Beneath the Surface

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In the first part of their book, Dean Baker and Jared Bernstein argue for placing a higher priority on reducing unemployment, as opposed to the current policy preoccupations of holding down inflation and reducing the federal deficit. The later chapters discuss different ways of increasing labor demand and boosting employment.

Before the recent recession, the economy was creating more jobs, but growth was driven mainly by a housing bubble that both created a boom in construction and made homeowners feel wealthy enough to spend more. The problem now is to replace the economic demand that was lost when the bubble burst. That requires some combination of increases in consumption, investment, government spending or net exports.

The authors do not expect consumption to return to its former level by itself, since consumers no longer feel very wealthy, and “tens of millions of baby boomers stand at the end of retirement with little or no savings.” They also reject the view that “investment will surge if we reduce the tax and regulatory burdens on business.” Over the last fifty years investment has averaged less than 9% of GDP, and so it would take an enormous increase to make up for much of the lost demand. And I might add, why invest in more production until one is confident that potential customers are willing and able to consume more?

Increasing net exports by reducing the trade deficit has the potential to create millions of jobs. The authors estimate that balancing exports with imports could increase GDP by 5.4% and lower the unemployment rate from over 7% to under 5%. Investments in infrastructure and education may make American products more competitive, but that is a long-term project. Letting the dollar fall in value against foreign currencies would have more immediate benefits by making our products cheaper, although it would also hurt big importers of cheap foreign products, such as Wal-Mart.

In Chapter 6, Baker and Bernstein make their case for public spending to create more jobs. Their reasoning is solidly in the Keynesian tradition:

Downturns are characterized by a drop-off in demand that the private sector is unable to fill. The government, with its capacity to borrow on favorable terms, can afford to spend when everyone else is hunkered down. Some forms of spending are better than others in terms of reinvigorating demand, and one of the best forms is public infrastructure investment, which can employ hundreds of thousands of workers in projects that yield long-term, continuing returns on the dollar.

They also recommend public investments in areas where the United States lags behind other developed countries, such as rail systems, energy-efficient construction and high-speed internet access.

But won’t additional public spending make the federal deficit even worse? The authors reject the popular but simplistic argument that debt is just as bad for a government as for an individual. How much an individual can ever repay is limited by the human lifespan. The government never dies [unless Grover Norquist succeeds in drowning it in that bathtub!], and can draw on revenue from a growing economy to finance its debts. Public investments that stimulate growth pay off in additional tax revenues, while “austerity measures that would cut spending in order to generate growth have the counterproductive effect of hurting growth, and they typically fail to reduce deficits because slower growth lowers tax revenues and requires more spending on economic stabilizers” like public assistance and unemployment benefits.

The best way to measure the burden of debt on government is to consider the interest paid as a percentage of GDP. That percentage rose steeply in the 1980s but declined steeply in the 1990s. It has remained relatively low since 2000, as interest rates have come down. The ratio of the deficit itself to GDP has declined from 10% in 2009 to 4% in 2013. “The bottom line is that the government is nowhere near the limit of its ability to take on additional debt.”

The United States does have a longer-term problem of containing health care costs, which impact government through spending on Medicare and Medicaid. “The United States spends more than twice as much per person on health care than do other wealthy countries, with too little to show for it in the way of outcomes relative to these other advanced economies.” But that is a problem for the country whether we finance it with tax dollars or consumer dollars, and the best solution is to reduce health care costs, not reduce other economically and socially beneficial public spending.

Baker and Bernstein have an excellent response to the common argument that government borrowing is hurting the next generation:

One of the most peculiar arguments about deficits is that we must save our children from the phantom menace of future debt tomorrow by severely underinvesting in them today. We must defund Head Start, public schools, universities, libraries – not to mention our own employment opportunities. This absurdity is accepted wisdom in today’s fiscal debates, even though the extraordinarily low interest rates at which the government can borrow money would be taken as a signal by any private investor that now is a good time to borrow. If government were run like a business, it would be taking advantage of low interest rates to finance a wide variety of public investments. Franklin Roosevelt did that during the New Deal, undertaking infrastructure projects that still support the economy today.

The authors also recommend “a flexible program of publicly funded jobs that can ramp up and down as needed.” The jobs themselves can be in the private sector, with public subsidies to promote additional hiring, as long as regulations are in place to make sure that the new jobs are truly new, not just replacements for existing jobs.

Finally, they recommend policies to promote shorter work hours, more paid vacation days and more generous family leave policies. These would spread the available work among more people and reduce the number without jobs altogether. It would also save money on unemployment compensation and keep workers attached to the workforce so that their skills don’t deteriorate. Germany’s average work year is only 1,400 hours, compared to 1,800 hours in the United States. Germany also uses public money to supplement the wages of workers whose hours are cut during economic downturns.

Baker and Bernstein believe that a high rate of unemployment is unnecessary, and that it can be ameliorated with the right policies. Although the economic demand for labor is too low, the ultimate need for labor is not a problem. True, new technologies and higher productivity are reducing the need for labor in many traditional industries, but that’s been going on for a long time. In the twentieth century, new technologies like the assembly line also boosted productivity, but the country was ultimately richer for it. Workers whose productivity went up eventually received a share of the benefits in the form of higher wages, and the money they spent created new jobs in expanding industries. Workers also got some of the benefits in the form of a shorter work week, when the 40-hour week became standard with the Fair Labor Standards Act of 1938. So what’s not to like? Pay went up, hours went down, massive unemployment was avoided, and living standards improved dramatically from the 1940s until the 1970s.

The point here is simple: We need never worry that a reduced need for labor will lead to massive unemployment. If workers are sharing in the gains of productivity growth, and they take a portion of these gains in the form of more leisure time, then the supply of labor will to some extent adjust to any reduction in need due to improved productivity. When productivity growth is translated directly into shorter work years, the sense in which these gains are a source of wealth rather than impoverishment is more clearly visible. If workers can have the same living standard by working fewer hours, then they are obviously better off.

What is stopping us from making the same kind of progress again? In Baker and Bernstein’s view, the policies that tolerate high unemployment and stagnating wages derive from the mistaken belief that any measures to stimulate economic demand can only bring back inflation. That in turn depends on the assumption that the productive labor is already employed, and that the rest just aren’t worth being paid a wage they could live on because they can’t produce enough to justify it. The weak demand for labor hurts the bargaining power of all workers, helping to hold wages down even when their productivity is rising. So we try to keep the economy expanding and profits growing while refusing to place a higher value on human labor. Except, of course, for executive labor, since executives, after all, are the “job creators”(!)

I would also suggest that an underlying problem here is a zero-sum mentality, a fear that nothing can be done for the unemployed, or for low-wage workers, without taking something away from someone else, either in higher taxes or higher prices. Anyone who speaks up for workers is quickly accused of engaging in “class warfare,” which is another way of calling someone a communist. How did we lose our confidence in our nation’s ability to prosper and to create opportunity for all?

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Dean Baker and Jared Bernstein. Getting Back to Full Employment: A Better Bargain for Working People. Washington, DC: Center for Economic and Policy Research, 2013.

In this short but cogent book, Baker and Bernstein make their case for focusing public policy more on the goal of achieving full employment. That goal seems strangely out of fashion, considering how high unemployment has been since the financial crisis of 2008. Reducing the federal deficit and holding down inflation are the goals that preoccupy policymakers, but the authors see that as economically counterproductive.

As economists use the term, “full employment” doesn’t mean that everyone who would like a job is actually working. The labor force always includes some people who are currently between jobs (the “frictionally” unemployed) and some who lack the ability or skill for the existing jobs (the “structurally” unemployed). An economy does not have to employ those groups to be considered at full employment, but it does have to have enough jobs to eliminate “cyclical unemployment,” unemployment resulting from a weak demand for labor in general. While structural unemployment is a problem of labor supply, requiring improvements in the qualifications of workers, cyclical unemployment is a problem of labor demand, potentially responsive to stimulatory fiscal and monetary policy. To the degree that government can stimulate demand through such measures as cutting interest rates or increasing public spending, it can reduce cyclical unemployment and move the economy toward full employment.

If, however, the economy is already near full employment, and most of the remaining unemployment is structural, then policies intended to promote additional employment could mainly generate inflation instead. If the job-seekers are mostly underqualified for existing jobs, then employers who wish to hire must either bid up the price of the qualified workers or pay the unqualified more than the value of what they can actually produce. Either puts upward pressure on wages and/or prices. Theoretically, there is a rate of unemployment at which cyclical–but not structural–unemployment is absent, and below which unemployment cannot go without increasing the rate of inflation. Economists call that the “non-accelerating inflation rate of unemployment,” or NAIRU. It is the theoretical sweet spot of “full employment and stable inflation.”

In practice, economists have trouble agreeing on the NAIRU rate, or on the inflationary cost of trying to get unemployment even lower once that rate has been reached. Baker and Bernstein are concerned that an excessive fear of hitting an inflation threshold makes policymakers too timid about fighting today’s high unemployment, unemployment at a rate they consider well above NAIRU.

To acknowledge this relationship between low unemployment and price pressure is common sense. But there is a huge difference between acknowledging the relationship and believing that public policy must avoid full employment because it will cause inflation, or that it must tolerate a cruelly high level of unemployment simply to avoid a slight risk of inflation.

In the early 1990s, most economists thought that unemployment couldn’t go below 6% without triggering more inflation, but it actually came down to 4% by the end of the decade, while wages remained stable. Today, the Congressional Budget Office estimates NAIRU at 5.5%, and a few economists regard unemployment rates over 7% as mostly structural rather than cyclical. That view blames unemployment primarily on the poor qualifications of the workers and discourages efforts to stimulate economic demand by warning of inflationary consequences.

Baker and Bernstein disagree. They reason that if employers generally were having trouble finding qualified workers, they would be offering higher pay or lengthening the workweek for existing workers. That’s true for a few jobs, but not for the economy generally. The authors also point out that unemployment that appears structural could actually be cyclical, since employers are much more likely to upgrade worker qualifications through training when the demand for labor is high.

I would add that a lack of high-paying jobs has a structural dimension, since it is at least partly due to a lack of education or skills in a particular population. But as Arne Kalleberg argues in Good Jobs, Bad Jobs, it also reflects how employers choose to organize work. Some companies deliberately create jobs that can be performed by cheap, low-skill labor, and such jobs have proliferated in our “post-industrial” economy, especially in service industries. When labor demand is high, skill requirements are not as significant an obstacle to employment as all the talk about hi-tech industries would suggest.

Believing as they do that today’s very high unemployment is mostly cyclical, Baker and Bernstein argue that the benefits of reducing it far outweigh any inflationary costs of doing so. “If the unemployment rate could in fact fall to 4.0 percent, and possibly lower, without leading to accelerating inflation, then the result of a policy that kept it higher would be the needless unemployment of millions of workers and lower wages for tens of millions.”

When the demand for labor is low, as it has been since the financial crisis, that creates unemployment for some and low wages for many more. Workers are in a much stronger bargaining position when labor markets are tight. Long-term unemployment has negative effects on earnings that last for many years beyond the actual period of unemployment. Since these effects are greatest for workers at the low end of the income scale to begin with, slack labor markets tend to widen the income gap between rich and poor.

Moreover, the damage of job loss extends beyond earnings and hours worked, as job losers have been found more likely to experience a number of noneconomic negative impacts, including increased rates of stroke and heart attack, higher rates of divorce, lower rates of home ownership, and even lower life expectancy. Generational effects have also been found as the children of parents facing long-term unemployment are more likely to have lower test scores and reduced earnings as adults than similarly placed children whose parents avoid long jobless spells.

Beyond the effects on workers and their families, economic downturns that drag on needlessly have huge costs for the entire country through lost productivity. Since 2008, United States has produced $6 trillion less than the CBO projected it would before the recession. “This is a large cost that dwarfs the estimates of the losses associated with modestly higher rates of inflation.” Unemployment also affects the federal budget deficit, since it reduces tax revenue and increases the number of people qualifying for government assistance. For example, workers with chronic health problems who could find jobs when labor demand is high have been applying for disability benefits since demand declined.

Baker and Bernstein see the costs of inflation as much smaller than all that. Even if stimulatory economic policies were to push the unemployment rate a full percentage point below NAIRU–and they believe that it is well above that point now–the research indicates that the rise in inflation would only be in the range of 0.3 to 0.5 percent. The costs in terms of economic growth would be less than those of persistently high unemployment. Although some studies have found a negative impact of inflation on economic growth, “the size of the estimated impact of inflation on growth in the studies that found an effect is certainly well within the range that could be explained by measurement error.” (Here they discuss a particular type of measurement error that plagues these studies. If, as many economists believe, conventional measures often overstate inflation, such overstatements would both increase measured inflation and decrease measured GDP growth, since real growth is nominal growth minus inflation. Such cases could skew the results so that the same countries appeared to have both higher inflation and lower real growth.)

A modest amount of inflation can even help with some policy issues. Suppose the Federal Reserve reduces the federal funds rate to 2%, in order to stimulate the economy by making borrowing more affordable. If inflation is 1%, the real federal funds rate (nominal rate minus inflation) also becomes 1%. But a higher inflation rate can bring the real rate down to 0% or even below zero, making borrowing really pay.

The authors are especially critical of central bankers who make low inflation their overriding policy objective, especially when the central bank has a legal mandate to pursue both price stability and high employment, as it does in the United States. They summarize:

The evidence used to support inflation-targeting policy is dubious. If the general public and even most politicians fully understood the costs and risks associated with the inflation policy pursued by central banks, few would agree that it is appropriate to keep millions out of work and deny wage growth to tens of millions simply to reduce the risk of modestly higher inflation.

While Baker and Bernstein focus on the economics rather than the politics of unemployment, one may observe how easily full employment gets relegated to the back burner. Although high unemployment hurts the entire economy, the costs fall disproportionately on the have-nots, the workers whose labor is in least demand. Inflation, on the other hand, erodes the value of whatever wealth and income people already have. In a society with extreme inequality and minimal restrictions on political spending, the haves can use their influence to create a systemic bias toward fighting inflation instead of unemployment. Prevailing policies may not be optimal for economic growth, but they help perpetuate the unequal distribution of the benefits that flow from whatever growth occurs. Much of the resulting unemployment may not be structural in the economic sense, that is, resulting from the workers’ inability to do today’s jobs. But it could be structural in a more political sense, resulting from the weak position in the power structure of workers in general and unemployed workers in particular. That would explain how unemployment could be technically cyclical as Baker and Bernstein argue, and yet so persistent.

Continued