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11/29/2009

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Anonymous

I am not as concerned with the problems of implementation of a hiring tax-credit. I think there are relatively easy and straightforward (though, not necessarily bureaucratically cheap) techniques to prevent mere *churning* of employees and ways to verify true net new hiring.

But while high unemployment levels are only slowly wage-deflationary due to the well-understood lags, I wonder if hiring subsidies might present a more rapid deflationary problem.

Most firms choose levels of output and employment so that marginal revenues equal marginal costs. The marginal profit on the labor of the last hire is $0. During a recession, the demand and marginal revenue curves fall, and the new meeting point is at a lower output but *higher* price (because the marginal cost curve in inflexible in the short-term, and let's assume, has diminishing returns to scale).

The "last worker" is now a liability and will be let go, and let's assume the "second-to-last" worker is kept on. Now consider the effect of the subsidy. The marginal cost curve now breaks at the current low level of output, and continues, disconnected, at a level below the original line by an amount equal to the subsidy divided by the last worker's productivity. The new price for the output must now also decline by that amount to meet the prior level of production - which yields instant deflation in the marketplace.

And, of course, that deflation would hit the profitability of any competing firm that had not previously needed to fire any workers - but now must either do so - or lower wagers - to remain competitive and solvent.

Something to think about...

-L. Indyk

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