'Structural Unemployment?' Why Not Throw Money at the Problem?

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Written by Dean Baker   
Monday, 19 August 2013 08:41

In a post for PBS NewsHour's The Business Desk, Dean Baker takes on Paul Solman on what the government can do to address unemployment. Solman responded to Dean here, and Dean responded this morning on Beat the Press.

Paul Solman takes me and my grumpy friend Paul Krugman to task for insisting that there is a growing consensus within the economics profession that we are not suffering from structural unemployment. Krugman and I used our blogs to complain about Aug. 2's segment in which Brooks suggested structural unemployment was the economy's main problem and that there was little that could be done about it.

The United States currently has about 9 million fewer people working than if it had continued on its trend of growth from 2002 to 2007.

The question is whether the unemployment problem is a lack of demand due to a loss of $8 trillion in housing bubble wealth, or whether there are structural problems that would prevent most of these 9 million people from being re-employed even if the demand were there. Krugman and I support the former idea; those who see unemployment as structural are in the latter camp. Here's another way to think about the problem. Imagine someone found a $1 trillion bill in the street and decided that, as a public service, she would spend the money over the next 12 months to boost the economy. For simplicity, let's assume that she decides to divide her $1 trillion so that it is spent in exactly the same way that the economy's current $16 trillion in annual spending is spent.

In my view, this $1 trillion of new spending would cause output to increase by roughly 6 percent. (I'm ignoring multiplier effects to keep things simple.) Employment would also rise by roughly the same amount, filling the bulk of the 9-million-jobs hole. In other words, this would be great news for the country.

However, if Brooks and other proponents of the structural unemployment argument are right, the economy lacks the ability to increase production by enough to fill this additional demand. In that case, by adding $1 trillion in demand to the economy, our philanthropist would create all sorts of bottlenecks and shortages.

This may appear in soaring prices for specific commodities (oil or gas), but it should also show up in shortages of various types of labor. For example, we might see the wages of people with computer or engineering skills soar while the wages of factory workers languish. Let's be clear what a structural unemployment problem would look like: There wouldn't be a shortage of labor, but a shortage of workers in the right places or with the right training.

In short, this story -- that employers would be hiring workers if workers just had the right skills -- is not supported by the evidence. If employers can't find the workers they need, they raise wages. This is how a market economy works.

The problem with the structural unemployment story is that it is very difficult to identify any substantial segment of the labor market where there are rapidly rising wages. In the last decade, even the wages of college grads have not kept pace with the rate of inflation. If college grads just got their share of productivity growth, their wages would be rising by more than 1.5 percentage points a year above the rate of inflation. In fact, there is no major occupational category, even among workers with a college degree or higher, where wage growth has kept pace with productivity growth over the last decade.

We don't see rising wages, therefore we can assume that employers are not having trouble finding workers; end of story.

This simple fact, and others that follow from it, has led to a growing consensus in the economics profession that the economy's problems stem from a lack of demand rather than from structural issues.

In my Aug. 3 blog post, I cited the change in views on this topic by Narayana Kocherlakota, the president of the Minneapolis Federal Reserve Bank. Kocherlakota had been a vocal proponent of the structural unemployment view, but he changed his position when he saw that the Fed's quantitative easing policy was not leading to the inflation that he had predicted.

Krugman cited the work of Eddie Lazear, a well-respected economist who was the head of President George W. Bush's Council of Economic Advisers. Lazear argues explicitly that the economy's problems are cyclical, not structural. And we can also point to recent research by the International Monetary Fund, not a known hotbed of leftist economic thought, which finds that cutbacks in government spending have lowered growth and raised unemployment, exactly as we Keynesian-demand types predicted.

Economists holding to the structural unemployment view espouse this position largely without evidence, I think it's fair to say. Most had predicted that fiscal and monetary stimulus in the last five years would lead to soaring interest rates and rising inflation, but these predictions have proven false.

Let's look at the specific claims. Brooks notes that a smaller percentage of the population is part of the labor force, meaning that they neither have a job nor are looking for work. Some seem to view this drop as a reflection of a change in people's willingness to work. While this is possible, it is highly unusual for large numbers of people to suddenly change their attitudes towards work. (Most don't have this luxury.) The fact that this change in behavior coincides with a period in which many people can't find jobs leads us demand-side types to think the problem is that people don't see jobs out there.

We heard the same argument in the weak recovery following the 2001 recession. The labor force participation rate fell from a high 67.3 percent in the early months of 2000 to a low of 65.9 percent in December 2004. Coincidentally, when the economy began to create jobs again at a healthy pace, the labor force participation rate rose back to 66.4 percent in December 2006 and January 2007. So, we can believe that the dropouts from the labor force indicate a change in willingness to work, or we can believe that this is simply the normal cyclical pattern that we always see with labor force participation rates following employment growth.

It is also noteworthy that this is overwhelmingly a story of prime-age workers dropping out of the labor force, not baby boomers edging into retirement. According to Organization for Economic Cooperation and Development (OECD) data, the employment-to-population ratio for workers between the ages of 25 and 54 fell from 79.9 percent in 2007 to 75.9 percent in the second quarter of 2013.

Structuralists also say that firms are hiring machines instead of workers. The data does not support this claim either. While investment has been reasonably healthy given the overall weakness of the economy, it is still down as a share of the economy from its pre-recession level. In 2007, investment in equipment and intellectual products was 9.8 percent of GDP. In 2012, it was down to 9.4 percent. That change is moving in the wrong direction for the structuralists; firms are hiring fewer machines now than they were when employment was growing rapidly.

We can also look more directly at productivity. The structuralist argument implies that firms don't need workers because machines allow them to produce more with the same number of workers. But the numbers don't go in the structuralists' favor by this measure either. According to the Bureau of Labor Statistics, productivity growth averaged 2.7 percent annually in the dozen years from 1995 to 2007. In the last three years, productivity growth has averaged just 0.8 percent annually. Insofar as machines are displacing workers, they are doing it far less rapidly than in previous years when the economy was creating large numbers of jobs.

In short, structuralist claims do not square with the evidence, and we haven't heard a plausible reason why our imagined philanthropist could not quickly create millions of jobs by spending her $1 trillion jackpot.

Since I am not betting on a do-gooder finding a trillion dollar bill in the street, I want the government to play this role. The economics would be exactly the same, even if some people don't like the idea of the government spending money. And, since the well-being of tens of millions of people hinges on the willingness of the government to follow this path, people like Krugman and I can get a bit grumpy over its failure to do so, and at the people who oppose its doing so.

Tags: demand | economy | labor | structural unemployment | unemployment