Knowing and Making

This BBC article asserts that... Productivity, as measured by output per hour of work, rose at an annual rate of 9.5% between July and September. The data suggests that firms, which have cut jobs in the downturn, are now increasing their output, which may in turn lead to them needing more staff. This is truly a paradox. Greater productivity normally means firms need fewer staff - until, eventually, rising income increases aggregate demand, and then the laid-off people are employed in other sectors. The article seems to be another example of the equilibrium fallacy *, where a reversion to equilibrium is mistaken for a first-order effect. That is, firms cut staff because they had insufficient demand for their products - naturally, getting rid of the least productive staff. The remaining workers are more productive on average, and the reduction in output is less than the reduction in staff. This doesn't imply at all that either demand or output is increasing . If productivity had in...

OK, this solution is simple only to the extent that it's also simplistic. But it might just make a contribution. Arnold Kling asks (via Mark Thoma) " Why is the Recovery of Modern Labor Markets So Slow? " Part of the answer - I emphasise it's only a part - is the reluctance of people to accept low paying jobs while they still feel there's a chance to get a better paid opportunity. This means that people burn through their savings, reducing their own economic welfare as well as society-wide GDP, when they may end up having no choice but to take the same low-end job that was available to them when they were first laid off. Why do people act this way? Undoubtedly part of the cause is a cognitive issue: the hit to pride and self-esteem from accepting a lower-paid and lower-skilled job. But another aspect highlighted by Thoma is that they want to spend their time looking for a better job instead of working at a worse one. Now how much time do people really spend lookin...

One of the primary criteria in designing any system of pay is to influence the recipients' behaviour. Traditional pay structures work on the assumption that people behave rationally. Thus, they will pay people for generating profits for their company; on the basis that if you pay them more for higher profits, they will generate more profits. This has the attraction of simplifying the manager's job - assume that the employee can figure out the best way to make profits, and leave it to them. However, this structure has at least three intrinsic problems. One is asymmetry: you can pay someone for making profits, but you can't penalise them for making losses. Virtually no employee will work for a company if there are circumstances in which they would have to pay  for the privilege. The other is the agency problem: the employee has control over the company's resources but does not get all of the benefits of using them in the most productive way. Thus, a temptation exists for ...