Thursday, March 29, 2007

Skill Shock and Stagflation

Something occurred to me while I was looking through Bernanke's statement yesterday. Bernanke mentioned the oft repeated fact that while it was easy for employers to find low skilled workers the market for high skills is becoming tighter and tighter. These tight conditions keep alive concerns that inflation will remain high even as the economy weakens - a mild case of seventies style stagflation.

What I hadn't thought of before, however, was that the decline in skilled labor represents a supply side shock of the same type we experienced during the oil crisis. The economy increasingly depends on skilled workers for growth but the supply growth is slowing and may even decrease in the coming years.

This drives up the price of skill labor but it doesn't do much to drive up the average productivity. The result is a real supply side shock - the kind that can lead to slower growth and higher prices. If this is true then stagflation may prove unavoidable.

What are your thoughts?

12 comments:

Anonymous said...

Karl, you can model this using a standard supply-demand diagram for the 'US high skills market.' It is true, as you said, that the leftward shift of the supply curve ('stagflation') will raise wages, but the other half of the story is that the demand curve is shifting leftward also, but by a smaller distance than the shift of the supply curve. (enough to raise high skill wages some) This does not mean that just because there is a leftward shift in the demand curve, the demand for high skill labor decreases. It simply means that due to offshoring, we are cutting back supply of domestic high skills jobs, but feeding that demand into India and China.

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