.

What started all of this is this graph showing a negative relationship between unemploment and investment.

The question is which way does causation run? From investment to unemployment or the other way round? Or is the relationship due to some other third factor?


MacDoctor said...

I see the guys at Freakonomics have pointed out that this correlation disappears if you use data stretching back more than 10 years I.e Taylor has been overly selective with his data.

I did wonder if the strong negative correlation is the past decade was due to the current nature of investment being not so much into the means of production but more into the means of speculation.

Productive investment may increase unemployment as automated processes displace workers. Speculative investment, OTOH, usually increases bureaucracy, thereby increasing employment.

Paul Walker said...

Taylor responds to Justin Wolfers here:

"Wolfers argues that the relationship did not exist in earlier years. He is wrong.

His argument is based on the observation that the scatter of points for the 1990-2010 period, shown in one of my graphs, shifts up and to the right—higher unemployment for a given level of investment—if you include the 1970s and 1980s. The scatter of points shift back down and to the left if you go back further. This shift up in unemployment in the 1970s and 1980s was due in part to the well-documented longer term increase in the natural rate of unemployment in the 1970s and 1980s, which many macroeconomists have researched and written about, but which Wolfers does not mention. When you recognize that such longer-term historical trends exist, you can see that there is a strong correlation between investment and unemployment that goes back before 1990."

Eric Crampton said...

I was really surprised that Wolfers jumped to dishonesty rather than to structural break.