A recently released study by the Congressional Budget Office entitled "Understanding and Responding to Persistently High Unemployment" examines the current state of the labour market and suggests an array of policy changes that could be made to reduce unemployment.
The United States is currently suffering from its longest stretch of unemployment greater than 8 percent since the Great Depression, the unemployment rate passed the 8 percent marker in February 2009 meaning that the American labour market has now suffered for three full years. The peak unemployment rate of 10 percent in October 2009 was only exceeded once since the end of World War II, during the 1981 - 1982 recession. As if that weren't bad enough, the Congressional Budget Office (CBO) projects that the unemployment rate will remain above 8 percent until 2014. As we all know, the official U-3 unemployment rate excludes individuals who would like to work but who have not searched for a job over the previous four week period as well as those who are working part-time simply because they cannot find full-time employment. If those individuals were counted, the unemployment rate would be in excess of 15 percent.
Compounding the unemployment problem is the share of unemployed American workers who have been looking for work for more than six months - the long-term unemployed. For the first time since data was collected in 1948, this number topped 40 percent in December 2009 and remains elevated as shown here:
The extent of long-term unemployed is much greater than what is normally experienced; had it followed its historical pattern, long-term unemployment would have been between 20 and 25 percent of all unemployed rather than 40 percent. This means that the burden of unemployment has fallen on the shoulders of Americans who have been unemployed for long periods of time, rather than the normal pattern of more workers being unemployed for shorter periods of time.
Now, let's take a look at who made up America's unemployed and long term unemployed in March of 2011:
Interestingly, the distribution of both unemployed and long-term unemployed came disproportionately from certain groups of Americans; males, people with a high school diploma, married people, African Americans, construction workers and people under the age of 25. As well, while the geographic distribution was more-or-less distributed in rough proportion to the size of the workforce, there were exceptions. Unemployment in the western states of California and Nevada was higher than would have been expected as was the case in Florida and Michigan where real estate and difficulties in the automotive industry led to higher rates.
These employment issues have a marked impact on the economy. Households with unemployed workers note a drop in earnings that often persists even when the unemployed family member finds a new job because of fewer hours worked and lower hourly wages. Older workers, in particular, often find that new jobs pay less and have less potential for earnings growth. As well, people that start their careers during times of high unemployment tend to have persistently lower earnings than their peers that start employment during when the economy is strong. Data compiled by the Bureau of Labor Statistics shows that among workers that lost their jobs between 2007 and 2009, 55 percent earned less per week once they were employed and 36 percent took at least a 20 percent cut in weekly earnings. This drop in income can persist for decades; workers displaced during the 1982 recession were still making 20 percent less than their non-displaced peers 15 to 20 years later.
What factors are causing high unemployment and high long-term unemployment?
1.) Weak demand for goods and services following the recession was related to a fall in household spending and the end of the wealth effect attached to home ownership. The CBO estimates that this accounts for 2.5 percentage points of the elevated unemployment rate.
2.) Mismatches between the needs of potential employers and the skills or location of the unemployed or frictional unemployment generally ranges from 4 to 5 percent but was at elevated levels after the end of the recession because of the inability of many workers to move to new geographic locations for work because of the collapse in housing prices that resulted in underwater homeowners. The CBO estimates that this factor accounts for 0.5 percentage points of the elevated unemployment rate.
3.) Incentives from extensions of unemployment insurance for people to stay in the labour force (i.e. not drop out of the statistical database) and continue searching for work accounts for about 0.25 percentage points of the elevated unemployment rate. The availability of UI also discourages unemployed people from taking jobs that are less than suitable because the benefits paid reduce the hardship of being unemployed, particularly as benefits are extended by the government with studies showing that these UI extensions elevate the share of long-term unemployment.
4.) Many employers believe that the skill sets of long-term unemployed workers erode and that long-term unemployed workers are of "lower quality" (stigmatization). Fortunately, when unemployment levels are very high, this affect is minimized as potential employers attribute the length of unemployment to economic conditions rather than individual issues. Unfortunately, even during periods of weak economic growth, long-term unemployment is still regarded as a stigma and results in a self-perpetuating cycle. The CBO estimates that this factor accounts for about 0.25 percentage points of the elevated unemployment rate.
Okay, what solutions does the CBO suggest for fixing the unemployment problem?
The CBO suggests that there are three main pathways that can be taken to prop up the job market; first by assisting households by increasing their disposable income thereby propping up the demand for goods and services, second by supporting businesses and third by increasing aid to state governments and government spending on infrastructure. The impact of these spending policies is measured using the number of full-time-equivalent employment (FTE) (one FTE is 40 hours of employment per week for one year) that is created per million dollars spent over the next two years.
Here is a chart showing the impact of various policy options on employment as noted above:
The CBO suggests that, as a rule of thumb, an additional $30 billion expenditure used in 2012 for an option that would boost employment in 2012 - 2013 by about 9 FTE-years per million dollars of total cost would reduced the unemployment rate by one-tenth of one percentage point. For example, the American Recovery and Reinvestment Act of 2009 which spent $825 billion, resulted in a 0.4 to 1.8 percentage point drop in unemployment in 2010.
In looking at the results of the CBO's analysis, it is apparent that the biggest employment gain bang for the buck is to increase aid to the unemployed, followed by reducing the employers share of payroll taxes for firms that increase their payroll and, in third place, by reducing employers payroll taxes for all firms. The poorest returns are for both reducing taxes on business income (not a surprise to me and a lesson to both President Obama and the remaining Republican Presidential candidates) and reducing tax rates on repatriated foreign earnings, a lesson the Bush II Administration learned the hard way in 2004 when they extended a generous tax holiday to American corporations that were supposed to create jobs in return as posted here. You'll also note that the jobs gain resulting from increased spending on infrastructure is also very, very low compared to the other alternatives, tied for third least effective policy with reducing personal income taxes in 2013.
As I noted above, the CBO's study shows that by far, the greatest employment gains are made by changing the current structure of the Unemployment Insurance system. Modifications to UI could be used to encourage unemployed people to return to work more quickly. Changes could include awarding reemployment bonuses to people who find a job quickly, offering wage insurance payments to people who accept a job that pays less than their previous job, using UI benefits to temporarily place unemployed workers with private-sector employers so that they can gain experience in a new occupation or industry or supplementing the earnings of workers who agree to accept shorter working hours rather than being laid-off (short-time compensation). As well, the UI system could be used to help unemployed workers relocate to areas where employment opportunities are greater; unfortunately, the general goal of programs that assist underwater homeowners are designed to keep owners in their current homes rather than moving them to a new location.
As well, the CBO suggests that direct government employment in public service jobs could reduce unemployment, as was the case during the Great Depression. As well, specialized training programs that improve workers skills that target specific industries and geographic locations could address the issues of skills mismatch, loss and the attached stigma faced by long-term unemployed Americans.
Programs also need to focus on America's youth who are suffering from 23.2 percent unemployment (January 2012). The use of career academies, small learning communities of high school students that focus on specific careers, have been proven to increase employment among young men from low-income families. In addition, apprenticeship programs that provide specific trade skills have been shown to result in both employment and earnings gains when compared to the training received at community colleges. With baby boomer tradesmen about to retire by the tens of thousands over the coming decades, there will be an increasing demand for trained journeymen.
The CBO's study shows that by far, the greatest employment gains are made by changing the current structure of the Unemployment Insurance system. Modifications to UI could also be used to encourage unemployed people to return to work more quickly. Changes could include awarding reemployment bonuses to people who find a job quickly, offer wage insurance payments to people who accept a job that pays less than their previous jobs, use UI benefits to temporarily place unemployed workers with private-sector employers or supplementing the earnings of workers who agree to accept shorter working hours rather than being laid-off.
All in all, the CBO has done a very interesting job in trying to solve what seems to be an unsolvable employment problem in America. While Mr. Bernanke suggests that America’s economy appears to be recovering more quickly than he expected, there are millions of unemployed Americans who would argue otherwise. At least the CBO is making an effort to suggest policies that would be most effective and efficient in changing the employment situation for the better, particularly in light of growing levels of government debt.
As an aside, I apologize for the length of this posting but the CBO study had so many interesting points that I felt should be included.