Written by Andrew Maragni
The financial crisis of late 2008 helped sparked what many refer to now as “The Great Recession”. The fall of Lehman Brothers that September ignited a worldwide panic which sent stock markets plunging and government scrambling to save the global economy. While government intervention in the forms of bailouts and economic stimulus averted a total economic calamity, the economic pain resulting from a financial meltdown could not be completely avoided. Two years later, we no longer fear the total collapse of the global economy but we are still dealing with the economic damage wrought by such a crisis. There are plenty of dire economic situations the world still faces such as an imminent Greek default or China’s manipulation of their currency, but no economic issue compares to high unemployment in the eyes of the general public. The economy is clearly recovering by all objective measures but until the unemployment begins to fall, for many recovery is just a word thrown around by economists and politicians. Long-term unemployment is particularly worrisome problem.
Unemployment is defined as, “An economic condition marked by the fact that individuals actively seeking jobs remain unhired. Unemployment is expressed as a percentage of the total available work force. The level of unemployment varies with economic conditions and other circumstances” (1). Unemployment is always present as 100% employment is considered impossible. Each country or specified geographic area does, however, have an unemployment rate that is considered to be full employment or the natural rate of employment. This rate typically varies depending on various market forces and government policies. Unemployment cannot reach 0% even during an economic boom due to a combination of frictional unemployment and structural unemployment. Frictional unemployment refers to fact that it takes time for workers and employers to find the correct matches. Time is spent by workers trying to find the best possible match rather than taking the first match available. Structural unemployment is a bigger problem and refers to when an area’s available workers’ skill sets do not match their area’s employers needed skill set (2). What full employment is can change even within a single economy. In the United States, full employment was considered to rest between 4.5% and 5% by most economists just a few years back. In the wake of the financial crisis, economists predict that that number has risen. What that new number will be isn’t known for certain but economist Edmund Phelps of Columbia has estimated it may be between 6.5% and 7.0%. Even he, however, qualified each figure with a maybe signifying the uncertainty surrounding the situation (3).
The Great Recession kick started a rise in another kind of unemployment, cyclical unemployment. The unemployment rate rises to levels substantially higher than what is expected at an economy’s full employment rate during periods of cyclical unemployment as a direct result of negative changes in a country’s macroeconomic conditions (4). Okun’s Law is a simple predictive tool economists use to predict how much unemployment should rise or fall given how much GDP has risen or fallen in a given period of time. It states that as a general rule of thumb, unemployment should rise approximately 0.5% for every 1% that GDP falls and unemployment should fall approximately 0.5% for every 1% rise in GDP (5). What specifically causes unemployment to rise when GDP falls is, “Lower demand for products due to lack of consumer confidence, disinterest, or reduction in consumer spending results in the workforce cutting back on production. Since production is reduced, companies that retail such products may also cut back on workforce, creating yet more cyclical unemployment” (6). This described loopback situation can lead to what is known as the paradox of thrift and is arguably the most difficult trap to escape.
Any discussion of the current unemployment problem would be incomplete without first describing what central banks usually do in normal recessionary conditions where unemployment rises and why our current situation differs. In a normal recession, a central bank’s ability to adjust monetary policy (usually interest rates) is sufficient to spur the demand necessary to pull an economy out of recession. Examples of this can be seen in almost every recession that has taken place in the United States since the end of World War II (7). The Great Recession didn’t get that name by being a garden variety recession though. The depth of our latest downturn was so deep, that the Federal Reserve, led by Ben Bernanke, dropped interest rates to the lowest point that they could go, between 0% and 0.25%. The problem was that even this rate wasn’t low enough to spur demand and economic growth (8). With nothing left to cut there was, “nothing to stop the economy’s downward momentum. Rising unemployment will lead to further cuts in consumer spending, which Best Buy warned this week has already suffered a ‘seismic’ decline. Weak consumer spending will lead to cutbacks in business investment plans. And the weakening economy will lead to more job cuts, provoking a further cycle of contraction” (8). This is a classic case of a self-perpetuating downward economic spiral which is also known as a liquidity trap.
The response of the United States to this quandary was a mix of extraordinary central banking techniques that the Federal Reserve refers to as quantitative easing and the federal government implementing standard recessionary adjustments of fiscal policy, which is a combination of cutting taxes and raising spending. The Obama Administration’s stimulus plan, The American Recovery and Reinvestment Act, did just those two things for the American economy. It totaled an estimated $787 billion in tax cuts and federal deficit spending. Since demand was heavily sagging in the American economy, the government would be the so-called spender of last resort. While this was the proper response, there were problems with the plan. The most glaring problem was that the Obama economic team, along with the Federal Reserve and most outside economic forecasters, vastly underestimated the severity of the downturn. When the statistics were revised later on, we realized that almost 1 million more jobs had been lost over the previous year (March 2008 to March 2009) than had initially been estimated. The second problem was political. Christina Romer, Chair of the Council of Economic Advisers for the Obama administration, estimated that the United States would need $1.2 trillion worth of stimulus in order to close the output gap. That estimate was derived using the unrevised statistics, which failed to show how bad the jobs market had truly gotten. The Obama administration, however, did not believe congress would pass a bill of that magnitude and opted to press forward with a smaller package. What was a stimulus that was too small by $400 billion for the recession they thought they had inherited became even weaker once the true depth of the downturn became apparent. Given the revised statistics, it is not surprising that the stimulus failed to keep unemployment at the level that the Obama economic team predicted (9). These problems led to unemployment in America peaking at 10.1% and it holding steady at 9.7% currently. And while we added 162,000 jobs in March of 2010 and the unemployment picture seems to be turning a corner, the overall job market still looks bleak. I personally hold the opinion that the stimulus package was indeed, far too small. It should have been $400 bigger to match Romer’s estimates and the vast majority of that extra sum should have been targeted to increased federal aid to the states. State budgets are a mess across the country and to fix them, the states have been forced to raise taxes and cut spending in order to comply with their constitutionally mandated duty to have balanced budgets. That is the exact opposite of optimal recessionary policy and works to offset a lot of the federal tax cuts and spending projects. However, there seems to be little to no political appetite for more stimulus spending in congress. They seem satisfied with the current, slowly improving employment conditions, eschewing the real impact of prolonged unemployment.
Given these criticisms, it is important to remember that the actions of the Federal Reserve and the federal government, first under Henry Paulson and the Bush administration and then under the then brand new Obama administration, pulled the economy from the brink of utter destruction. It’s easy to forget how close we came to repeating The Great Depression and without the actions taken by the Ben Bernanke at the Federal Reserve and the Bush and Obama administrations, unemployment could have been double or even triple of what it ended up being. The mere fact that we avoided a much worse economic fate was a great accomplishment considering the dire situation we faced and the three parties involved in the rescue do deserve credit for this along with what end up being relatively minor criticisms in the grand scheme of things. The Federal Reserve’s extremely aggressive and creative monetary policies, Bush’s bailouts, and Obama’s stimulus all played a large role in making sure that we avoided the second great depression.
As I stated earlier, the U.S. economy is clearly recovering. GDP has increased over the past few quarters more robustly than previously expected. Unemployment, however, is a lagging indicator of economic recovery. “Labor is the first cost that employ¬ers cut when a reces¬sion looms, and it is the last cost that com¬pa¬nies incur when a recov¬ery begins. The rea¬son is sim¬ple: Labor is fre¬quently the most-expensive cap¬i¬tal that a busi¬ness has, so peo¬ple are the first fat to be trimmed and the last to be added. (This is bad news for fam¬i¬lies, but this is how a free mar-ket works)” (10). The actual lag time between the end of a recession and the peak of unemployment has grown steadily longer over the past few recessions. There was just a 6 month period between the end of the 1982 recession and unemployment beginning to come down. After the 1991 recession ended, it took a full 29 months for unemployment to start falling. Unemployment following the end of the 2001 recession took an incredible 55 extra months to begin falling. Productivity growth was especially quick following the 1991 and 2001 recessions making it unnecessary for companies to rehire workers for an extended period of time (11). Indeed, shortly following the official end of our latest recession the 4th quarter of 2009 saw a productivity jump of 6.9% while shedding hundreds of thousands of jobs according to the U.S. Bureau of Labor Statistics (12). Luckily, however, unemployment peaked in October of 2009 and has come down 0.4% since. Should recovery in the labor market lag substantially behind GDP recovery for an extended period of time, the long term impacts can be extremely harmful to an economy.
For many individuals being laid-off creates a permanent loss of earning power. Studies showed that the average worker who was laid off during the 1981-1982 recession earned 30% less when they reentered the job market and had not recovered even half of their prior earnings almost 20 years later. Younger individuals aged 16 to 24, who do not use the downtime to attend higher forms of education become idle. This period of idleness leads to much lower paying work once they do find work. Income inequality will likely rise due to the fact that educated people were much less likely to lose their job during this recession. Workers without a high school diploma face an unemployment peak of 15.6% while college graduates faced an unemployment rate a full 10% lower. It is long-term unemployment (defined as unemployed for 27 weeks or more), however, that may be the most damaging of all this recession’s symptoms. These workers find it harder and harder to find work the longer their unemployment status lingers. This is due to their deteriorating skill sets and an erosion of their job connections. Employers also tend to be skeptical of these individuals’ ability to do work (due to a personal flaw or simply due to them falling behind on the latest technological advances) or their work ethic. I claim this to be the most damaging symptom of the recession due to its ability to not only slow cyclical unemployment’s recovery, but to also raise long-term structural unemployment. Long-term unemployment is the biggest threat to raising the expected unemployment rate that America would experience while running at full employment (13).
There are two prevalent views regarding the lingering unemployment situation in regards to its cause and how best to fix it. The first is that America’s economy has already developed structural problems. The manufacturing and construction sectors of the economy were hit particularly hard by this recession. People laid off from those industries don’t have the necessary skill sets needed to move into rapidly growing sectors of the economy such as healthcare and education causing the dreaded mismatch between employers and job-seekers. Another problem cited is that the property bust has decreased the mobility of the American worker. Unable to sell their houses for more than their mortgage is worth, they are unable to move to places that have better demand for their particular skills as they would in the past. The extremely long extension of unemployment benefits may also have the adverse effect of increasing frictional unemployment (13). The second view is that there are no structural problems in the economy and unemployment is high simply due to weak aggregate demand. This is the view held by Christina Romer. She points to four things that are holding the economy and unemployment down: “Credit availability remains tight. State and local governments face continuing budget shortfalls. No one expects consumers, after the searing events of the past few years, to go back to their free-spending ways. Foreign demand for U.S. goods remains subdued because the recovery has not taken hold as firmly in Europe as in the U.S., limiting European demand” (14). The remedies she prescribes are additional fiscal aid to the states, pumping money into smaller banks who will then lend to small and medium firms, and opening up new foreign markets to U.S. goods and services as aggressively as possible (14).
Unfortunately for the United States and the global economy, high unemployment is likely to remain with us for an extended period of time. However, the last couple of months have finally given way to good economic news. That is no reason to sit back and act like the problem has been solved though. On the two opposing views on the causes and fixes of unemployment, I tend to side with Christina Romer’s weak aggregate demand diagnosis over the structural problems diagnosis due to the fact that “the rate at which unemployed workers get new jobs has fallen across all industries” (13). While I agree that there are structural problems within the economy that should be tended to, I don’t think that the impact those problems have is as great as the lingering demand problem. I believe that we have the economic know-how and tools to tackle this problem in a more efficient manner. Whether or not we do depends on political will in congress, which unfortunately seems to be sorely lacking today.
Works Cited
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(3) Benjamin, Matthew, and Rich Miller. "‘Great Recession’ Will Redefine Full Employment as Jobs Vanish." Bloomberg.com. 4th May 2009. Web. 30 Apr. 2010.
(4) Koczaja, Ron. "Causes and Effects of Unemployment, Page 2 of 4." Associated Content - Associatedcontent.com. Web. 30 Apr. 2010.
(5) Krugman, Paul. "How Far out of Line Is the Unemployment Rate? - Paul Krugman Blog - NYTimes.com." Web log post. Economics and Politics - Paul Krugman Blog - NYTimes.com. 31 July 2009. Web. 30 Apr. 2010.
(6) Ellis-Christensen, Tricia. "What Is Cyclical Unemployment?" WiseGEEK: Clear Answers for Common Questions. Web. 30 Apr. 2010.
(7) "FRB: Monetary Policy." Board of Governors of the Federal Reserve System. Web. 1 May 2010.
(8) Krugman, Paul. "Depression Economics Return." The New York Times 14th Nov. 2008, Final ed., Op-Ed sec. Print.
(9) "American Unemployment: Could Have, Should Have | The Economist." Economist.com. 5th Feb. 2010. Web. 01 May 2010.
(10) Scott, Samuel J. "Economic Statistics | Unemployment Statistics | Labor Data | Considerations." Politics | Israel | Business | Online Marketing | Religion. 5th Sept. 2009. Web. 01 May 2010.
(11) "Fasten Your Seatbelts for the Jobless Recovery..." Web log post. Grasping Reality with Both Hands. 17th July 2009. Web. 1 May 2010.
(12) "Productivity and Costs, Fourth Quarter and Annual Averages 2009, Revised." U.S. Bureau of Labor Statistics. Web. 01 May 2010.
(13) "America's Labour Market: Something's Not Working." The Economist 1st May 2010: 78-79. Print.
(14) Wessel, David. "Romer: ‘It’s Aggregate Demand, Stupid’ - Real Time Economics - WSJ." WSJ Blogs - WSJ. 17 Apr. 2010. Web. 01 May 2010.
