When the Democrats took control of the White House in 2008, they
inherited, along with the burden of a deep worldwide recession, the
enormous promise of the political capital guaran-teed to accrue to
whoever presided over an economic recovery. Indeed, many
forecasters are tentatively predicting such a turnaround. Even
assuming the rosiest projections come true, however, there remains
a looming threat to the incumbents’ agenda and reelection chances,
not to mention the country’s well-being: the jobless recovery.
Barack Obama and company would not be the first political
victims of a jobless recovery. When Bill Clinton successfully
framed his 1992 campaign’s rhetoric with “it’s the economy,
stupid,” the country was actually no longer in a recession, gross
domestic product (GDP, a measure of a country’s total production)
growth having resumed in March of 1991. The fact that the recovery
was “jobless,” meaning that unemployment stayed high long after GDP
began growing, undermined George H. W. Bush’s chances. The Obama
administration knows that, despite recent improvements in the
economic outlook, a jobless recovery will have Obama facing the
same criticisms Bush I faced — and also that if recent history
holds up, a jobless recovery is likely.
The past two recessions have broken previous downturns’ patterns
of GDP growth and unemployment. In 1962 the Yale economist Arthur
Okun developed a rule of thumb, soon known as Okun’s Law, that
every 2 percent decrease of GDP from potential output (what the
economy could produce if it were functioning at full capacity) is
related to a 1 percent increase in unemployment. From WWII through
the late 1980s, this relationship held fairly closely.
The recovery from the 1991 recession, however, featured an
employment outlook that actually worsened as GDP grew: it was not
until more than four years after the official end of the recession
that there were more Americans employed than before the recession
began. The recovery after the 2001 recession was similarly jobless.
Unemployment did not peak until the recession had officially ended,
and remained high even into 2004.
The current downturn, which began in December 2007, is the third
consecutive recession to defy Okun’s Law. Unemployment has
increased at a faster rate than the law would predict, ballooning
to 9.8 percent without a correspondingly huge drop in GDP. And even
as most economists believe the recession is over or nearly over,
job losses continue to pile up. Assuming that the turnaround is for
real and we’ve escaped the worst of the recession (no small
assumption), the question isn’t whether we’ll have another jobless
recovery, but whether it will be even worse than the previous two
episodes. The situation hasn’t escaped the political radar of
Speaker of the House Nancy Pelosi, who in October told the press
that the “number-one subject on the minds of the American people”
was “jobs, jobs, jobs, and jobs.”
The most recent unemployment statistics must terrify the
president, especially because his policy options are constrained by
economists’ lack of understanding of the causes of jobless
recoveries.
There are a few competing theories. Economists of a statist or
Keynesian bent tend to posit that modern managers are quicker to
fire employees and squeeze extra productivity out of their
remaining workers, and then explore why that might be so. For
instance, executive compensation schemes have changed since the
1980s, resulting in more incentives for managers to keep profits
high by laying off under-exploited workers. Another example: highly
trained workers are no longer as important as brand image,
technology, and flexibility, and consequently they are the first
asset to go in a downturn.
There is a more compelling, more market-based explanation that
borrows insights from Austrian-style economists like Joseph
Schumpeter and Chicago business cycle theorists like Fischer Black.
It focuses on the changes that the modern labor market has
undergone, and explores the possibility that recessions now cause
structural, as opposed to cyclical, changes in hiring. Cyclical
changes are responses to the business cycle: companies across all
industries tighten their belts and start laying off employees when
austerity threatens, but then rehire the workers they laid off when
good times roll again.
A structural change in the labor market, on the other hand,
occurs when hiring patterns change not as a function of economic
fluctuations, but because of shifts in the economy’s production
that reallocate workers among industries. In other words, a
mismatch between what consumers demand and what producers are
making necessitates a shake-up in the mix of industries. Perhaps
the most familiar example of a structural change is the Industrial
Revolution, when, starting in the 18th century, Great Britain’s
labor force transitioned from manual labor to machine-aided
manufacturing jobs in great numbers.
This hypothesis makes sense intuitively, because it is much
easier for workers to slip back into their old jobs than to find a
new line of work. The employment recovery following a downturn will
be much slower if, to expand on the Industrial Revolution example,
the laid-off worker has to pack his bags and leave the farm, move
to the city, and learn how to operate and maintain a steam
engine.
The difference between Okun’s days and the present is that we
now have recessions with structural shifts. Two reasons for this
come to mind. First, modern technologically advanced firms do a
better job calculating their optimal amount of labor without
resorting to temporary layoffs — if they downsize, they downsize
permanently because their industry is shrinking. Second, thanks to
wiser officials and the lessons of time, the Federal Reserve is
less likely to mismanage the money supply and create recessions
entailing mass temporary layoffs owing to an artificial scarcity of
money. Of course, the Fed still can only do so much to anticipate
real scarcity and structural changes.
The beauty of the structural change theory of jobless recoveries
is that it is testable. If hiring is determined by shifts in what
the economy produces, then the data will show that permanent
layoffs outnumber temporary layoffs — that is, workers aren’t
returning to their old companies. Also, there would be noticeable
differences in hiring and firing patterns between different
industries before and after the recession. The market would
determine in which activities firms were overinvested, and which
were ripe for further growth.
The data does seem to conform to the theory. In a 2003 study,
Federal Reserve economists Erica L. Groshen and Simon Potter found
that in past recessions, temporary layoffs spiked. They also found
that the two recent jobless recoveries involved clear winning and
losing industries, a conclusion they arrived at by looking at
payrolls in different industries before and after the recession.
The industry that best exemplifies this trend is the dot-com boom
of the the late '90s. During the recession of 2001 it became clear
that there was a bubble in web companies, and the industry began
rapidly to shed trained workers. The extreme over-investment in the
dot-com bubble is an identifiable reason why the job reports were
so bleak so long after the end of the downturn. It simply took a
long time for the economy to shake out where the former dot-com
workers belonged. One industry, notably, that did take off in the
wake of the ‘01 recession was…housing.
With economic “green shoots” — encouraging signs — cropping up
even as the employment outlook languishes, the current recession
seems to follow the precedents set by the past two. As for
structural changes, no one knows what the next big thing will be,
but it doesn’t seem to difficult to guess which industries will be
pruned, most apparently the housing industry. John Cochrane of
Chicago memorably suggested that the recession meant that the
construction industry should contract: “People who spend their
lives pounding nails in Nevada need something else to do.”
If the recessions of 1991 and 2001 are any indication,
unemployment will be a serious problem for a while. Furthermore,
the current recession includes a banking crisis, which will likely
create difficulties that we were spared in the previous two jobless
recoveries. With the financial system still in disarray, lenders
and borrowers are less able to get credit to new engines of growth
and employment that need financing. Edward Knotek of the Kansas
City Federal Reserve estimates, based on a review of the past two
jobless recoveries and recoveries in countries that simultaneously
suffered a banking crisis, that a middle-of-the-road projection has
unemployment increasing beyond 10 percent and remaining at that
level through 2011.
Clearly, unemployment anywhere near that dismal projection would
be a weight around the Demo-crats’ neck that would surely drag them
under in the 2010 midterms. And in the ramp-up to the 2012
elections, President Obama would find it difficult to make the case
that he fulfilled his promise to restore vitality to the damaged
country his predecessor had left him.
The administration is keenly aware both that a jobless recovery
means prolonged real suffering for millions of people, and that
allowing it on its watch will take a toll on its political capital.
That is why the president and his team have emphasized the jobs
“created or saved” by the $787 billion stimulus plan. When the
stimulus was enacted, at the height of the panic, the
administration made the — conveniently unfalsifiable — claim that
it would “create or save” 3.5 million jobs.
The administration has maintained this messaging tactic even as
unemployment has sky-rocketed. In late October, the Obama team
brazenly reported saving 250,000 jobs in education alone — a
claim for which it provided scant evidence. Throughout the year,
the administration has reaffirmed with each grim job report that
the stimulus is on track to save or create more than 1 million jobs
by the start of 2010. This, despite the fact that unemployment has
only worsened, documented jobs created by the stimulus are very
few, and even the Office of Management and Budget, the White
House’s own economic outfit, predicts unemployment to stay at 9.7
percent through 2010.
The Obama stimulus is more conducive to a government-subsidized
jobless stasis than to growth if indeed the labor market changes
are not cyclical. And if they are structural, fired workers won’t
be able to rejoin their old companies once they get off the
government’s payroll. The market will still need to find them a new
growth industry, a process that the temporary government jobs might
simply have postponed. Instead of forestalling the jobless period
altogether, the stimulus-funded jobs could spread the pain out over
an even longer time.
The labor market becomes more complex, more dynamic, and,
accordingly, more difficult to manage every day. The Obama
administration and the Democrats know that reversing the trend of
jobless recoveries will be the key to success in the upcoming
elections, but they have chosen a blunt and inflexible
tool-government intervention — for that task. If they find
themselves increasingly unemployed in 2010 and 2012, it will be
because so many others were as well.
