Wednesday, August 23, 2017

More on the "Real Growth" Phillips Curve

I have been trying to build a case for a "real growth" Phillips Curve, where low unemployment leads to rising wages.  Normally, this is associated with rising inflation or with rising labor share of national income.  But I think it mainly equates with higher real growth.  (I think there is a case to be made for labor share of domestic income rising during extended periods of stability.  But, I think this has more to do with capital requiring a lower risk premium than it has to do with things like negotiating power.)

Conor Sen has been noting on Twitter how restaurant margins are getting squeezed by rising labor costs.  It looks like what we have here is a battle between inflationary or labor share versions of the Phillips Curve.  Either restaurants will raise prices and stay in business or they can't raise prices, and their profits will suffer.

But, if we think one more step here, we can see that this is economic growth.  This is sorting.  Wages are rising because workers have better things to do.  In other words, the economy has moved to a new regime where more value can be added somewhere than could be added in the restaurant that used that labor in yesterday's economy.

Sen notes: "We have too many restaurants and a lot are going to close over labor costs and an inability to raise prices."

What will happen, if growth continues, is that the better restaurants will have pricing power, the worst restaurants won't.  Or, more generally, the weaker firms will naturally be the firms that fail.  There will remain a restaurant sector of some size, where wages will be higher and profits will remain at normal sustainable levels.

Interestingly, restaurant employment is growing as a proportion of total employment.  So, this may not even require a contraction in the industry itself.  Weak firms might be forced out by shrinking margins, even as the category remains healthy.

This is creative destruction.  And, we can see quite clearly that this is happening during an expansion.  It is happening because of expansion.  This is the sort of pressure that we need to apply to weak firms in the restaurant industry.

A contraction would also cause weak firms to fail.  But, why would we choose that?

It seems to me that many people see rising wages and they expect that to be inflationary, so they decide that this is unsustainable, and a contraction will pull us back down to earth.  Then, on the other hand, some employers see rising wages and they find their profits being squeezed - in other words, it's not inflationary.  And, they decide that this is unsustainable, and we need a contraction that will pull us back down to earth.

What is really happening is that wages are rising, and this is unsustainable.  We are approaching a better tomorrow.  It is unsustainable in the same way that blacksmithing, film developing, and candlemaking were unsustainable in the past.  Our reaction should be, "This is unsustainable.  Let's keep it up!"


  1. Well, I am biased to favor this post, but then sometimes one has to cave in to their own biases and say, "I like it."

    Certainly, the 1990s did not see much inflation despite pretty good job markets.

    That is a keen observation that restaurant employment (I assume nationally) is growing as a fraction of total employment.

    It sure seemed like in Los Angeles, the hip thing to do was open a restaurant. Most go out of business. It is like financing films. These sectors are flooded with capital. I assume there are too many art galleries too.

    Here is a reverse-a-rama: Sometimes you hear, "Well higher interest rates and a recession will squeeze out the weakling businesses, so they are good."

    How about, "Higher wages will squeeze out poorly managed and weakling business, so they are good. "

  2. "Higher wages will squeeze out poorly managed and weakling business, so they are good."

    This is a great insight. I love it!

    1. also biz like home care agencies, nursing homes, for which demand might b more elastic than need

  3. one day we'll get to test ngdp level targeting, one day...

  4. FYI:

    Denver homes up 60% since the bubble?

  5. Egads:

    “According to the Asian Real Estate Association of America, Seattle is currently the sixth most popular destination for Chinese immigrants in the world. And there’s good reason for it; Seattle is the closest mainland U.S. city to travel to from Beijing and offers things that really appeal to the Chinese, like clean air, quality education, and employment opportunities with several Fortune 500 companies,” said OB Jacobi, president of Windermere Real Estate, covering the Seattle market. “This is why Chinese buyers are now estimated to represent upwards of 40 to 50 percent of all real estate activity in Seattle’s most expensive neighborhoods, of which at least 75 percent are paid in cash. While some call this a trend, I believe it’s an emerging aspect of our market that’s here to stay for the foreseeable future.”


  6. I wonder if restaurants enjoy job search advantages related to visibility