“A big puzzle looms over the U.S. economy: Friday’s jobs report tells us that the unemployment rate has fallen to 6.7% from a peak of 10% at the height of the Great Recession. But at the same time, only 63.2% of Americans 16 or older are participating in the labor force, which, while up a bit in March, is down substantially since 2000. As recently as the late 1990s, the U.S. was a nation in which employment, job creation and labor force participation went hand in hand. That is no longer the case,” wrote R. Glenn Hubbard, the dean of Columbia University Business School, on April 4 for Stanford University’s Hoover Institute.
In March, the unemployment rate — the fraction of the labor force that is without work — held steady at 6.7 percent. However, while that figure has steadily declined over the last few months from the 7.5 percent rate recorded in March of last year, it hides a great number of the labor market’s problems. “When the recession began, 66 percent of the working-age population was part of the labor force. Participation dropped, as it normally does in a recession, but then kept dropping in the recovery,” explained Federal Reserve Chair Janet Yellen in a late March speech. “It now stands at 63 percent, the same level as in 1978, when a much smaller share of women were in the workforce. Lower participation could mean that the 6.7 percent unemployment rate is overstating the progress in the labor market.” To be exact, in March, the labor force participation rate stood at 63.2 percent, while the employment to population ratio was 58.9 percent.
Hubbard pointed out several reasons why the labor force participation rate — the share of working-age Americans who were employed or looking for work — is at nearly a record low. If the problem is cyclical, then as economic growth accelerates, workers will return to the labor force as they have in past recoveries. However, if low labor force participation is a function of deeper structural problems within the U.S. economy that must be fixed before the employment situation improves noticeably. Currently, economists are debating whether job growth is about to accelerate.
In Hubbard’s opinion, the reason the labor market recovery has progressed so slowly can be explained as the result of both cyclical and structural problems. On the one hand, the Great Recession is the source of current unemployment problems, meaning workers should rejoin the labor force as the economy improves. Yet, structural changes are also at work, he noted. The U.S. population is aging, and about one-quarter of the decline in the labor force participation rate is due to retirements. But equally important is the discouragement of job seekers, poor work incentives created by government policies, the growth of federal disability programs, and the inadequacies of schooling and training. Plus, globalization and technological advancements have severely curtailed employment and wage growth for low-skill workers.
If slow employment growth has been caused by structural problems, economists must examine whether the Obama’s administration’s activist policies and the Federal Reserve’s “extraordinary” easy money policies were the right approach to address the unemployment crisis. Hubbard argued that the Obama administration’s “targeted, timely and temporary” stimulus package “appears to have been a poor match for the severity of the downturn and the magnitude of the required boost.” Rather than a temporary infrastructure program for what he described as “shovel-ready” projects, the administration should have developed a sustained infrastructure program. What is unclear is whether the stimulus failed to put more Americans back to work because the policies were poorly executed or because they simply did not go far enough to raise aggregate demand for labor. Still, a better designed fiscal policy would have “made more headway in encouraging growth,” he wrote. Of course, the deeper issues keeping the labor force participation also played a role.
Yellen has strongly defended why she believes the Fed’s continued use of “extraordinary” easy money policies as necessary to combat the lingering malaise in the labor market. “The most important thing we do is to use monetary policy to promote a stronger economy,” she said at the late March conference. Yellen then proceeded to explain why she believes “there is still considerable slack in the labor market” and therefore why she thinks “there is room for continued help from the Fed for workers,” citing the high number of underemployed Americans, the meager increases to wages, the extraordinarily large share of the unemployed who have been out of work for six months or more, and the record-low levels of labor force participation.
If the labor force participation rate is low because of cyclical factors, like typical recession-era downturn in business activity, then keeping interest rates low has been a smart policy, according to Hubbard. Research by the Federal Reserve Board also suggests as much. But by comparison, “If the real problem lies in the rules of the game — that is, structural factors accounting for labor force participation,” then easy money policies will spark inflation but not improve the employment situation.
“As I see it, the policy response to our disturbing doldrums in the labor market has indeed struck the wrong balance,” wrote Hubbard. “Whatever can be said for shorter-term measures to jump-start job creation and business activity, it seems clear by this late date that our problems are in no small part structural. What we need most urgently is to rethink the federal government’s wider role in the labor market. The importance of structural problems doesn’t imply that policy can play no role beyond conventional fiscal or monetary policy.”
Washington is currently discussing several issues that will change the labor market; both an increase to the minimum wage and the extension of unemployment insurance have been hotly debated in recent weeks. But Hubbard believes that neither of those issues will address the larger employment problems at work in any meaningful way.
Hubbard had several suggestions. First, he argued the disability insurance program — which is part of Social Security — must be reformed. Since qualifications were eased in the 1980s, making it easier to receive federal benefits, the reported number of working individuals with disabilities has dropped by half. “For some, disability insurance has become an incentive to give up on work—but it doesn’t have to be this way,” he wrote. Instead, tax advantages should be given to employers of disabled workers so that they can be retrained. As has been argued by the Republican party, Hubbard also believes that the Affordable Care Act has created a disincentive to work because federal subsidies become smaller the more a person earns. His argument assumes that an individual will choose to supply less labor in order to retain subsidized health insurance. To reduce this particular problem, he suggested that a broader tax reform that gives a more uniform subsidy for health insurance be implemented.
Also in need of reform is unemployment insurance, Hubbard stated. Extensions of unemployment benefits do provide income support to jobless workers longer, but they also lengthen periods of joblessness, he argued, which potentially make “workers less attractive to employers going forward.” Instead, he sees “a policy pivot toward easing the return to work” as better option. Under this proposal, unemployment benefits would be supplemented with grants to states that would support retraining out-of-work Americans through community colleges and vocational schools.
Lastly, Hubbard proposed that given the demographics of the current workforce, the payroll tax on older workers, who delay retirement, should be eliminated. That tax is a strong incentive to stop working early, he claimed.
In conclusion, Hubbard acknowledged that these changes would not be easy to enact; Democratic lawmakers would be forced to admit the Obama administration’s stimulus plan to increase employment had failed, while congressional Republicans would have to agree to changes in federal labor policies rather than solely push for greater economic growth. The GOP “will need to face up to the need for a more opportunity-oriented agenda for work, as Rep. Paul Ryan and Sen. Marco Rubio have argued, rather than simply opposing the extension of unemployment insurance or raising the minimum wage,” he stated.
“John Maynard Keynes once famously declared his fear that, at some point, much of humankind would have to cope with the problems of abundant leisure and little work. Perhaps. But we can no longer sit back and watch as growing numbers of Americans — not just the wealthy or the elderly — exit the labor force. This trend spells trouble for the nation’s economic and fiscal future,” concluded Hubbard. “It is a bigger and less understood problem than we think, and it requires bolder policy action than we have contemplated so far.”
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