A new way of thinking about recessions?


Arnold Kling has been blogging lately about a proposed new paradigm in macroeconomics that he’s calling ‘patterns of sustainable specialization and trade’, or PSST for short. Unlike the Keynesian paradigm, which focuses on aggregate demand shortfalls as the causes of prolonged recessions, Kling thinks that we should look at economic activity with a focus on comparative advantage. Many periods in history can be better understood, he says, if we look at people’s specializations and see recessions as periods where businesses and labour are out of sync with demand. Rather than there being an aggregate demand shortfall, a recession could be a time when people don’t want what labour and businesses are offering.

A recent (and simplified) example might be the Great Recession, as the 2008–present period has come to be known among some economists. Say there was a big demand for housing in the 2000s, so lots of people became skilled in construction and lots of businesses thrived in this sector. Once consumers’ tastes changed (let’s leave aside why for this post), there were a lot of people and a lot of businesses that were great at building houses without sufficient demand for those skills that all those people could stay employed at the same wage level. It’s likely that a lot of those former construction workers will have to reskill and find new work satisfying whatever consumers now want. Likewise, a lot of businesses will fail, and not just those directly involved with construction – the economy is so complex that businesses that have built themselves around construction businesses may fail, and so on.

This reskilling and reallocation of capital is aimed at finding new patterns of sustainable specialization and trade. And it takes time – the market is a discovery process where entrepreneurs experiment with different enterprises to see what succeeds and what doesn’t. It’s a messy process but it’s the only way of finding out what people really want. This process goes on all the time, but Kling suggests that if there are large-scale shifts in what people demand, recalibrations will have to take place across the economy. And you get a recession.

This isn’t a conventional Austrian approach to the business cycle, because it doesn’t require that a monetary expansion was the cause of the disconnect between demand and supply – all sorts of exogenous factors might cause people to change their minds en masse. Using this PSST paradigm would imply that financial stimulus packages might exacerbate and extend the recalibration period (ie, the recession). “Shovel ready” projects might inhibit the signals that let workers know that their skills are no longer needed, and prolong the pain of the recession. It’s an interesting perspective, and hopefully one that Arnold will develop in greater length sometime.

You can download an interview with Arnold talking about PSST at Russ Roberts' EconTalk podcast here.