The AI Layoff Trap

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.

Figures (2)

• Figure 1: The over-automation wedge $\alpha^{NE} - \alpha^{CO}$ across the parameter space. Shading runs from white (zero wedge) to black (wedge $\geq 0.50$). Dashed lines mark the $N = N^{*}$ boundary below which no firm automates. (a) Number of firms vs. cost saving $s = w - c$ at fixed wage ($\lambda = 0.5$, $\eta = 0$, $k = 1$). (b) Number of firms vs. demand loss $\ell = \lambda(1-\eta)w$ ($c = 0.60$, $\eta = 0$, $k = 1$). (c) Number of firms vs. income replacement ($c = 0.60$, $\lambda = 1$, $k = 1$).
• Figure 2: Welfare consequences of over-automation. All panels use $c = 0.30$, $\lambda = 0.5$, $\eta = 0.30$, $N = 7$, $k = 1$, $A = 10$. (a) Normalized owner surplus $\mathcal{K}$ and worker income $\mathcal{W}$ vs. automation rate ($1$ = cooperative benchmark): both groups lose at $\alpha^{NE}$. (b) Factor payoff frontier: $\alpha^{CO}$ at $(1,1)$, $\alpha^{NE}$ strictly southwest (Pareto dominated). (c) Planner's optimum $\alpha^{SP}(\mu)$ vs. worker weight $\mu$ (not normalized): the gap to $\alpha^{NE}$ is the over-automation wedge, positive even at $\mu = 0$.

Theorems & Definitions (13)

• Proposition 1: Equilibrium and over-automation
• Corollary 1: Frictionless limit
• Proposition 2: Generalized planner and surplus loss
• Corollary 2: Sign of the externality
• Proposition 3: Worker equity reduces but cannot eliminate the wedge
• Corollary 3: Voluntary profit-sharing does not arise
• Proposition 4: Partial coalitions cannot eliminate the wedge
• Proposition 5: Pigouvian automation tax
• Proposition 6: AI productivity widens the over-automation wedge
• Proposition 7: Endogenous entry in the frictionless benchmark