Stubbornly High Unemployment

I agree with Becker that the underemployment rate is a more meaningful measure of the health of the labor market than the unemployment rate, but they are closely correlated, and both have changed little since last fall. Thus the recovery has been slow. I would emphasize the economic as distinct from the political reasons why it has been slow, though the latter have played a role as well.

Producers responded to the economic crisis that crested with the collapse of Lehman Brothers in mid-September 2008 by slashing prices and costs. Slashing prices tends to keep output up while slashing costs increases labor productivity (output per unit of labor) because it involves layoffs and (what has the same effect) outsourcing to foreign countries. If all the recent productivity gains had taken the form of outsourcing production, there would be no reason to expect that lower prices would have reduced unemployment even though they would have tended to maintain output and therefore consumption. If higher productivity were achieved by technological advances rather than by layoffs or outsourcing, we would expect it to herald rapid economic growth. If it's just the result of layoffs and outsourcing, however, it will fall when, faced with increased demand, producers do more hiring.

But how fast will demand increase? There is pent-up demand from postponement of purchases (especially of durable goods, where postponing replacing is feasible) and selling from inventory rather than from new production. These probably are the most important factors in the recent increases in GDP. But unless there are other factors pushing demand, GDP will plateau when the pent-up demand is satisfied and inventories are restocked to a normal level. Such plateauing is possible because no fewer than six factors are weighing on the economy. One is the continued tightness of credit. Interest rates are low but credit standards have risen, partly under pressure from federal bank examiners trying to prevent further bank failures, and partly from the new credit card law. The tighter credit is, the less production and consumption there is, because both producers and consumers depend heavily on credit to maintain their desired level of current production and consumption. And just as outsourcing has been used to achieve cost reductions, speculating in foreign currencies (the "carry trade") and other high-risk lending and investing have been the source of the enormous recent bank profits. Federal Reserve policy has enabled the banks to borrow at very low rates, and they find it more profitable to invest the foreign funds abroad (or in trading) than to lend into a depressed consumer and small-business market with high expected default rates.

A second factor in the sluggishness of the economic recovery is the housing market. Housing prices remain very depressed, and because houses are the major component of consumer wealth, depressed housing prices spell reduced wealth for much of the population. A reduction in personal wealth tends to lead to a reallocation between spending and savings, in favor of the latter, and this slows current economic activity.

Third is the European financial crisis sparked by the insolvency of Greece (no mere liquidity crisis in that country—it's broke), which has driven down the value of the Euro relative to the dollar. The consequence is to make U.S. exports more costly, which retards production in the United States. And Greek (or Portuguese, or Spanish, etc.) bond defaults will hurt U.S. banks that have large investments in those countries.

Fourth is the dreadful finances of U.S. states and cities (California, New York, and Illinois are close to being bankrupt), which will require Greece-like austerity measures, which will slow economic activity.

Fifth is the huge and mounting public debt of the United States, which creates a likelihood of either tax increases and spending cuts, both of which measures would reduce economic activity in the short run, or of inflation designed to reduce the debt burden—a danger rendered more acute by the increase in the money supply engineered by the Federal Reserve.

And sixth are the uncertainties created by the Obama Administration's economic policies. In fact the Administration has not pursued a radical leftwing course, as some have feared. Its policies have been, in general, continuous with those of the Bush Administration. But the health care law has created enormous uncertainty for business, which cannot calculate the effects of the law on its costs, and for many individuals as well. (There is also uncertainty concerning taxes and spending, as I said, but the federal debt cannot be blamed primarily on this Administration. It is largely the result of the Bush Administration's fiscal incontinence combined with the unavoidable effects of a very severe economic crisis.)

I agree with Becker that the Administration's pro-union policy is no help, but it's not clear that it will amount to much. The long-term decline in unionization seems irreversible. The exception of course is public employees' unions, but the fiscal distress of state and local governments is likely to weaken the public employee unions, just as in Greece.

Uncertainty is an enormous retardant to economic recovery, and the Administration could do more to allay it by, for example, giving up on banker bashing. For in the face of uncertainty—in the sense of risk that cannot be quantified and thus embedded in a cost-benefit analysis—both producers and consumers tend to freeze. That is a rational response to uncertainty: one freezes both to protect oneself against unknown dangers and to gain time for learning more about them. But the effect of such freezing is to depress economic activity by channeling investing and spending into inert savings, such as government securities (which does however tend to alleviate the deficit). Political turmoil in the United States, two unresolved wars abroad, dangerous political instability in nuclear-armed countries such as Pakistan and North Korea (and soon perhaps Iran), the European economic crisis—all are sources of uncertainty that have economic effects just by virtue of their uncertainty, apart from any direct effects on the government, business, or consumers.