GUEST BLOGGER: Unemployed but Happy

I think I may have just stumbled upon the holy grail of macro-economics. I think I have found qualitative evidence in support of the seemingly ridiculous intuition of the Real Business Cycle (RBC). RBC theories try to explain why there are booms or recessions which deviate the economy from their growing trend.

RBC created a revolution in economic understanding but in recent years has experienced significant backlash. Theoretically RBC models, given a few simplifying assumptions, seem extremely sound.  They are derived from the almost now canonical micro foundation of utility maximizing individuals and profit maximizing firms. The problem however is their seemly nonsensical conclusion. Basically they imply that unemployment during recessions, even those as horrible as the current one, is optimal. The idea is that as real wages go down because of the recession, the relative value of leisure goes up and some people, even many people, choice to go on an extended holiday until the good times return. So then we would expect the unemployed in a recession to be happy. Sounds crazy right?

Well not in Sunny South Africa. I just returned from a short visit home to find many of my friends are now unemployed and to my surprise absolutely loving life. Golf 3 mornings a week, hours at the gym and of course long leisurely lunches. Funnily enough their status as victims of the global recession is also helping their sex life. In addition to the benefits of the extra gym and sun, they have more time to actively pursue girls. And their sad sob story about being retrenched really seems to work.

Now despite what you may think these people are no bums.  Most are professionals with tough undergraduate degrees and at least 3 years work experience. Granted most of them have hated the working world and only studied what they did to appease their parents but their expected future earning potential is very high. They also very importantly have no significant credit constraints. You see most still live at home and have access to their generally well off parent’s credit cards. So why shouldn’t they be taking full advantage of their fortuitous situation.

I asked sarcastically if their lifestyles had been hurt in anyway. The only possible consequence they could think of was that maybe the regular oversees December holiday would be a bit extravagant this year. Sadly renting a house for 2 weeks overlooking the sea in Cape Town is all that they will be able to afford.

How can this be the case you ask? Every good economist knows that people should smooth their consumption over their lifetimes. If they were rational they would follow Milton Friedman’s life cycle hypothesis and go on that big holiday to Brazil or Thailand. The problem is that here they run into a credit constraint. This is where their parents draw the line. They can understand their children loafing around the house while the recruitment agent searches in vain for a suitable job. An important key to this whole story is the need to keep the bankroller (in this case the parents) sure that this is just a temporary phenomenon. They need to believe that the expected future earning of their darlings is still high and one day, very soon, they will be back on their feet.

Now you might be forgiven for thinking my friends are spoiled brats. Perhaps you may even be a bit jealous. But if you put aside your personal feelings for a moment and think like an economist you will understand that they are in every sense rational utility maximizing individuals and we shouldn’t expect or want them to behave in any other way. Viva la recesión!!!