Krugman on Schumpeter
Krugman wrote the other day that Schumpeter’s macroeconomics falls apart because:
[Schumpeter says] mass unemployment is necessary, because you have to shift resources away from sectors that got too big, stimulus is a bad thing because it slows the necessary adjustment. And now as then, the whole notion falls apart when you ask why, say, a housing boom — which requires shifting resources into housing — doesn’t produce the same kind of unemployment as a housing bust that shifts resources out of housing.
Thus urged, I did ask myself why there would be unemployment in a housing bust, but not a boom. The answer, Mr. Krugman, seems pretty obvious:
- Investment bubbles collapse much faster than they inflate. In the real world, labor can only redeploy so fast. If capital reallocation exceeds that rate, you get unemployment. So on the way up, capital redeploys slowly enough for labor to react smoothly. No unemployment. On the way down, capital redeploys much faster than labor can. Presto, unemployment.
- (more speculatively) In the short run, bubbles increase the blended rate of return on capital for the whole economy. Higher ROI permits overall employment to rise above the rate that would have prevailed without a bubble. When it bursts, ROI falls, so unemployment rises.