The AI Layoff Trap

2026-03-20

AI Summary

This study addresses the negative externality arising from AI-driven over-automation, which, while enhancing firm efficiency, suppresses aggregate consumption through job displacement. The authors develop a task-based general equilibrium model integrated with game-theoretic analysis to examine strategic interactions in firms’ automation decisions. The findings reveal that, despite rational agents and a rich set of policy instruments, competitive pressures combined with advances in artificial intelligence intensify an “AI layoff trap.” Conventional interventions—such as universal basic income, retraining programs, and employee equity sharing—prove insufficient to correct this market failure. Only a Pigouvian tax on automation aligns private incentives with social welfare, thereby achieving the socially optimal outcome.

Technology Category

• Game Theory and Economic Paradigms: Mechanism Design
• Multiagent Systems: Mechanism Design
• Philosophy and Ethics of AI: AI & Jobs/Labor

Application Category

• Economics, Online Markets and Human Computation: Uses of LLMs and GenAI for marketplace design, bidding, and strategic interactions
• Responsible Web: Machine-in-the-loop, human agency and autonomy
• Social Networks and Social Media: Generative AI / large language models and their impact on social systems

Abstract

If AI displaces human workers faster than the economy can reabsorb them, it risks eroding the very consumer demand firms depend on. We show that knowing this is not enough for firms to stop it. In a competitive task-based model, demand externalities trap rational firms in an automation arms race, displacing workers well beyond what is collectively optimal. The resulting loss harms both workers and firm owners. More competition and "better" AI amplify the excess; wage adjustments and free entry cannot eliminate it. Neither can capital income taxes, worker equity participation, universal basic income, upskilling, or Coasian bargaining. Only a Pigouvian automation tax can. The results suggest that policy should address not only the aftermath of AI labor displacement but also the competitive incentives that drive it.

Problem

• AI displacement
• demand externality
• automation arms race
• competitive incentives
• labor market

Innovation

• automation arms race
• demand externality
• Pigouvian tax
• task-based model
• AI labor displacement