The Indian government has already announced three fiscal stimulus packages. The most recent stimulus package announced by the government is worth Rs 29,000 crore-though in the form of tax cuts. Across the world the fiscal propulsion effort is epic ($787 billion in the US; euro 200 billion in EC; 23 trillion yen, $250 billion, in Japan; $568 billion in China). Public expenditure on well chosen projects is a highly practical way of offsetting the steep decline in private demand, and creating employment?among immediate beneficiaries first, and through the multiplier, across wider swathes of the economy. President Obama intends to create 2.5 million jobs with new spending.
But the creation of new jobs will not stop existing jobs from being destroyed. We know from careful analysis across a wide range of countries, of the way employment changes over time, that the creation of jobs and the destruction of jobs go hand in hand in every period. They offset each other, and in normal times result in only small net change in employment. In any economy and in any year, some industries expand, adding jobs, while others contract, destroying jobs. Within any industry and in any year, some firms expand, creating jobs, and some firms contract, destroying jobs. Even at the level of an individual plant, some jobs will be added and others cut in any given period of time. These are natural and healthy patterns in firm and industry dynamics.
We will need to steel ourselves to the fact that even as fiscal measures pump up aggregate demand and create jobs (and infrastructure), alarming job losses (e.g., US firms closed off nearly 6,00,000 positions in January) will continue to shock country after country for a some time yet. Each month, even as tens of thousands of jobs are created, iconic firms will shed employees. Unfortunately, headline news will focus only on this! If only to address some of the misplaced criticism of stimulus packages that can be expected, it is worth examining why some firms will go relatively untouched by fiscal measures and continue to suffer losses.
It is obvious that jobs are destroyed or created according to variations in demand that firms face for their products. When it comes to allocating expenditures to non-essentials, as consumers we look to our long term and sustainable income expectations. So our discretionary expenditures (for example, on durables, but equally in the choice between more and less expensive varieties in all categories, including clothing and food) depend on what has been called ?permanent incomes?. Very simply, this notion of income differs from current disposable income in that it factors in the likelihood of continued employment in the future, and accumulated wealth, in the form of housing and financial assets, for example.
It is intuitive that there are two types of asymmetry that characterise the way consumer behaviour is predicated on ?permanent income?. The first is that people shift down in lifestyle very rapidly when they perceive a decline in their permanent incomes; but they would shift up only gradually in response to any perceived increase in permanent income. This is perfectly rational behaviour, given positive complementarities between many components of lifestyle, the benefit of scaling them up together, and the time involved in coordinating such choices. The second asymmetry, equally rational, is that people are readier to revise permanent incomes downwards in response to negative changes in economic circumstances, than they are to revise it upwards in response to positive changes in circumstances.
Negative economic circumstances are more rapidly perceived and factored in, than positive developments. Prosaically, an economy can be considered a distribution of (households with their) estimates of permanent incomes. In every country, the crisis has squashed and shifted this entire distribution very rapidly in such a way that sizeable segments of the population have dropped instantaneously out of the markets for many specific goods and services. In their calculation, their permanent incomes have dropped below the thresholds that allow some goods and services to be in their choice sets. The consequent declines in demand faced by firms selling these products are sharp and disproportionate to the decline of aggregate demand in the economy.
The fiscal stimulus will create many jobs fairly quickly, but it will take longer for uncertainty to abate and for household assets to recover; for consumers to perceive increases in their permanent incomes; and for discretionary demand to respond to these perceptions. Many firms that have suffered drops in demand will be stuck in their lows for some time. Deep discounts may entice consumers with safe jobs to spend more, but that will not stop operating losses and job destruction. The challenge is to get the stimulus to address long-term sustainable incomes.
-The author is reader in economics at the Judge Business School, University of Cambridge, and fellow of Corpus Christi College