Why Is Unemployment So High?

In his column this morning Paul Krugman turns his gimlet eye (there’s a joke in there somewhere about The Onion) on the high level of unemployment that we have seen in this recession in particular, which is both higher and of longer duration than might have been expected based on the drop in GDP:

What can be done about mass unemployment? All the wise heads agree: there are no quick or easy answers. There is work to be done, but workers aren’t ready to do it — they’re in the wrong places, or they have the wrong skills. Our problems are “structural,” and will take many years to solve.

But don’t bother asking for evidence that justifies this bleak view. There isn’t any. On the contrary, all the facts suggest that high unemployment in America is the result of inadequate demand — full stop. Saying that there are no easy answers sounds wise, but it’s actually foolish: our unemployment crisis could be cured very quickly if we had the intellectual clarity and political will to act.

In other words, structural unemployment is a fake problem, which mainly serves as an excuse for not pursuing real solutions.

He goes on to describe two competing explanations for the high level of unemployment. The first, which he disparages, is that the unemployment is structural:

Who are these wise heads I’m talking about? The most widely quoted figure is Narayana Kocherlakota, the president of the Federal Reserve Bank of Minneapolis, who has attracted a lot of attention by insisting that dealing with high unemployment isn’t a Fed responsibility: “Firms have jobs, but can’t find appropriate workers. The workers want to work, but can’t find appropriate jobs,” he asserts, concluding that “It is hard to see how the Fed can do much to cure this problem.”

It seems to me that there is some level of structural unemployment is inescapable. The sector which has seen the most dramatic loss of jobs is housing constuction. New housing construction is virtually flat and there’s a year’s worth of housing stock inventory. Those jobs won’t return soon. Housing demand had two components: end-user demand and investors’ demand. For the rate of construction to return to what it has been since, say, 2002, we’d need to see a return of both sorts of demand and, frankly, I doubt that we’ll see a new housing bubble any time soon. There is always structural unemployment following the collapse of a bubble and the more people that were employed in the sector in which the bubble occurred, the more structural employment there will be.

The only sectors doing much hiring are healthcare and education. Is Dr. Krugman claiming that out of work carpenters can just take work as classroom teachers? Or nurses? Lab technicians, perhap? Taking jobs as teachers aides or nurses aides would entail a substantial loss in pay, something that few will elect until there really is no other option.

Dr. Krugman’s preferred explanation is inadequate aggregate demand:

I’ve been looking at what self-proclaimed experts were saying about unemployment during the Great Depression; it was almost identical to what Very Serious People are saying now. Unemployment cannot be brought down rapidly, declared one 1935 analysis, because the work force is “unadaptable and untrained. It cannot respond to the opportunities which industry may offer.” A few years later, a large defense buildup finally provided a fiscal stimulus adequate to the economy’s needs — and suddenly industry was eager to employ those “unadaptable and untrained” workers.

The NFIB (of which I am a member and which Dr. Krugman cites in his piece) recently did a study of its member (which I believe I’ve cited here before) to determine the reasons that small businesses aren’t hiring. The single most important reason they gave for not hiring was lack of demand, which supports Dr. Krugman’s position.

However, it wasn’t the only factor. The next two factors in order which between them outweighed lack of demand were taxes and government regulation which can be clumped together as “regime uncertainty”. According to the owners of small businesses more of them are not hiring due to regime uncertainty than due to lack of demand.

I can think of any number of other reasons for high unemployment. Let’s just consider three: culling the herd, underwater houses, and unemployment benefits.

Contrary to what one might believe employment in large firms tends to be downwards inelastic. There are several reasons for this. Union contracts may have restrictions on layoffs. Large firms are always bureaucracies and influence in a bureaucracy is measured by how many people report to you. Managers can be very reluctant to let go of their empires. The recession created a perfect opportunity to reduce excessive employment and many businesses seized it.

As a consequence of the collapse of the housing bubble an astonishing number of home mortgages are “underwater”, i.e. the homeowners owe more on their mortgages than their homes are worth. That (and the sluggish market) makes houses hard to sell since they’d need to bring cash to the closing. Since so many people these days live paycheck to paycheck, that’s not an alternative. Underwater houses makes people less willing or even able to move to seek employment where it might be more available. Note that underwater houses also reduce the ability of those who have jobs to take better jobs should they become available. They introduce a general rigidity into the system.

In normal times unemployment benefits last 26 weeks. These, however, are not normal times and benefits have been extended and extended again until they can last as long as 99 weeks (and some people may have decided that they will be extended indefinitely). Unemployment benefits have the measurable effect of extending unemployment a small amount and, consequently, will inevitably increase the rate of unemployment.

Don’t misconstrue that observation as my thinking that we should not extend unemployment benefits; I don’t think that. However, I do think that we should start considering other alternatives with better incentives, e.g. maintaining benefits at some level after work has been secured or paying employers for the additional 73 weeks for hiring people who’ve been unemployed for 26 weeks rather than the workers.

My point is not that Dr. Kocherlakota is right and Dr. Krugman wrong or vice versa. It is that I very much doubt that there is a unitary explanation for the high level of unemployment we’re seeing right now and a simple, unitary solution, whether it be education or an additional stimulus package, is unlikely to be as effective any of us might like.