November 29, 2009
How to Increase Employment
How to Increase Employment- Becker
During this "Great Recession", unemployment has risen from under 5% at the beginning of the recession in December of 2007 to more than double that rate to reach its highest level so far in October of 10.2%. This is the second highest unemployment rate in the postwar period, surpassed only by the 10.8% rate in December of 1982. In light of such rather dismal employment figures, it is not surprising that the President will have a "jobs summit" in a few days to consider how to improve the employment market.
Posner correctly indicates that the unemployment rate understates the employment problem since some men and women have left the labor force after giving up finding work, or they are working part time when they would like to work full time. The so-called "underemployment" rate is estimated to be 17.5%, much higher than the unemployment rate. Note, however, that the underemployment rate is far harder to estimate accurately than is the unemployment rate, which itself is difficult to measure.
I have responded to Posner's emphasis on the underemployment rate in previous posts that apples have to be compared with apples. If the underemployment rate, not the unemployment rate, is used to measure the severity of this recession, than the underemployment rate also has to be used for past recessions. Not surprisingly, underemployment was also considerably higher in these recessions than was unemployment. The underemployment rate for December of 1982 is estimated at about 17.1%, also much above the high unemployment rate at that time. Yet while the unemployment rate has not yet reached the rate obtained in 1982, for the first time the estimated underemployment rate has slightly surpassed the rate for that earlier recession.
In addition, while this recession ended during the third quarter (I believe), unemployment usually lags any pickup in the overall economy, so that the unemployment rate is likely to continue to rise further. However, there are signs of a pickup beginning in the labor market: hours worked of those working have been rising, and wage rates rose by about 2% during the past year. The rise in wages-which is uncommon during recessions- also casts doubt on claims of extensive wage cutting during this recession. Yet it is an unusual combination: workers who still have a job are doing better than in other serious recessions, but the underemployment rate has grown to its highest level since the Great Depression.
Keynes and many earlier economists emphasized that unemployment rises during recessions because nominal wage rates tend to be inflexible in the downward direction. The natural way that markets usually eliminate insufficient demand for a good or service, such as labor, is for the price of this good or service to fall. A fall in price stimulates demand and reduces supply until they are brought back to rough equality. Downward inflexible wages prevents that from happening quickly when there is insufficient demand for workers.
The usual suggested remedies are either to stimulate demand for labor, or to reduce the real cost of workers to employers. The stimulus package has tried to stimulate demand. While I believe this package has failed to stimulate demand to any significant degree (see the discussion my earlier posts on January 11, 18, and November 1, 2009), and that the claimed employment effects of the stimulus are vastly overstated, I concentrate my discussion, as Posner does, on reducing the real cost of labor to employers.
If rigid nominal wages were the culprit, inflation would reduce the real value of labor costs, and hence stimulate demand by companies for workers. But deflation rather than inflation is the greater worry now, so this approach does not seem feasible at this time. The alternative is to cut the cost of labor to employers. A frequent suggestion by economists and others is to give employers subsidies for each unemployed person that they hire, but I believe this approach has many problems of implementation. Clearly, companies would have an incentive to fire some employees and replace them with subsidized unemployed workers.
Moreover, if the unemployed hired under the subsidy program received higher pay because companies compete for the subsidy, some workers might remain unemployed rather than accepting jobs now because they expect to do better when the subsidy program is introduced. Others might even quit to become unemployed, so that they can then become employed at better wages through this program. Many other adjustments would make such a subsidy program both extremely difficult to enforce in a net job-creating way, and highly intrusive into the employment decisions of companies as the government tries to close various loopholes that are bound to be discovered.
It is wiser to cut labor costs in other ways. I fully endorse Posner's suggestions to cut the minimum wage, but I do not see that happening with the present Congress. My favorite approach it to try to stimulate the economy by cutting income taxes, especially corporate income taxes and other taxes on capital, both physical and human capital. Such tax cuts will stimulate investments in the economy, and in this way increase the demand for workers.
Of course, tax cuts at this moment would add to the deficit and increase the size of the government debt at a time when the debt has already grown rapidly. Tax cuts may also take time before they raise investments and jobs. On the other hand, tax cuts that add significantly to the growth rate of GDP will have only modest, and possibly even negative, effects on the ratio of the debt to GDP while they increase investments and the demand for workers. This seems to me to be an attractive way to approach solutions to the unemployment problem at the jobs summit this Thursday.
The President's Forthcoming "Jobs Summit"--Posner
On December 3 the President will convene a "jobs summit" to consider what if anything to do about the dismal employment picture. And dismal it is. The figure of 10.2 percent unemployment in October understates the problem because people who have given up on seeking a job, or who are involuntarily working part-time rather than full-time, are not counted as unemployed. They are, however, included with the unemployed in the statistics of underemployment, and the underemployment rate has reached 17.5 percent. These rates may continue to rise. And more than in previous downturns, employers have been cutting wages and benefits, which from a worker's standpoint is a form of quasi- or partial unemployment.
At the end of the summer there was some hope for a rapid economic recovery, but that has faded. Recovery from a recession or depression precipitated by a collapse of the banking industry secondary to a housing collapse tends to be slow. Weakened banks are hesitant to lend, and because housing is a big part of household wealth a collapse of housing prices tends to inhibit spending, or alter spending patterns, and especially to inhibit borrowing: debt is a fixed cost, so when household wealth declines people find themselves overindebted. With the supply of and demand for credit weak, economic activity slows. The banks' reluctance to lend, which expresses itself in stricter credit standards, is especially hard on small business, which depends on bank loans for credit; small businesses unlike big cannot finance themselves by issuing bonds or commercial paper or using retained earnings in lieu of credit. And small businesses in the aggregate are big employers. The Administration's ambitious health-care reform is inhibiting hiring by small business by creating uncertainty about the health-insurance costs that employers will bear. Mounting concern with our rapidly growing national debt is a further damper on investment and hence employment.
There is even concern that we may be in a trap in which rising unemployment feeds on itself. Credit defaults are highly correlated with the unemployment rate, so as unemployment rises, defaults rise, and defaults impair bank capital, causing a further tightening of credit, which by hurting small business pushes unemployment up.
All this is speculation and for all I know the unemployment rate will start falling soon and rapidly. But most forecasters think not, and so it is understandable that the Administration would like to do more than it is doing to curb unemployment. But what is there to do? In part because of mistakes in the design, implementation, and explanation of the $787 billion stimulus program enacted last February, and in part because of concern with the rapidly growing federal deficit, the stimulus has become extremely (I think undeservedly) unpopular, and Congress will not enact another stimulus program as urged by left-wing economists.
What then can be done? One possibility, which has been tried in Europe recently, apparently with some success, is to pay employers, through tax credits or otherwise, to hire workers. This is fiscal stimulus--Keynesian deficit financing--by another name. It is like the government's paying a construction company to build a highway, which will require the company to enlarge its workforce. All that might seem to distinguish the job subsidy is that the link between funding and jobs is more direct, which increases its political appeal.
A common objection is that it will encourage fraud--employers will fire workers and then rehire them, to obtain the subsidy. Or, less transparently, it will fire workers and hire replacements, again in order to obtain the subsidy. But a bigger objection, which is also an objection to the original stimulus program, is that it's not targeted on industries or areas of above-average unemployment. Even in an area of low unemployment. an employer will have an incentive to hire workers in order to obtain the subsidy, but he may do this by hiring workers who already have a job, and the net effect on unemployment will therefore depend on what the hired worker's former employer does--maybe just pay him to stay.
There are other ways of stimulating employment, at lower cost and probably with greater impact. One would be to reduce the federal minimum wage, which over a three-year period beginning in 2007 will have risen from $5.15 to $7.25 an hour--a 40 percent increase. As time passes, unemployment becomes less a matter of layoffs and more a matter of failing to provide jobs for new entrants to the workforce, and a reduction in minimum wage would make these new entrants--inexperienced workers with modest wage expectations--far more employable.
Another way to reduce unemployment would be to amend the stimulus law to redirect the remaining unspent funds to areas and industries of high unemployment. Another would be to reduce payroll taxes, including the unemployment-insurance tax and the employer's share of the social security tax; for payroll taxes are part of the cost of labor. The effect on the employer would be similar to that of a wage cut, and would increase the demand for labor. Since social security and unemployment benefits (as opposed to taxes) would be unaffected, the reduction in the taxes would not reduce the employees' full wages and so induce a demand for higher wages. So the employer's net labor cost would fall and his demand for labor rise. The problem is that the government's deficit would increase, but that would also be true of a subsidy for hiring, though it would not be true of a reduction in the minimum wage.