Productivity, Unemployment, and the End of the Recession-Becker
On October 7, 2008 I wrote an op-ed piece for the Wall Street Journal ("We're Not Headed for a Depression") in which I said there would not be a depression, certainly nothing at all resembling the Great Depression of the 1930s. As the economy continued to decline after that I began to worry that my predictions were going to look foolish, and become famous as one of the many absurdly bad forecasts.
Fortunately for me, and even more so for the world, the forecast turned out to be basically correct. I recently claimed in a post on this blog on August 9th that the current world recession is over, and many economists and official organizations since then have come to the same conclusion. The recession was big and world wide, but it was far from a depression-a rule of thumb is that a contraction is a depression only if the fall in output is at least 10%. The output fall in the US and the world has been less than 5%. Indeed, this recession is hardly more severe in the US- the epicenter of the financial crisis - than a couple of previous recessions, such as the one from 1973-75 brought on by the first oil shock, and the one in 1981-83 resulting from the Fed's successful efforts to squeeze inflation out of the system.
During the Great Depression American unemployment peaked at 25% and was high during the whole of the 1930s, while output declined by more than 20%. During this present (or past) recession, output has fallen by a little over 4%, and unemployment so far has remained under 10%-the latest figure gives an unemployment rate of 9.7%. Since a world of difference exists between the two events, the prevalent fear of a major depression was never realized.
Those who are more pessimistic about this recession point out that unemployment is still rising, and may reach a much higher level than its present rate. They also rightly indicate that total unemployment and underemployment is much higher than 9.7% because some persons have only found part time jobs, while others have been so discouraged by the weak labor market that they quit looking for work, and so are not counted as unemployed.
I will take up both aspects of this pessimism in turn. To understand what has been happening to unemployment, it is crucial to recognize that employment has declined, and unemployment has risen, much more relative to output during this recession than in past recessions because labor productivity-measured by output per worker or per hour of employment- has continued to grow during the recession. Productivity grew by 0.3% during the first quarter of 2009, and by a whopping 1.8% during the second quarter. Typically, measured productivity falls during serious recessions because of excess capacity of capital and the many employed workers who are underutilized. Basic arithmetic indicates that for any given fall in output, the greater the rise in measured labor productivity, the greater the fall in employment, and the greater the increase in unemployment.
Unemployment is typically a lagging indicator in the sense that it usually begins to fall only months after output has started to increase again. Since I expect output to rise only a little in the US during the third quarter that will be over at the end of September, unemployment should continue to rise for a while, almost certainly surpassing 10% at its peak. However, if, as I expect, the growth in productivity will continue into the future at a good pace because of the many innovations and inventions coming on line, that will lead to greater, not a lesser, growth in employment. For at some point, the economics of the positive relation between productivity and employment becomes more powerful than the short-term arithmetic negative relation that occurs during recessions.
In the longer run, advances in productivity are partly produced by investments in R&D and other innovations that generate new products and new processes. Both new products and new production methods typically require investments in both physical and human capital. They also stimulate the use of more workers of various skills that utilize the greater capital stock. This is why over longer time periods, productivity advances and robust labor and capital markets in different economies are strongly positively, not negatively, related. For this reason, the continuing advances in productivity in the US and elsewhere will at first limit and then reverse the falls in employment and rises in unemployment.
It is true that the total underemployment rate during this recession would be well above the official unemployment rate of 9.7%. Some estimates put total underemployment at over 16%, which includes individuals who are reluctantly working only part-time, and also persons who have given up looking for work. However, apples have to be compared with apples, and in judging this recession relative to prior ones, the same calculations have to be made for these past recessions as well. Exactly the same type of growth in underemployment was operating in these prior recessions, and especially for the severe recession of the 1930s. Perhaps the fractions of reluctant part timers and persons who stopped looking for work are greater during the present recession than recessions than say in 1973-75, or 1981-83, but I have not seen any demonstration of this. My guess is that whatever differences exist, they are not enough to reverse the ordering of the severity of different post-war recessions.
My overall conclusion is that productivity advances will lead the world out of the recession, and after a while toward a decent rate of growth in world GDP. These advances will occur even if the financial sector is not fully recovered from its crisis. As productivity advances continue at robust levels, that will stimulate the demand for labor, and begin to reduce unemployment and produce sizable rates of growth in employment.