Demand Drives US Jobs Success
The Guardian, September 4, 2000
Advocates of the US model argue that there's nothing about high unemployment in Europe that a good dose of US-style labour-market flexibility couldn't remedy. The US economic recovery since 1996, however, has provided remarkably little support for this diagnosis. The data show that the real secret is old-fashioned macroeconomic policy.
The conventional version of the US model rests on three assumptions about job creation: first, that employers need low wages to create jobs; second, that wages must be especially low at the bottom for employers to hire "less-skilled" workers; and third, that even low wages sometimes aren't enough - employers must also be able to hire on flexible terms, including being able to offer part-time, temporary and contract work.
The US boom, however, contradicts each of these assumptions. Since the middle of the 1990s, the US jobs machine has not depended on low wages.
Although the US created jobs between 1979 and 1995, when the inflation-adjusted median wage fell by 7%, the jobs machine only started running in top gear after 1995. Since then, the median wage has risen by more than 7%.
Nor has job creation at the bottom depended on falling wages. Between 1979 and 1995, the real wage for the typical low-wage job fell 17%. Unemployment, however, reached 30-year lows only after 1995, when real wages grew faster at the bottom (more than 9%) than they did at the middle (up 7%) and the top (up 6%).
And recent US employment performance has not relied on "contingent" or "non-standard" jobs. According to US Census data, the shares of regular part-time workers, temp, on-call workers and independent contractors fell between 1995 and 1999. Many European economies already have as many or more non-standard workers than the US.
There, about 17% of workers are part-time, compared with more than 20% in Britain and 17% in France; 2% are temps, compared with 6% in Britain and 10% in France; and only 6% are self-employed, compared with 11% in both Britain and France.
If flexibility is not behind the boom, then what is? The simultaneous rise in employment and wages points towards macroeconomic demand. For better and for worse, three factors have been fuelling that demand.
The first is the rise in household debt. While US politicians have focused on eliminating the national debt, US households have been amassing a mountain of private debt. Between 1995 and 1999, household debt grew from 92% to 103% of disposable income, sparking a consumer-spending spree that has boosted employment (and the trade deficit). Debt, however, cannot grow faster than income indefinitely.
The second demand catalyst is the stock-market bubble, which has reinforced debt-financed consumer spending, particularly among the top 10% of households (which hold 85% of all shares).
Massachusetts Institute of Technology economist James Poterba concluded that, even if households spend only three cents of every $1 increase in their share portfolios, the $6.6 trillion rise in the value of equities between 1995 and 1999 would have raised GDP by 2%.
The final and most important demand factor is the Federal Reserve Board's de facto rejection of the economic profession's now embarrassing consensus supporting a 5.5% to 6% floor for the US unemployment rate. After recession hit in 1991, the Federal Reserve allowed real short-term interest rates to remain near zero for almost two years. When unemployment first fell below 5.5% to 6% in 1995, the Fed wisely adopted a wait-and-see attitude. Just as the Fed lost its nerve, the Asian financial crisis left Alan Greenspan little choice but to lower interest rates to avoid making matters in Asia even worse. (Unfortunately, the Fed appears to have lost its nerve again, despite scant evidence of inflation.)
By contrast, European central bankers have been driving their economies with one foot on the brake. Despite high unemployment, they kept real short-term interest rates at a growth-choking 3% to 4% for most of the 1990s.
The ECB continues to keep rates well above those that the Fed would use at comparable levels of unemployment. With Europe's large pool of unemployed and its respectable productivity growth, the ECB should not be afraid to follow the Fed.
Labour-market flexibility is not responsible for the US boom, demand is. Debt and equity bubbles are the wrong way to run an economy, but growth-oriented macroeconomic policy has been key to US success. Importing US-style flexibility without US-style macroeconomic demand risks ending up with the worst of both worlds: US levels of inequality and continued high unemployment.