Our understanding of markets and of the economy in general is undertaking a thorough rethinking.
In his New York Times magazine piece last weekend, Paul Krugman asserted that "Economics, as a field, got in trouble because economists were seduced by the vision of a perfect, frictionless market system." In this view, economists must study - and incorporate - the imperfectly rational human being into their models of how markets work. Others claim that it is rationality itself that deserves reexamination. Keir Martin, a professor at Manchester University, wrote in The Financial Times in August that "our understanding of how markets work may be better served by an examination of how different measures of rationality emerge in different contexts, and how to manage them when they come into conflict." Others, including Krugman, emphasize a need to realize that "The financial sector is just as real as the real economy." Understanding finance is critical to understanding macroeconomics.
More broadly, Douglas Rushkoff criticizes those who have viewed the market as a product of nature because doing so "is to deny ourselves access to its ongoing redesign...[O]ur ability to envision new solutions to the latest challenges is stunted by a dependence on market-driven and market-compatible answers." And Nancy Folbre of Amherst concludes that "We have overestimated the size and significance of the very thing we call 'the market.'" Her reasons for this overestimation include an overreliance on our incomplete measure of economic output, a sentiment shared in a recent Times op-ed entitled "G.D.P. R.I.P."
But even as this expansive rethinking proceeds, a disconnect remains between what we are told is a nascent economic recovery and what most Americans consider that recovery to be. Indeed, the G-20 bragged last weekend that their policy action arrested the economic decline and boosted global demand. This is true enough, as forecasters in the United States believe that the stimulus package increased GDP several percentage points. Economists in the UK and Germany feel similarly.
Yet, two new articles from regional Federal Reserve banks suggest that we ought to rethink whether market recovery is really the same as economic recovery. In a study of unemployment duration, the Cleveland Fed finds that:
[T]he sharp rise in unemployment that we have seen is not due primarily to a sharp rise in separations but rather to the fact that once unemployed, the chance of finding employment has fallen dramatically. This means that unemployment durations are getting longer.
While cautioning that the length of the recession might be a factor as well, the authors suggest that this "may reflect a permanent mismatch of skills among the unemployed...To the extent that this is true, we might expect to have an unemployment rate that stays relatively higher even after the recession."
In its study, the San Francisco Fed notes similarly elongated lengths of unemployment duration and worries that some UI unemployment insurance claimants will "exhaust their regular and extended benefits, which will further offset the intended roles of UI payments as an automatic stabilizer and means of low-income support."
These studies suggest that even as the market recovers, a significant group of Americans is being pushed further from economic recovery. As Folbre, the Amherst economics professors, describes, "Prolonged unemployment represents more than a loss of potential market output. Like extreme poverty, it reduces the ability of families to produce, develop and maintain the human capital on which our economy relies."
Congress must make sure that the 1.5 million Americans who will run out of unemployment benefits have access to further extensions. But economists and non-economists alike must reevaluate what we consider economic recovery when only the market recuperates.