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NAIRU, Structure, and the Case for a Minimum Wage

The non-accelerating inflation rate of unemployment – or NAIRU – is the level of employment above which we risk dislodged inflationary expectations tempting a positive wage-price feedback loop. Almost everything in macroeconomics comes back to NAIRU which is broadly determined by “supply-side” factors like technology, institutions, etcetera.

NAIRU, a practical tool, is closely associated with two more abstract concepts of general equilibrium: the natural rate of unemployment, and full employment. NAIRU is becoming an increasingly irrelevant concept. I think the “natural labor employment demand” has fallen, but this is not really the same thing. This is closely linked with a case for higher minimum wage, as I’ll explain below.

Technology

Consider a world where all consumer goods are automatically produced. Everyone, aside from a small cohort of designers and technocrats is unemployed, and receive goods and services through basic income. NAIRU makes no sense for the labor force as a whole. The rental rate on a robot is only the cost of replacing depreciated capital, without permanently strong patents, labor substitution will increase prices which will tempt further increases in the wage rate (or taxes on technocrats to finance a higher basic income). Hence NAIRU for workers is 100%.

On the other hand, since technocrats aren’t substitutable the opportunity cost is only the wage rate determined by an imperfect market – which naturally includes rents since the barriers to technical skill are non-zero. By definition, NAIRU for technocrats is non-zero since the supply-side of the economy is entirely determined by supply of technocrats. Since markets are imperfect, and rents are high, any increase in wages will come from taxes on capital returns rather than price inflation.

This is an extreme case, but the United States is moving towards an increasingly capital dominated economy. NAIRU was a useful concept when the labor-share of income was 70%, but as it falls to and below 40% – as I imagine it will within two decades – the unemployment of labor becomes a useless concept.

Inequality

The rate of unemployment – perhaps the most ubiquitous economic statistic – is useless in periods of high inequality. When unemployment rate is high, economists today like to claim that GDP is “below potential”. The “output gap” is measured – sensibly – in dollar terms. Unemployment rate, instead, is measured in unit terms.

The output gap includes auto-workers made redundant, as well as factories shut down, and fields unplowed (that of labor, capital, and land respectively). In the previous section I noted the diminishing relevance of NAIRU considering the rising preponderance of capital; but even within labor markets it is a crude measure at best.

Let’s say in an economy, I had a factory rented at $5 billion, an airplane rented at $5 million, and a screwdriver rented at $5. In a recession, suppose I couldn’t afford to lease the screwdriver. What is unemployment? I’d say it’s epsilon, but someone sufficiently crazy can say it is 33% – since one-third of capital units are disemployed.

But let’s say in an economy I have 2 engineers, 8 scientists, and 90 fry cooks. If 20 fry cooks were disemployed by recession, we’d freak out about 20% unemployment, and yet if both engineers were disemployed we’d be content at 2% unemployment. The unit rate of unemployment purports that we are all equal and that, believe it or not, isn’t the case.

An increase of technology allowing for the replacement of precisely one doctor is more disinflationary than that allowing for the replacement of precisely one fry cook. This distinction is not relevant when we are talking about socioeconomics – where unit rate dominates – or when inequality is irrelevant. Neither, when we speak of shifts in NAIRU in 2013, is the case.

Form

We can be disemployed in many forms. A single-mother wishing to work two shifts to save for her son’s college may be given only one. An auto-worker may be laid off. A physician’s assistant may be asked to work only part-time. Not all of these, in practice, are actually measured but each represents an equally valid claim to unemployment as stipulated by economists.

The way many economists talk, NAIRU moves in tension with aggregate supply. That is, when David Brooks suggests NAIRU has increased, he’s saying the output gap isn’t as big as we think it is, and hence fiscal or monetary stimulus cannot be beneficial any longer (never mind the fact the low inflation today suggests he’s wrong anyway). 

That means an increase in NAIRU – as such – isn’t a good thing. But Americans, especially poor Americans, are among the most overworked people in the world. Technology-biased capital change can, on the one hand, increase the unit rate of unemployment. It can also redistribute hours – something I’ve suggested before – which  can have powerful social benefits.

The scenario I set up in the linked post purports a world with large technological automation augmented with a basic income and high quality social programs. In this case, there would not necessarily be an increase in “hour unemployment” as the quantity of labor supplied in hours falls – resulting in a lower equilibrium.

The point here is twofold:

  1. NAIRU can become relevant if measured in hours,
  2. Under proper and justifiably stipulated economic institutions such an unemployment will be illusory, under standard reasoning.

The Case for a Minimum Wage

A common refrain on the economic right suggests that any significant increase in the minimum wage increases NAIRU. Take this from Peter Tulip, a staff economist at the Federal Reserve, asking whether “Minimum Wages Raise the NAIRU”:

Probably yes.

A high minimum wage (relative to average wages) raises nominal wage growth and hence inflation. This effect can be offset by extra unemployment; so the minimum wage increases the Non-Accelerating Inflation Rate of Unemployment or NAIRU.

This effect is clearly discernible and robust to variations in model specification and sample period. It is consistent with international comparisons and the behavior of prices.

I estimate that the reduction in the relative level of the minimum wage over the last two decades accounts for a reduction in the NAIRU of about 11⁄2 percentage points. It can also account for the substantial reduction in the NAIRU in the USA relative to continental Europe. 

My approach to NAIRU – predicated on high inequality and forceful capital-biased tailwinds – renders this type of analysis wanting, for a couple reasons:

  • A higher NAIRU can be “felt” through shorter shifts and fewer months worked – neither of which are socially debilitating. Furthermore, because the fewer hours are worked at a higher wage rate, it is not clear that living standards will fall too steeply. 
  • Minimum wages subsidize labor-substituting innovation. The opportunity cost of replacing one fry cook with automated robots falls as the minimum wage rises – this suggests an expansion of aggregate supply.

None of this is necessarily a good thing and is premised on the assumption that the government will work with employers in crafting policy that supports hour reduction and wage sharing policies. This is how U3 in Germany miraculously fell over the last decade. As the wage share of income falls, it will be incumbent on any government to impose more progressive taxes and perhaps even a basic income: but this isn’t necessary for my theory – except in the extreme.

If you share my conviction that a large part of the American population either works too much, or would like to, leaving little time for family, then a minimum wage sends the market that signal, without causing the unemployed any strife. 

The NAIRU is an idea whose time has gone.

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2 comments
  1. Henshaw said:

    I still can’t believe anyone thinks the minimum wage is a good idea. It was almost a settled topic 25 years ago, but it’s zombie economics. It’s a perfect mix of low information voter populism and intelligentsia gone amok. It’s simple… when the minimum wage is raised unemployment goes up among the people it’s supposed to help. Teenage unemployment is already way too high. The only studies to the contrary are people who “want to believe” it helps.

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