William J. Polley

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August 12, 2005

Job creation: gross vs. net

A million sounds like a lot. A million here, a million there,... you know the rest. I'm pretty sure that talk about millions of whatever just sounds to most people like "a lot." But economists know that you need to understand the significance of a million (or a billion, or whatever) in context--are we talking gross or net?

We begin with Paul Krugman's latest op-ed: (NY Times)

I used to live next door to a Russian émigré. One day he asked me to explain something that puzzled him about his new country. "This place seems very rich," he said, "but I never see anyone making anything. How does the country earn its money?"

The answer, these days, is that we make a living by selling each other houses. Since December 2000 employment in U.S. manufacturing has fallen 17 percent, but membership in the National Association of Realtors has risen 58 percent.

58 percent is a lot--that is true. In that same period, the BLS figures for the real estate sector show an increase of 150,000 jobs, or about 10 percent of the total jobs in the sector. Obviously, not every job in the real estate sector is accounted for by Realtors. However, the overall increase in the sector is not out of line with the growth in the 5 years preceeding that period. It is blatantly obvious that employment in rental and leasing is practically flat (actually down just a bit) since December 2000. It's probably reasonable to hypothesize that some people who worked in the rental business are now real estate agents. If the housing bubble deflates, I think we could expect that trend to reverse.

Given the interest many of my readers have in the housing picture, I thought you might like these charts. The BLS sure has a great web site.

Krugman continues:

The housing boom has created jobs in two ways. Many jobs have been created, directly and indirectly, by a surge in housing construction. And rising home values have fueled a simultaneous surge in consumer spending.

Let's start with home building. Between 1980 and 2000, which was before the housing boom, spending on the construction of new homes averaged 4.25 percent of G.D.P. In the most recent quarter, however, the figure was 5.98 percent. That difference is equivalent to about $200 billion a year in additional spending, generating roughly two million extra jobs.

He's correct about the $200 billion a year in additional spending. But two million extra jobs? Since he's talking about an increase in the fraction of GDP spent on housing construction, isn't he really talking about two million more jobs in the economy being supported by spending on construction as opposed to being supported by other spending? Fewer jobs are being created from increases in other types of spending. It's gross job creation vs. net job creation, and it includes both direct and indirect effects.

Then there's the jump in house prices. Over the past five years housing prices have grown much faster than the overall cost of living, adding about $5 trillion to the public's wealth. Typical estimates say that each additional dollar of housing wealth adds about 3 cents to annual consumer spending, as families reduce their savings and borrow against their newly valuable homes. So we're talking about an additional $150 billion in spending, and roughly 1.5 million more jobs.

Same story; same multiplier. We're talking about new wealth in the last 5 years contributing to additional consumption spending. Consumption spending kept right on rising during the recession and recovery of the last 5 years while investment and net exports fell. Again, Krugman is really talking about jobs that are now being supported by consumption spending (housing induced) as opposed to being supported by investment or exports. They may be new jobs, they may not be. We are, after all, talking about one sector growing while others are shrinking. Of course, to the extent that during the recession and shortly afterwards total jobs fell, it is probably the case the additional spending was taking up the slack and keeping net job destruction from looking worse. The same is true of construction. Whether these jobs are taking up the slack in the labor market now is less obvious. Again, it's gross vs. net.

I can tell a (really simplified) story that illustrates the point. Imagine a small town--we'll call it Keynesville. Suppose aggregate home values rise by $10,000 in Keynesville and people take out all that equity. They spend it all on consumption goods in town which, after a multiplier process, raises total income by $50,000 (assuming a simple Keynesian multiplier of 5). The increased demand causes a local firm to hire an additional worker for $50,000. A job is created. Of course, if net exports exogenously fell at the same time, a job might be destroyed. Gross job creation (the story Krugman is telling) from the increase in home values only tells half the story.

Does anything else in the U.S. economy rival housing as a source of job creation? Well, there's also the military buildup. The Economic Policy Institute estimates that increased military spending over the past four years has created 1.3 million private-sector jobs.

I looked up the EPI brief whence cometh the 1.3 million estimate. The author cites the administration (OMB), but doesn't give a link and I couldn't find it. If anyone has a link, let me know.

Here's what the EPI says:

Federal, state, and local government spending has created 2.1 million jobs in the last four years (see footnote). According to the administration's budget report, defense spending is generating 1.33 million more jobs in the private sector this fiscal year (for a total of 3.85 million jobs) than it did four years ago (2.52 million). At the same time, government jobs have increased by 760,000. In a fully employed economy, the additional 1.2 million jobs generated by government spending would have caused a reduction in jobs in other parts of the economy. But because the current labor market is so weak, the spending by people holding these 2.1 million new jobs has actually resulted in what is known as a "multiplier effect," leading to the creation of even more jobs in the labor market.

Footnote:

This estimate does not include private-sector jobs resulting from more spending for homeland security, health, education, and other purposes.

The report goes on:

Defense spending gave its largest single-year boost to private-sector jobs in the fiscal year that ended in September 2004. In that year alone, defense spending directly generated almost half a million jobs (495,000). The multiplier effect from that spending no doubt contributed to the other 434,000 jobs added in the private sector that year. By contrast, in this fiscal year, additional defense spending is supporting only 70,000 more jobs, a small fraction of the 2 million private-sector jobs being added this year.

Where do I begin? Estimiting the size of the multiplier here is pretty dicey business. But if you try to assume something reasonable for 2004, you end up concluding that the effect is pretty small this year. Pretty small indeed. This was a temporary effect.

I also question the extent to which the private sector defense jobs created many additional jobs that would not have been created without defense spending. This multiplier is greater than one perhaps, but I'd like to see evidence.

And what of the 706,000 jobs created by the government in the last 4 years? That's about right, in fact. But when you dissect that number, it's not that impressive. Here is the BLS chart:

If my memory serves me correctly, the spike in May 2000 would be temporary census workers. Notice that growth of government jobs has slowed recently. Federal government employment is actually falling.

At the end of all of this, we've used the word "million" a number of times but haven't really pinned very much down. Krugman is talking about housing supporting a few million more jobs out of 134 million, some new, some not. Couple this with the EPI attributing defense spending for 1.3 million private sector jobs, again some new and some not. Some taking up the slack in the labor market, some displacing growth that could come in other sectors. What do we make of all this?

Krugman is using these millions of (gross) jobs created because of changes in the composition of spending (with multipliers flying around everywhere you look) to make a statement about how the labor market is on shaky ground because of these shifts. The real story beneath the story here is that he's saying that the economy is more dependent on housing than before--and that much is true. All those millions of (gross) jobs created directly and indirectly by housing must mean millions of (gross) jobs directly and indirectly lost elsewhere, right?

But the indirect effects, that is, the (gross) jobs created through these multiplier effects (as elusive to track down as they may be) would have been created anyway in all likelihood. I find it a little troubling to talk about multiplier effects resulting from people moving from jobs in the rental sector to the real estate sector. Ditto for an increase in construction's share of GDP.

And where are the jobs that have been indirectly destroyed by the sectors of the economy that are shrinking? There must be millions of them. But you might never know which jobs they are. The restaurant worker whose job was created indirectly by factory expansions 30 years ago might now be earning a living serving real estate agents instead of factory workers. Aside from any social implications beyond the scope of this discussion, he probably doesn't care.

If you believe in any sort of resiliency in the labor market, I think you would want to put less emphasis on the jobs created through the indirect effects. When the pendulum swings in the other direction, some jobs will be directly created, some will be directly destroyed, and a lot of others will notice changes, but they'll see it through.

I have trouble seeing the purpose in using multiplier effects to think about gross jobs created by shifts in spending patterns unless you believe in a lot of labor market rigidity. If the housing boom ends and all those new real estate agents and mortgage brokers are out of work with no other prospects, then we could have problems. But I think the labor market is more resilient than that. It did, after all, survive the pendulum swinging in one direction. I'm confident the pendulum could swing back without breaking.

Posted by William Polley at August 12, 2005 7:59 AM

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Posted by: CalculatedRisk at August 12, 2005 6:24 PM

Posted by: William Polley at August 14, 2005 3:42 PM

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