Wednesday, October 16, 2013

My Supply-Side Senses Are Starting to Tingle

One of the most contentious debates over the past few years has been whether the U.S. slump is the result of  an aggregate demand shortfall or a spate of negative supply shocks. Depending on which view you take, the policy implications are very different. In the former case, monetary policy could help by closing the output gap. In the latter case, it would only be 'pushing on string' and might even create more problems. 

I have argued that the slump has largely been the result of an aggregate demand shortfall. One piece of evidence for this view I have repeatedly pointed to is a question on the NFIB Small Business Economic Trends survey. This survey question asks firms what specific developments they see as the "single most important problem" they face. Answers to question include lack of sales, regulation, taxes, inflation, financing costs, quality of labor, insurance availability, competition from large business, and other. This question, therefore, allows us to see from a small firm's perspective how important supply shocks are--as measured by regulation, taxes, financing, and quality of labor--compared to demand shocks--as measured by a lack of sales. Since the crisis the started, a lack of sales has been the number one problem. This series has led changes in the unemployment rate in a remarkably consistent manner since the data starts, as seen below. The easiest and most straightforward interpretation of this relationship is that firms cut back on production and employment as a result of the expected weak sales. From the firm's perspective, this suggests an aggregate demand shortfall is the key driver behind the slump.

Now I still buy this story, but recent developments in the survey question suggest supply-side concerns are becoming a bigger deal. In fact, a lack of sales is no longer the number one problem. Rather, it is concerns about regulation, as seen below.

What is even more alarming about these regulation concerns is that they have consistently risen since 2009 and are now at their highest level since the previous peak in 1994. See the figure below:

So what possibly could be driving the rise in regulation concerns? I think the answer is obvious: Obamacare. And I think observers like Brad DeLong, Paul Krugman, and myself who have been so quick to use this NFIB data when it fits our views need to be honest and acknowledge what this data is saying now.

So how do we interpret the rising small business concerns about government regulation? One manifestation of these concerns might be the claim that some firms are cutting back employee hours to under 30 so that they do not have to offer them health insurance. This claims resonates with me since I know people in my community who have had their hours cut back for this reason. Brad DeLong, Jared Bernstein, Max Sawicky, and others say no way, there is no evidence of this in the employment data. They also ask why would firms start doing this now if this requirement does not become law for another year.

I acknowledge their point on the employment data, but would direct them to two polls that suggest firms are cutting back on hours in one form or another. The first one was a Gallup poll and reported on CNBC:
Small business owners' fear of the effect of the new health-care reform law on their bottom line is prompting many to hold off on hiring and even to shed jobs in some cases, a recent poll found.
"We were startled because we know that employers were concerned about the Affordable Care Act and the effects it would have on their business, but we didn't realize the extent they were concerned, or that the businesses were being proactive to make sure the effects of the ACA actually were minimized," said attorney Steven Friedman of Littler Mendelson. His firm, which specializes in employment law, commissioned the Gallup poll...

Forty-one percent of the businesses surveyed have frozen hiring because of the health-care law known as Obamacare. And almost one-fifth—19 percent— answered "yes" when asked if they had "reduced the number of employees you have in your business as a specific result of the Affordable Care Act." 
A more telling survey was done by the Foundation of Employee Benefit Plans. They found that 15% of firm with 50 or more employees and 20% of firms with less than 50 employees had plans to adjust hours so that fewer employees qualify for full-time medical insurance under the ACA. The smaller firms also planned to make other changes in seen the figure below from their survey:

So according to these surveys and the data from the NFIB, Obamacare is now having an effect on labor markets. Now this evidence does not speak to the size or magnitude of this effect. The figure above suggests it is limited to smaller firms. Maybe that is why folks like Brad DeLong, Jared Bernstein, Max Sawicky, and others who are associated with big institutions have not met anyone adversely affected by the ACA. I too work at a large institution, but live in rural Tennessee where I have met people whose hours have been cut because of Obamacare. Further examples of people affected by the ACA can be found here in this Guardian article.

So yes, firms appear to be cutting back on employees and hours. And they are at a high point for concerns over regulations. This has my supply-side senses tingling. Your supply side senses should be tingling too. The only question is how big is this effect.

P.S. To be clear, I still view most of the lingering labor market weakness as a result of the ongoing shortfall in aggregate demand. However, the evidence above suggests supply-side concerns are increasingly becoming important.

Update: Jed Graham has compiled a list of firms who have cut hours or jobs because of the ACA.


  1. Two things:

    First, the rules are apparently backward looking, so that firms will get hit in 2014, if they are not up to standard the prior year according to a couple possible metrics, so they need to start changing now if this report is correct:

    Second, it was my understanding that the law was written in a way to penalize firms shifting work from full time to part time. They have tried to gauge what would be "full time equivalent" work of part timers and base penalties off of that. There is only so much shifting they can get away with. However, the big action has always been for firms around 50 workers. My understanding is once you reach 50 full time workers you are penalized $2000 for each worker above 30 if you don't offer insurance. Talk about distorting marginal decision making. I expected a lot more changes would come from the smaller firms ex ante.

    1. Thanks for the information. That explains a lot. Yes, marginal decision making is being distorted. The question is how big is this effect overall.

    2. right, I think june was the start of the "lookback" to determine # of full time and part time workers. as I recall, there were 360k new part time jobs that month and a loss of 240k full time jobs, leaving total hours about the same but a manager's nightmare,

    3. When we disaggregate part-time work down to economic and non-economic reasons, and compare these trends to 2012, we see two things. First, part-time work for economic reasons for 2013 is following the trend for 2012. Second, the spike in part-time work was largely due to non-economic reasons (72%).

  2. This is definitely a problem, but I don't think that the aggregate effects will be too big. The CBO estimated that, on net, the ACA will cause the amount of labor used in the economy to fall by 0.5% - mainly through a voluntary contraction in the supply of labor (page 48 if you're interested):

    With regards to the survey, it's only focusing on the negative effects of the law. Another reading could be that 20% of firms with less than 50 employees plan to consciously shift their health care costs onto the public while the other 80% don't have to do anything to achieve this.

    1. I hope the CBO is right on the aggregate effects. Thanks for link.

    2. I'm assuming that you consider 0.5% as an acceptable number. I'm curious, though, if you would prefer to wait it out and see if the CBO is correct or if you think that this is a big enough problem to warrant a change in the law immediately.

  3. There is no private sector slump in the United States. It has been growing at 4% for about 4 years now. The problem is the public sector "contraction" which has never happened before in the modern statistical era.

    Thus, the problem isn't demand or supply. There is no problem.

    1. check out consumer spending, especially for services (and esp excluding autos), growth has been terrible

  4. David, that´s almost the natural consequence of a deep and protracted demand slump. At a minimum, governments itch to legislate a recovery. The unintended consequence is that it works in reverse!

  5. Great point Marcus. An interesting question, then, is whether Obamacare would have passed had there been no Great Recession.

  6. David,
    The biggest issue with Obamacare's effect on business may be occur through a game theoretic dynamic.

    Imagine in a competitive market, firms decide to offer health insurance (given the tax benefit) as a means of attracting labor. Of course, they would rather not. Cutting it back is a non-transparent way of reducing their wage bill. The only thing that keeps them from doing that is competition: if one cuts back and the others don't, the firm will be at a competitive disadvantage in the labor market.

    Now along comes an incentive for all firms to cut back on health insurance at the same time. If firm x cuts back, firm y won't steal its workers because it is also cutting back (hours to below 30). The "equilibrium" is for workers to receive less corporate health insurance in aggregate. In a sense, this is "facilitated collusion". Labor may not adjust it's quantity supplied given 1) opacity of the lost health benefit $ value; and 2) presence of unemployment.

    In the end, though, this is a real wage cut that Keynesians argue is the solution for unemployment, is it not?

  7. First time on your site, interesting discussion. I believe the effects are temporary currently for the ACA and what we are seeing is simply a paradigm shift in market labor. The real question is going to be how the market looks once workers start being forced to participate in the insurance market place. For a place like Massachusetts where almost everyone had insurance anyway and is one of the higher paying places in the country the market distortion is going to be far different than say in a place like California or Texas. People are going to shift their demand to other things due to a drop off in spending power. I know subsides should make up for this but.... I somehow doubt it will.

    In the end it will be interesting to see how things shake out the next 2 - 6 years.

  8. gofx - David, its even worse if you add together the Taxes and the Regulation dimensions. Krugman will never see this, but both are governmental drags on business profitability via policy, and many regulatory actions have tax consequences associated with them, directly or indirectly. This "government drag" dimension is usually on par or higher than the Poor Sales dimension. This is not cherry picking, it is recognizing the total direct impact of government policy on small business.

  9. David,

    I tend to agree with you on this. As you know I have recently been making the point that it was time for the Fed to led bygones be bygones and start to look forward instead and deliver NGDP growth of 4-5% from the present levels and I don't think that there would be much to gain by an attempt to make a "one-time shock" to demand to push down unemployment.

    That is not say that there is not demand problem in the US economy, but the problem is gradually being sorted out and the key risk now seems to be that supply problems are increasing the the US economy. On the other hand judging from inflation and wage developments it is still very hard to make the argument that the worsening of supply problems are large. That could of course change as demand side weakness ease further.

    I would, however, also add that there are good reason to be optimistic on the supply side of the US economy - fracking is just one factor to mention. Another factor I believe could become quite important is that no matter what US fiscal policy will continue to be tightened in the coming years. It might be that the US political system is dysfunctional, but the end result is consolidation of public finances. Hopefully the historical compromise will include a significant reduction in US military spending and if we are really lucky decriminalization of drugs and prison reform. Such reforms would be an extremely positive supply shock to the US economy.

    So yes, Obamacare is not good news for the supply side of the US economy, but other positive supply factors might actually be quite positive. That actually makes me quite optimistic on the outlook for the US economy for the coming 4-5 year - we could very easily get 3-4% GDP growth and 1-2% inflation and a continued decline in unemployment.

  10. Good post David. I think you should also look at the "Labor Quality" data as confirmation for demand-side problems. In normal times, some firms will report difficulties in hiring good quality labour as their most important problem. When AD falls, fewer firms will report difficulties hiring. In 2008/9 the "labor quality" dog stopped barking, and the "lack of sales" dog started barking. Both were saying the same thing. Now, the labor quality dog is slowly starting to bark again.

  11. Obamacare is an obvious regulatory problem today, but what caused the increase in regulatory issues starting in mid 2008? The long term chart on regulations shows long term upswings and downswings. What are the major drivers? Do they stem from the federal government, state governments or from the local level? Cities and counties have been known to be pretty anal about the requirements they impose on local businesses. I don't think the NFIB differentiates between regulations from the various level of government.

  12. I wonder how much of the spike in concerns about regulation is due to fear mongering rather than rational evaluations ?

    1. To the extent they are caught in the conservative echo chamber that is exactly where it comes from.

  13. Here is the problem with your idea from a scaling problem. 94% of all firms with 50+ employees already provide coverage. Now are they taking advantage of a once in a lifetime opportunity to shaft employees? Maybe so.

    This screwing of labor has been going on for 30+ years. For example, Kaiser's healthcare yearly survey has seen cost shifting in the last 5 years of a scale not previously seen. Historically, health insurance cost increases have been absorbed 70% employer 30% to the employee. Last five years has inverted that history.

    The sad thing is that the wealthy don't create jobs b/c they have and/or spend money. The true job creators in our economy are the poor/middle class that spend the money to drive marginal revenue above marginal cost to create a new job. The more we take their spending or wealth away the more each wealthy person hurts himself and the overall economy.

  14. I'm a bit more skeptical about survey data. I haven't seen the second survey you posted, but the SBET is probably influenced by the non-stop propaganda 20-some percent of America has been consuming that's telling them that the black/Kenyan/Indonesian/Communist/Socialist/Muslim/atheist in the White House and his gang of leftists in the Senate are going to increase all regulations, generally. I wouldn't be surprised if small business owners were more likely to subject themselves to those media influences and then respond that way to surveys.

    Or: The spike in worries about regulations happened when Obama was elected, long before the ACA was passed. If the ACA made them worried about regulations and not simply Obama's election, then lots of these small business owners are employing psychics.

    I was talking with a person really into the gold standard who said that the dollar would be worth almost nothing in 3 years (I was talking to him in 2011, so it should soon be upon us!). I suggested he take out a huge loan and just have a blast since by 2014 that loan would be worth almost nothing and he could pay it off easily. For some reason, he didn't actually want to do that.

    There's a difference between what people say they believe and how they act. I'd trust employment data more than survey data, and even people who were told that their hours were cut because of Obamacare because there is a fair number of employers out there who are sick enough to engage in political propagandizing while reducing hours they would have reduced anyway.

  15. Found this link today and it applies to this discussion.

    An employer was one Sean Hannity and said that he was cutting work hours because of Obamacare. A Salon reporter called him and asked how many employees he had; he had 4. Obamacare only requires employers with 50 or more employees to provide insurance. The employer on Hannity pretty much admitted that he had other reasons to reduce work hours.

    There are other people Salon caught up with who hadn't even checked how much they'd pay post-Obamacare but they were complaining that they were going to pay thousands more.

    Survey data has these problems. That's why I'd trust the jobs data more; pay attention to what people do, not what they say.

  16. Alex, Salon calling up some employers is not a good indication of anything. Do you really think the Foundation of Employee Benefits Plan--a professional HR organization--would do so sloppy a survey? And the same for Gallup? Dismissing these, the NFIB, and link of documented firms cutting back (linked to above) sounds likes you are working too hard to preserve your priors. Go read the first commentator on this post. There are good reason for firms to be cutting back now.

    Plus, there is some evidence in hours worked data that shows some decline for low income workers.