Keating: Parsing Unemployment, Looking for a Cure

September 14, 2012

by Maryann O. Keating, Ph.D.

Without identifying the cause, we know when we are ill and hurting. Obviously, it is not advisable to experiment with a variety of remedies to determine which one works. Similarly, in economics, we know that an unemployment rate exceeding eight percent is too high. And even though the situation is desperate for those unemployed, randomly selected policy initiatives are not a solution.

The unemployment rate may be parsed into various components. About three to four percent of unemployment in a free society is considered “normal.”  New entrants to the labor force, those between jobs and the seasonally unemployed account for this normal unemployment. The actual percentage of normal unemployment varies depending on the amount of time individuals and employers on average allocate to searching for new jobs or new employees.

Even if we generously accept four-percent unemployment as normal, we must account for current residual unemployment. A “cyclical” component of the unemployment rate rises as the growth rate of GDP (Gross Domestic Product) declines and lags until the economy begins to recover.

Recessions last on average about 18 months from start to finish. Certainly, recent excessively high unemployment rates are partially explained by the Great Recession of 2008.To deal with this cyclical unemployment, massive amounts of expansionary fiscal and monetary policy were aimed at lowering interest rates and stimulating aggregate demand. Nevertheless, the present recovery has been anemic, and job “creation” has been particularly resistant.

In addition to normal and cyclical unemployment, a third component of the unemployment rate is labeled “structural.” Structural unemployment suggests an imbalance in the economy that not only boosts the unemployment rate up but keeps it indefinitely at a higher level. Structural unemployment is attributed to labor-market imperfections or regional or global shifts in the demand for certain types of employees. Structural unemployment is not normal and does not respond to fiscal or monetary policy.

“Mismatch” is a measure of the structural maladies in the labor market.  A mismatch argument suggests that applicants lack skills needed in today’s job market. A Brookings Institution study analyzes job openings in the 100 largest U.S. metropolitan areas from 2006 to 2012. Forty-three percent of job openings typically require at least a bachelor’s degree but just 32 percent of adults 25 and older have earned one. Unemployment rates are two percentage points higher in large metropolitan areas with a shortage of educated workers relative to demand (and have been consistently since before the recession). Jonathan Rothwell, author of the Brookings’ study, measures the size of the gap for each of 100 U.S. metropolitan areas. Indianapolis falls near the middle of the pack both with respect to recovery from cyclically induced unemployment and with an education gap of 4.4 percent between the criteria listed for job openings and the actual supply of workers.

The Brookings study finds a relatively high share of job openings, offering good pay and intellectually challenging work, available to applicants with some college or associate’s degrees. It concludes that educational attainment, overall and relative to existing demand, benefits metro areas by making workers more employable and firms more competitive and entrepreneurial. Significantly, labor markets in cities with lower educational gaps are more resilient and bounce back more quickly from cyclical downturns. In addition, they offer more job openings for less educated workers. The author proposes that non-profit organizations, community colleges and government use detailed job openings data to align training curricula and certifiable skills with employer demand.

In an article entitled “There is No ‘Structural’ Unemployment Problem” (the Wall Street Journal, Sept. 4, 2012), Ed Lazear points out that in 2007 the unemployment rate was 4.4 percent and two years later reached 10 percent. This rapid change refutes the idea that the structure of the economy has changed. Lazear notes that the largest increases in unemployment took place in three industries: construction, manufacturing and retailing. Turning construction workers into nurses may help a little, but the “jobless recovery” is more the case of no recovery. An empirical rule of thumb is that each percentage point of growth in GDP contributes about one-half a percentage point to employment. In other words, to get unemployment down to five percent, increase the growth rate of the overall economy.

A letter to the editor of a Fort Wayne newspaper by Rod Vargo offers an interesting rebuttal. Mr. Vargo observes that in even with a relatively good GDP growth rate in northwest Indiana, employers find it difficult to find reliable workers with the necessary math skills. He observes that workers have little incentive to close this mismatch in skills. Wage income net of taxes and training does not compensate for longer hours at more intensive work plus forfeited unemployment or disability benefits.

Explaining the rise in unemployment and declining labor force participation for so many American workers is a daunting challenge. More troubling, yet, are the post-2000 real household income declines that are pervasive across all income and educational levels. A prudent response to theoretical conflicts over the causes of unemployment might be an investment boom fostered by eliminating regulations impeding higher growth rates. At the same time, we could address structural unemployment, not by a proliferation of programs trying to second guess the labor market, but rather by increasing the basic skill-level of job applicants.

Maryann O. Keating, Ph.D., an adjunct scholar of the Indiana Policy Review Foundation living in South Bend, is co-author of Microeconomics for Public Managers, Wiley/Blackwell, 2009.


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