The President's Forthcoming "Jobs Summit"--Posner

On December 3 the President will convene a "jobs summit" to consider what if anything to do about the dismal employment picture. And dismal it is. The figure of 10.2 percent unemployment in October understates the problem because people who have given up on seeking a job, or who are involuntarily working part-time rather than full-time, are not counted as unemployed. They are, however, included with the unemployed in the statistics of underemployment, and the underemployment rate has reached 17.5 percent. These rates may continue to rise. And more than in previous downturns, employers have been cutting wages and benefits, which from a worker's standpoint is a form of quasi- or partial unemployment. At the end of the summer there was some hope for a rapid economic recovery, but that has faded. Recovery from a recession or depression precipitated by a collapse of the banking industry secondary to a housing collapse tends to be slow. Weakened banks are hesitant to lend, and because housing is a big part of household wealth a collapse of housing prices tends to inhibit spending, or alter spending patterns, and especially to inhibit borrowing: debt is a fixed cost, so when household wealth declines people find themselves overindebted. With the supply of and demand for credit weak, economic activity slows. The banks' reluctance to lend, which expresses itself in stricter credit standards, is especially hard on small business, which depends on bank loans for credit; small businesses unlike big cannot finance themselves by issuing bonds or commercial paper or using retained earnings in lieu of credit. And small businesses in the aggregate are big employers. The Administration's ambitious health-care reform is inhibiting hiring by small business by creating uncertainty about the health-insurance costs that employers will bear. Mounting concern with our rapidly growing national debt is a further damper on investment and hence employment. There is even concern that we may be in a trap in which rising unemployment feeds on itself. Credit defaults are highly correlated with the unemployment rate, so as unemployment rises, defaults rise, and defaults impair bank capital, causing a further tightening of credit, which by hurting small business pushes unemployment up. All this is speculation and for all I know the unemployment rate will start falling soon and rapidly. But most forecasters think not, and so it is understandable that the Administration would like to do more than it is doing to curb unemployment. But what is there to do? In part because of mistakes in the design, implementation, and explanation of the $787 billion stimulus program enacted last February, and in part because of concern with the rapidly growing federal deficit, the stimulus has become extremely (I think undeservedly) unpopular, and Congress will not enact another stimulus program as urged by left-wing economists. What then can be done? One possibility, which has been tried in Europe recently, apparently with some success, is to pay employers, through tax credits or otherwise, to hire workers. This is fiscal stimulus--Keynesian deficit financing--by another name. It is like the government's paying a construction company to build a highway, which will require the company to enlarge its workforce. All that might seem to distinguish the job subsidy is that the link between funding and jobs is more direct, which increases its political appeal. A common objection is that it will encourage fraud--employers will fire workers and then rehire them, to obtain the subsidy. Or, less transparently, it will fire workers and hire replacements, again in order to obtain the subsidy. But a bigger objection, which is also an objection to the original stimulus program, is that it's not targeted on industries or areas of above-average unemployment. Even in an area of low unemployment. an employer will have an incentive to hire workers in order to obtain the subsidy, but he may do this by hiring workers who already have a job, and the net effect on unemployment will therefore depend on what the hired worker's former employer does--maybe just pay him to stay. There are other ways of stimulating employment, at lower cost and probably with greater impact. One would be to reduce the federal minimum wage, which over a three-year period beginning in 2007 will have risen from $5.15 to $7.25 an hour--a 40 percent increase. As time passes, unemployment becomes less a matter of layoffs and more a matter of failing to provide jobs for new entrants to the workforce, and a reduction in minimum wage would make these new entrants--inexperienced workers with modest wage expectations--far more employable. Another way to reduce unemployment would be to amend the stimulus law to redirect the remaining unspent funds to areas and industries of high unemployment. Another would be to reduce payroll taxes, including the unemployment-insurance tax and the employer's share of the social security tax; for payroll taxes are part of the cost of labor. The effect on the employer would be similar to that of a wage cut, and would increase the demand for labor. Since social security and unemployment benefits (as opposed to taxes) would be unaffected, the reduction in the taxes would not reduce the employees' full wages and so induce a demand for higher wages. So the employer's net labor cost would fall and his demand for labor rise. The problem is that the government's deficit would increase, but that would also be true of a subsidy for hiring, though it would not be true of a reduction in the minimum wage.

Comments

[Anonymous]

I am not as concerned with the problems of implementation of a hiring tax-credit. I think there are relatively easy and straightforward (though, not necessarily bureaucratically cheap) techniques to prevent mere *churning* of employees and ways to verify true net new hiring.

But while high unemployment levels are only slowly wage-deflationary due to the well-understood lags, I wonder if hiring subsidies might present a more rapid deflationary problem.

Most firms choose levels of output and employment so that marginal revenues equal marginal costs. The marginal profit on the labor of the last hire is $0. During a recession, the demand and marginal revenue curves fall, and the new meeting point is at a lower output but *higher* price (because the marginal cost curve in inflexible in the short-term, and let's assume, has diminishing returns to scale).

The "last worker" is now a liability and will be let go, and let's assume the "second-to-last" worker is kept on. Now consider the effect of the subsidy. The marginal cost curve now breaks at the current low level of output, and continues, disconnected, at a level below the original line by an amount equal to the subsidy divided by the last worker's productivity. The new price for the output must now also decline by that amount to meet the prior level of production - which yields instant deflation in the marketplace.

And, of course, that deflation would hit the profitability of any competing firm that had not previously needed to fire any workers - but now must either do so - or lower wagers - to remain competitive and solvent.

Something to think about...

-L. Indyk

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