November 29, 2009

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.

Posted by Gary Becker at 4:08 PM