Hard vs. Soft Landings

Falling off a roof, I'd rather have a soft landing than a hard one. Metaphorically, people speak positively of a "soft landing" for the economy. However, the economy is not a single organism that is falling. When an economy falls, individual units -- people or companies -- "fall": individual people become unemployed, individual homes are foreclosed upon, and individual businesses go bankrupt. I think the notion of a soft-landing for an economy is often a fallacy of composition.

Consider the experience of two countries. The unemployment rate is shown in this diagram:

Both countries start and end the period with the same rate of unemployment: 4.8%.

However, they experience very different changes in between. See how unemployment shoots up to 14% in the country of "Blueland" while "Redland" has a far milder rise to 8%.

The rate of unemployment comes back to 4.8% much sooner in Blueland, while it lingers at a 8% for a while in Redland.

So, the alternatives are: a short period of very high unemployment versus a longer period of medium-to-high unemployment.

Should government "help"?: Suppose the government of Blueland could engineer a soft-landing like the one in Redland, ought they do to so? We can object to this because it is not the government's role. Also, every such interference ends up with wealth-redistribution decisions, e.g. "is it better that Mr. Smith stays unemployed for 4 months, rather than having Mr. Jones and Mr. Paulson unemployed for 2 months each". It is not the government's role to pick winners and losers.

However, even if we abstract that away, there is a more technical (though less philosophical) point. Even if one grants the statist premise about the role of government, the soft-landing is still not necessarily "better". While the diagram above may seem to depict that more people lose their jobs in Blueland, it actually depicts the opposite. In this particular example fewer people lose their jobs in Blueland! As a bonus, each unemployed Bluelander stays unemployed for a shorter duration.

Data used: Here is the actual data that was used in the example: Both countries have a little over 10 million employable people. In Blueland, a million people of these lose their jobs in a short, 6-month "hard landing". Then, over the next six months, they start to find new jobs. So, we see a peak 6 months into the Blueland downturn, which then starts to correct. Meanwhile, in Redland, slightly over a million people lose their jobs, but over a two year period, and each of them finds a new job in slightly over six months. So, we see a jump, which stabilizes after 6 months, when people are being re-employed as others lose jobs. This stays steady for about a year and then the new employment surpasses the job losses. (1)

If we look at Blueland and Redland as two different possible scenarios for the same country, and assume that the same people are losing jobs in each, not a single individual is better off in the Redland scenario.

Of course, one might argue that a sharp downturn can create dynamics that makes unemployment or other things still worse. I mostly disagree, but that is a separate argument. In this post, I simply wanted to point out the fallacy of composition in the notion that a hard-landing is worse than a soft-landing as such.

Imagine a businessman faced with lower sales. He has to cut costs. If the downturn is hard, he will have to lay off both Tom and Bob, but if the government comes in with stimulus maybe he will only fire Tom. The problem is, the government stimulus holds back the correction, and Tom stays out of work longer. So, Tom is sacrificed to Bob. The most marginal workers are sacrificed in this way: including those paid the least. For instance, younger workers see their unemployment rate rise much higher than others.

Recently (summer 2009), the government introduced a "cash for clunkers" program where buyers got rebbates of upto $4,500 on the purchase of a new car. One objective was to stimulate auto-sales. Now, we hear that some auto companies had to run overtime in order to meet the unexpected demand. So, while more people are being unemployed each month, the government is subsidizing the overtime pay of others. A classic Tom vs. Bob scenario.

Notes:

(1) If you want to check the data for yourself, get out a spreadsheet and plug in some numbers yourself. I'd be happy to provide more info to anyone who is interested.

(2) Recently another dad in my son's school was laid off. He was telling me that he could comfortably last 6 months on a mix of his savings, unemployment payment and severance pay. He could even drag it out for a year. Much longer than that and he would be in trouble. A little illustration of why -- from the point of view of an individual -- the shorter the downturn, the better.