Get Ready for a “Jobless Recovery”

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Get Ready for a “Jobless Recovery� J. Bradford DeLong Professor of Economics, U.C. Berkeley Research Associate, NBER delong@econ.berkeley.edu July 17, 2009

Rising Unemployment As of this writing, it looks as though the average unemployment rate in 2009 is going to average at least 1.5 percentage points above where last December the incoming Obama administration thought that it was likely to be. Instead of the 7.8% forecast last December, year-2009 unemployment looks to average 9.3% or higher. Year-2009 real GDP also looks to be lower than the income Obama administration was forecasting last December: $11.40 rather than $11.53 trillion. The macroeconomic news has been bad. The financial crisis that gathered force from the summer of 2007 through the summer of 2008 and then exploded after the collapse of Lehman brothers did more damage to the economy than the consensus of forecasters had imagined. I, however, want to talk about something different than errors of forecasting—even though I could write a fine column about how the fact that our problems are worse means that our stimulus should be bigger: after all, as the Economist writes:

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if you accepted the arguments in favour of the previous stimulus bill, then based on recent macroeconomic data you should now be in favour of a larger stimulus package (and/or some kind of stimulus booster)...

I want to write about the fact that given the decline in GDP the rise in unemployment is too large, or perhaps that given the rise in unemployment the decline in GDP is too small.

Okunʼs Law Back in the 1960s one of President Johnson's economic advisers, Brookings Institution economist Arthur Okun, set out a rule of thumb other quickly named “Okun’s Law”: if production and incomes—GDP—rises or falls 2% because of the business cycle, the unemployment rate will fall or rise by 1% along with it: the magnitude of swings in the unemployment rate will be half or a little less than half the magnitude of swings in GDP. Why? For four reasons: • • • •

businesses will tend to "hoard labor" in recessions, keeping useful workers around and on the payroll even if there is temporarily nothing for them to do; businesses will cut back hours when unemployment rises, and so output will fall more than proportionately because total hours worked will fall by more than total bodies employed; plant and equipment will run less efficiently when hours are artificially shortened because of the recession; and some workers who lose their jobs won't show up in the unemployment statistics but will instead retire or drop out of the labor force.

For all four of these reasons, whatever rise in the unemployment rate we see in a recession is supposed to be a fraction of the fall we see in GDP relative to trend.

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But this time we are not following this rule. This time Okun’s Law is being broken. The unexpected 1.2% extra decline in real GDP in 2009 should have been accompanied by an 0.5 or 0.6 percentage-point rise in the unemployment rate, not by the 1.5 percentage point rise in the unemployment rate we are now seeing.

Jobless Recoveries I confess that the fact that this is happening comes as a surprise to me. But when I think back we have seen this before. In 1993—two full years after the National Bureau of Economic Research had called the end of the 19901991 recession—the unemployment rate was still higher and the employment-to-population ratio lower than it had been at the recession trough. And we saw the same “jobless recovery” after the recession of 2001: it took 55 months after the formal end of the recession in November 2001 before a greater share of Americans had jobs than had had them in November of 2001. 1990-1993 came as a surprise. 2001-2006 should, perhaps, not have been as great a surprise. We all remember the old Texas Ranger saying George W. Bush liked to quote—“Fool me once, shame on you. Fool me twice—we won't get fooled again!” (although I confess I had not known that Pete Townsend was ever a Texas Ranger). But three times? It would be very bad indeed to be caught by surprise three times. So: Don't get fooled again! Get ready for a jobless recovery! It is likely to be a recovery. The central tendency forecast right now is that real GDP contracted at a rate of 1% per year or less between the first and second quarters of 2009, and will grow between the second and third quarters at a rate of 2% per year or so. When the NBER Business Cycle Dating Committee gets around to it, it is most likely to call the end of the recession for June 2009, second most likely to call it's end in April, and a recession-end date later than June 2009 is a less likely possibility.

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Effects of Fiscal Stimulus And one reason that we are likely to see a recovery starting... right now... is the stimulus package. It probably boosted the real GDP annual growth rate relative to what otherwise would have been the case by about 1.0 percentage point in the second quarter, and is going to boost the annual GDP growth by about 2.0 percentage points between now and the summer of 2010—after which its effects tail off and its tailing off will not add to but rather subtract from GDP growth. (This is one reason that CEA Chair Christina Romer is now wandering around giving speeches about not repeating the mistakes of 1937 by pulling the plug on economic stimulus too soon.) So that to the extent that the politics becomes “did the stimulus work?” and the metric is real GDP and recession-dating, the answer is likely to be "yes": the economy would in all likelihood have been flat going forward a year and a half from now without the stimulus package, and instead it will in all likelihood have been growing when we look back in November 2010; the stimulus package was passed in the first quarter of 2009 and—Democratic House members seeking reelection will say—the recession ended in the second quarter.

Rapid Productivity Growth However, that is probably not the most relevant question to ask—either from a political or an economic standpoint. Comparing the second quarter to the first we see production declining at a rate of perhaps 1.0% per year and work-hours declining at 6.0% per year. Comparing the third quarter to the second we are likely to see production growing at a rate of perhaps 2.0% per year and unless new unemployment claims fall immediately and drastically we are seeing work-hours declining at a rate of perhaps 3.0% per year. Do the math: productivity is now growing at 5.0% per year not because we are deploying wonderful new technologies but because businesses now

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take the end of a recession as a moment to take one last look at their labor force and fire those who they think that they can—after all, the economy is so lousy that they cannot be blamed for doing so, and this is the last moment for them to fire lots of people without pissing the remaining workers off.

Note that this is a new pattern: employment growth after the 1982 recession lagged GDP growth by only six months. Thereafter it was very strong: in the eighteen months up until the end of 1984, growth in work hours averaged 4.8% per year. it took only 7 months after the 1982 recession trough for the employment-to-population ratio to rise above its trough level (1980: 2 months. 1975: 5 months. 1970: 18 months. 1961: 13

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months. 1958: 4 months. 1954: 8 months.) By contrast, it took 29 months after the 1991 recession trough for the employment-to-population ratio to exceed its trough level, and 55 months after the 2001 recession trough for the employment-to-population ratio to do so).

Why the shift? Why is a jobless recovery likely now, and why have there been jobless recoveries for the past two decades? Paul Krugman has a theory: [Past] recessions... were very different.... Each of the slumps — 196970, 1973-75, and the double-dip slump from 1979 to 1982 — were caused, basically, by high interest rates imposed by the Fed to control inflation. In each case housing tanked, then bounced back when interest

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rates were allowed to fall again. Since the mid 1980s, however... recessions haven’t been deliberately engineered by the Fed, they just happen when credit bubbles or other things get out of hand.... [T]hey’ve proved hard to end... precisely because housing — which is the main thing that responds to monetary policy — has to rise above normal levels rather than recover from an interest-imposed slump.

I guess that there is another set of factors at work. Manufacturing firms used to think that their most important asset was their skilled workers. Hence they did not want to let them go. They hung onto them, “hoarding labor” in recessions. And they especially did not want to let go of their prime productive asset when the recovery began. They were the franchise. Now, by contrast, it looks as though firms think that their workers are much more disposable and replaceable—that it is their brands or their machines or their procedures and organizations that are their key assets. They still want to keep their workers happy, they just don't care as much about these particular workers. This is only a guess. But the hypothesis is that firms believe that their remaining workers will forgive them if they fire large numbers of workers during a recession out of economic necessity, but not at other times. Hence the start of the recovery is a business's last moment to slim down its labor force and become more efficient and more profitable for the forthcoming boom. But that's just a guess.

The Answer to the Political Question So it looks like today, without much faster real GDP growth than currently looks to be on the cards, we are headed for a jobless recovery. Thus to the extent that the politics becomes “did the stimulus work?” and the metric is the unemployment rate, the answer is likely to be “no.” And the answer to the economic question—was the stimulus sufficient to rapidly return the economy to something like normal unemployment?—is likely to be:

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h—- no, it was much too small...

July 17, 2009: 1735 words.

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